Transparency might be seen as an industry reaction to the global financial crisis. But, whether borne out of regulation, competition or client demand, it will drive the most critical changes in investment management this year. It has, in fact, become a vital issue for our industry and will be for the next decade.Whether it’s about products or company culture, transparency is at or near the top of most clients’ priorities when they select investment managers. Private investors should welcome the coming shift in balance of power in their favour. The outcomes, from exposing complicated fee structures to enhancing the visibility of the underlying portfolio, will be to their benefit.The lack of transparency has given rise to some of the largest fraud cases and a slew of financial misdealings. Recent news coverage exposing the exuberant entry and exit fees charged by a number of UK wealth management companies highlight the importance of transparent operations and culture. One of the biggest investment frauds of the past decade, Bernie Madoff, could have been spotted sooner if investors and regulators had looked into what exactly was in the fund.Looking more closely might render the reality harder to swallow. Some clients might even be prompted to re-assess their current wealth manager relationships when they discover that the investment research team, who do the actual investment work, receives only 30 basis points from the 1.5% management fee. All while the remaining 1.2% goes to third-party salespeople who spend it on various excesses. Another example is the recently revealed 50bps premium that some UK wealth management clients are paying for third-party funds that they could access directly from the fund manager or on the platform for less than 1%.The industry’s fundamental problem lies in the broken chain of accountability. People making investment decisions are often disconnected from clients by layers of middlemen whose actions often go unchecked. Transparency in fees and performance reporting should end the abuse of less sophisticated retail investors and make the decision to “go passive” much easier.
Passively managed funds edged out active stock funds in US market share for the first time in August last year, reaching US$4.27 trillion in total assets (50.15%) as compared to US$4.24 trillion (49.85%), respectively, according to Bloomberg in September. In Europe, net flow into passive products (€95.3 billion, 51%) surpassed that of active funds (€90.7 billion, 49%) also for the first time, during 2019 through August (Refinitiv Lipper research). The passive fund industry on both sides of the Atlantic is thriving, because it allows clients to manage their money while cutting out the middlemen. Simply put, the fewer hands to pay in the supply chain, the lower the fees.The US mutual fund industry is expected to grow its AUM by 46% by 2025, while the revenues are expected to grow only by 10% to 15%, according to PwC (July 2019). Some firms will choose to pass lower fees to clients and accept lower revenues going forward; some will switch to a performance-based charging structure in hopes of making up more revenue; and some will do everything to mislead clients by masking their high charges. In fact, one of the most prominent asset management companies was recently fined almost US$2 million for charging “active fees” for passive products.The 1990s were the heyday of the hedge fund industry. Markets were more informationally inefficient than they are today, so having a talented team and some technology gave professional fund managers a pretty good chance of beating the market. Since the global financial crisis most active managers and hedge fund managers have underperformed their benchmarks and passive tracker funds. Without generating meaningful outperformance, the standard ‘2 and 20’ fee structure is no longer defensible.The longest bull market in recent history and fast technological advances have led to the decline of the traditional active fund industry. Thanks to the tech leap and proliferation of online options, most investors have direct access to low-cost, real-time channels to invest. This trend will also drive down active fees to almost passive levels, especially for mediocre active managers or third-party fund re-sellers. With more and more clients able to accurately assess and benchmark performance, there will be no place to hide for high fee products or below-market returns.
Since the global financial crisis, we have experienced a bull market in most publicly listed asset classes. Compared to the almost non-existent yield on most government and corporate bonds, it is not surprising that investors are becoming increasingly drawn to the alternatives sector.US$3.7 trillion needs to be invested in global infrastructure each year until 2035 to maintain current growth rates, according to a 2017 McKinsey report. The spending gap globally during that same period is estimated to be US$5.5 trillion.Most insurance companies and pension and sovereign wealth funds have vast amounts of capital available for liability-driven investment mandates, so many owners of infrastructure assets, including governments, have taken advantage of attractive valuations by putting assets up for sale. One of the most attractive features of infrastructure funds is economy-proof, inflation-protected cash flows.Of course, every project is different, and investors should always do their due diligence before committing any funds, especially when the underlying is relatively illiquid. Nevertheless, in a world starved of income-producing assets, infrastructure funds will continue to gain popularity.The renewables sector, especially solar power, experienced enormous growth over the last decade, close to 50% per annum, mainly due to its stable, RPI-linked income. Wind and solar’s combined share of energy generation is predicted to grow from 7% today to 48% by 2050, according to a June 2019 report by Bloomberg NEF.However, the big winner in the renewables sector will most likely be solar. As a source of electricity, it is much less volatile than wind, has a more stable infrastructure with few moving parts, and has the cost advantage over mechanically complex wind turbines.The global move to tackle climate change and, more importantly, the fall in renewable energy prices mean that the sector is now likely a long-term trend instead of the short-term fad many had initially thought.
Active ETFs are also gaining popularity; unlike some mutual funds, they have better transparency and allow intraday trading. Active ETFs and similar exchange-traded products now account for nearly US$110 billion, a small chunk of the over US$6 trillion global ETF/ETP market by November 2019, according to ETF/ETP research and consultancy firm ETFGI. Active ETFs are usually not tied to a traditional index but instead are based on actively managed strategy.Most active ETFs are rules-based or pure quant portfolios. One of the pioneering ideas in this space were so-called smart beta products. Smart beta strategies have been very successfully implemented and sold in ETF wrappers, attracting the most prominent passive players in the world, such as Vanguard and iShares, to enter the active ETF market. This resulted in competitive fees and broader choice for investors. With almost free access to online asset allocation tools and a menu of rules-based strategies, the role of traditional “wealth manager” will come under more pressure this year.