Future Asset Management

By Hendrik Schwarz, CMT, CAIA

Financial industry trends are transparency, diversity of funding, deposit taking,

greater supervision and regulation leading to higher barriers to entry and
probably fewer larger institutions. As baby boomers age, balance between
accumulation and preservation shifts. The current market environment extends
the length of the selling cycle (the cycle through which a potential investor moves
from prospect to investor). The willingness to rationalize product will allow
Economies of Scale in marketing and operations. For asset mangers, the only
hope and the only sustainable advantage is an enhanced value proposition by
aligning clients and firms’ interest. The asset management industry faces an era
where massive debt is being extinguished. This is not a great time in history to be
a saver. How does the asset management industry address that?

How do consumer and car companies handle marketing, distribution, product and
operational set-up?

VW’s platform strategy must be a role model on many levels:

A) Business

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 - Move away from the old integrated business model of doing every thing in-
house, to the new business model of focusing on the most value-adding
processes.
- Outsource a variety of services that go well beyond custody and settlement
and make effective use of prime brokers, administrators, auditors and other
service providers.

B) Product
- Similar products have to be approved centrally.
- Beneath different products should be identical back office and computer
systems.

The mutual fund industry is a marketing industry. Procter&Gamble as the biggest

global advertising spender is well known for its contrarian ad spending habit allowing
P&G to maintain its market leader position in addition to win market share from
competitors. This is the time for taking this as a unique opportunity to be in front of
clients as others retreat behind near-term cost controls.

Brand image is (almost) everything…

Our financial system is based on trust. Trust, however, is an emotional issue and the
marketing strategy must take this basic fact into consideration. Is the DWS brand
strong enough compared to the longevity and familiarity of the DB brand?

Offer products clients actually need (not what we have) and focus on product’s
quality. When you would offer those, how would you differentiate yourself from your
competitors?

…with a clear emphasis on empathy than strategy

Funds that are activist and are working to improve the value for all shareholders
through their work and investment in companies represent a big opportunity for long-
term value creation for the firm and its marketing. Focus on governance of companies
will become better understood as a way of adding significant value to client portfolios
in addition to leading public opinion in the companies’ strategy, which would reflect
the firm’s relationship to the world and how it is viewed by others. Investors would
feel empowered and feel like it's their right to participate in and effect change. This
could potentially address the challenge that younger investors accumulate much
differently than Baby Boomers.

Incentives need a clear alignment between managers and clients

Rather then start the race to the bottom by reducing fees, lead the industry
remodelling its fees, e.g. performance fees should be paid on a three-year view of
overall performance of underlying fund, or follow the Private Equity fee model by
only generating performance fees in the de-investment phase, and certain funds may
choose to trade for a lower management fee for more secure capital (“sticky assets” in
return for an increased lock up period of invested clients’ funds). Finally all investors
are happiest investing when they know the manager has a sizable stake in the fund
alongside their own. Through the implementation of all of the above the firm would

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become a leading example for the industry. Furthermore it would convince the
regulator rather than react out of the defensive.

Act ahead of the regulator

Regulators are struggling with identifying better solutions in order to address financial
markets issues. The opportunity for the investment business is to do more to help
government and regulators better understand the important role that they perform in
allocating capital within the economy and help shaping laws and regulations. Asset
management should introduce their own “special independent audit”, communicating
proactively a new best practice approach to the market and their clients. The new
audit format would be imaginable, say every three years, in addition to the annual
audits. This special audit would focus on risk, illiquid position valuation, tier ratios,
etc..

Seeking Alpha = Sound operations

Operational issues have had lower priorities in the recent past. What is being done to
improve operational excellence in the back office to mitigate various risks that worry
clients? What is done to fully realize UCITS III full potential of sophisticated risk
controls?

Add fresh blood

Bringing in some people who are experienced in, and confident about, using options
and futures, managing unconstrained mandates and looking across the capital
structure could energise investment teams who have found it hard to navigate the last
year without access and knowledge to hedging tools. There is also potential for
mainstream managers setting up some kind of white labelling agreements with
existing hedge fund mangers. Note only mainstream asset managers who can offer
relatively modern infrastructures and a progressive approach to business are well
placed to “in source” significant talent from the hedge fund industry.

Distribution is the new Asset Management

Complex advisory solutions are increasingly left in the hands of distributors. Retain
more of the economics of the relationship by cutting out the middle man and move
closer to the centre of individuals' long-term financial planning needs. There are five
major needs of consumers:

- savings,
- mortgages,
- brokerage,
- consumer credit and
- current accounts.

10-20 products across the five major consumers needs are sufficient to satisfy clients
and for a sustainable business. What are these products?

Treat your clients as you would treat yourself

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There is demand for absolute return strategies, combined with an element of principal
protection. For example, a focus on stable income generation in a tax-effective
manner that meets the individual investor's varied needs or an improved (vs. regular
insurance company product) annuity program. There is, however, a contradiction
between the demands for simplicity while simultaneously asking for downside risk
management.

Balanced funds with a holistic approach are one answer to client needs

Balanced funds are an easy to understand ‘All-in-one’ product which clients have
demanding for some time (see charts). Balanced funds are simple and therefore easy
to market. They offer many advantages such as they steer against the human pro-
cyclical behaviour of retail clients decreasing their equity allocation when equity
volatility increases. They can help to shift assets out of fixed income and money
market funds where the revenues are less. And finally balanced fund’s performance is
less volatile compared to equity funds.

Source: Merril Lynch

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 200

150

100

50

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Aktienfonds Rentenfonds Geldmarktfonds Gemischte Fonds wertgesicherte Fonds Dachfonds

Source: BVI

The ultimate mandate

Emphasise on tailor-made products offers two routes:

- Create building blocks for an individual asset allocation construction kit.

- Utilise the Riester-engine for made-to-measure balanced funds.

Who will be left to distribute?

The internet has been affecting consumer behaviour in material ways. Many industries
such as entertainment or consumer electronic goods struggle with distribution. Will
increased regulation and public criticism lead to a paradigm shift of the financial
distribution model? Is this the end of open architecture? Direct retail access facilitated
by Non Bank Institutions selling financial products to retail customers is a big
opportunity.

Question Investment Banks

Investors learned that the short-term-transaction-orientated investment banking

culture sits ill with their long-term goals. There could well be a realisation that,
investment banking products and services needs to be filtered through long-term-
orientated asset managers with sophisticated risk-management and analytical skills.

Hunt on tax heavens could change European private banking market …

A special off-shore product focus along special marketing efforts may not warranted
going forward. At the same time “soft tax optimised” products (using long lock-ups to
acquire favourable tax treatment and simultaneously “sticky” assets) could lead to
repatriation of funds back to onshore markets.

Beta is the next bubble to pop

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Increasing regulation of investment managers and their processes is driving everyone
towards a consensus and benchmark-driven portfolio which can lead to poor
outcomes which would penalise the ultimate savers. Beta won’t outperform equity
indices going forward when active management would become a minority.

There is always a bull market…

The financial bear market is giving way to a powerful new bull market in politics and
for the first time in many years, US domestic politics will become a central concern
for investors around the world. The background assumptions of the past three decades
- that there will be no major changes in trade, immigration, and tax policy - have
become unreliable. Where does global trade/finance go, in a post-US-consumer
world?

The capitalist model is fundamentally questioned, e.g. including whether capitalism’s

emphasis on economic growth ultimately threatened the planet. Is this sort of
viewpoint becoming the mainstream? What will be the way to measure investment
success when people are against economic growth?