planning for 2018: some observations - … · planning for 2018: some observations ... are the...
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PLANNINGFOR2018:
SOMEOBSERVATIONS
ABSTRACTInthesetransformativetimesfortheinvestmentmanagementindustry,whatarethemega-trends?Ifocusononesuchacceleratingdevelopment:theincreasinguseofassetallocation‘solutions’amongwealthmanagersandmutualfunddistributors.Thisimpacts:actively-managedfunddemandandretention;liquiditymanagement;newproductinnovation;shareclasspricingconsiderations;firmprofitability;andmore.AviNachmany
LookingBack,LookingAhead:
U.S.MutualFundIndustryKeyDevelopments,December2017
Thispastyearwasanimportantperiodforthetransformativechangeswithintheinvestmentmanagementindustry.Wehavewitnessedextraordinarystockmarketappreciationacrosstheglobe,triggeringrisingflowsintoinvestmentfundsvehicles(mutualfunds,ETFs,UCITs,etc.)nearing$2trillionworldwide.AfewyearsagoIforecastedthattheglobalmutualfundindustryAUMsmayreach$100trillionby2030,butrecentacceleratedgrowthsuggeststhismilestonemaybeeclipsedearlier.Yet,investmentmanagers’participationintheindustry’sorganicgrowthremainshighlyconcentrated,withveryhighportionofnetinflowscapturedbymanagersofpassivevehicles,aswellasbyasmallnumberofhigh-promiseactively-managedbondandequityfunds.AmplifiedintheU.S.,butevidencedelsewhere,themarchtowardslow-feepassivestrategiesishelpedbythegrowingemphasis--amongwealthmanagersanddistributionplatforms--onassetallocationsolutions(e.g.,wrappedfunds/ETFs,orstandalonefundswithbalancedstrategiesincludingtarget-datefunds).Indeed,such‘solutions’ nowaccountfor80-90%ofUSmutualfundpurchases(byinvestorsservedbyfinancialadvisors).As2017windsdown,andinyourplanningfor2018,Isharebelowanumberofobservations.
RisingBarofPerformanceExcellenceforActively-ManagedFunds
1. Toprovideawrappedassetallocationsolution,financialadvisorsincreasinglyarecombining(excellent)actively-managedfundstogetherwith(cap-weighted)indexfundsandETFs,‘smartbeta’funds,andmore(‘smartbeta’ETFs/funds2017USnetinflowsexceeded$30billionandcouldgrowsignificantlyin2018)
2. Morefinancialadvisors(FAs)arebecomingproductagnosticandconsideractively-managedfundsonlyiftheyofferhighestpast-performanceranking–suchastopdecile/quintiletrailingreturns(three-yearreturnsrelativetopeersremainsakeyscreen).Thedebateaboutthepredictivevalueoflookbackrankingcontinues(aninterestinginnovationisofferedinEuropebySharingAlpha.com)
3. Onceafundlosesitstopratings,FAsandfunds’selectorsarequicker(thanobservedhistorically)toremoveitfromtherecommended‘selectlist’–ortoredeemitifusedwithinexistingasset-allocation-basedportfolio(especiallyindiscretionaryaccounts)
LoweringTotalCostsInsidethe‘Wrapper’4. FAsandfundselectorsarefocusingonmutualfundshareclasseswiththelowesttotalcosts.
Low-feeshareclasses(noRule12b-1fees,somewithoutTAfees)accountforanincreasingshareofnewpurchases(over80%ofnewmutualfundsalesbyFAstodayareofsuchshareclasses).Inparallel,the‘race-to-zero’feesamongcoreETFsacceleratedin2017
5. ‘Fee-forservice’controlsthegreatmajorityofFAcompensationfrommutualfunds’salestoday(likelyover85%).Point-of-salescommissionsaccountforalowsingle-digitshareofnewsalesforthemajorityoffundmanagementcompanies.Suchproportionscontinuetodecline(thedatashowsthatinmutualfunddistribution,point-of-salescommissions–oneofthekeyrationalfortheDOLFiduciaryRule--arenearlyextincttoday)
6. DOLFiduciaryRule:thefutureoftheRuleisunclear.YetthepreparationstowardsRuleimplementationhaveinfluencedthefundindustryinwaysthatareirreversible(inparticulartheshiftstowardslowest-feesfundshareclasses).Thusthepathtowardsadoptionof‘clean’shareclassesislikelytocontinue.(Pondering:isitlikelytheSEC–incomingyears–movestointroduceprinciple-basedFiduciarystandards?Onceintroduced,thismaylowerregulatoryburdens,whosecostsarepaidultimatelybyinvestors)
7. Anticipatinga‘clean’shareclassfuture:who’llpayfordistribution-platformcosts?Ifno‘cost/revenue-sharing’mechanismexists,wouldinvestmentfirmspayforsuchoutoftheirprofits?Howlikelyisitthat(powerful,concentrated)distributionplatformsabsorbsuchsignificantcosts?Howanewcost-sharingequilibriumissetina‘managedarchitecture’
environmentwithsignificantlyshorterlistoffundmanagersincludedindistributors’preferredlists?Willinvestorsultimatelypayforsuchcostsdirectly,throughadditionalplatformfeesforfunds/ETFsadministeredonthisplatform?(Suchpaymentsbyinvestorsdonothavethecostbenefitsof‘mutualization,’orRule12b-1feetax-benefits…)
RebalancingOutofEquitiesExplainsHighDemandforBondFunds
8. Asglobalstockmarketsinchhigher,investorsandtheiradvisorsarerebalancing,replacingsomestockfundallocationswithbondfundallocations(thismayexplain2017largeinflowstobondfunds,whichcontinuedespiteexpectationsofa1%+increaseinUSinterestratewithinthenext12-18months…)
9. Otherimplicationsofspikingstockprices:lessinterestin‘alt’strategieswithlowerreturn/non-correlatedrisk(manysuchfundsexperiencedredemptionsin2017,andnumeroussub-scale‘alt’fundswereliquidated)
10. …Andagreaterinterestinlow-feeindexstrategieswhicharenot‘marketcap-weighted’(awayfromindexfundsbiasedbythemostexpensivestocks);suchfactor/’smartbeta’ETFs/fundsattractednear$30billioninflowsin2017
NewSalesvs.NetFlows:StockandBondFunds
11. Newsales(asopposedto‘netflows’):theshifttoassetallocationmindsetsbuffersthetendencyforstockmarketeuphoria.in2017,asinprioryears,ICI’sdatasuggeststhateachmonthabouttwo-thirdsofnewsalesofmutualfundscontinuetobedepositedintostockfunds(activeandpassive)whilethebalancewenttobondfunds(ICI’snewsalesdatadoesnotincludeETFs).(Redemptionsoutofsomefundsandintootherfundsaccountfromthemajorityofthesecirculatory‘newsales’)
Actively-ManagedFundsNewSales:StockandBondFunds
12. Activelymanagedfundscontinuetoaccountforthegreatmajorityofourindustry’snewsales(differentthannetflowswhichequalsalesminusredemptions).BasedonICI’sdata,in2016,activelymanagedfundsaccountedfor81%ofindustry’saggregatednewsales(ETFsarenotincludedinthisstatistics–clearlyaddingsuchwouldamplifytheshareofindexed,lowcoststrategies.)Ibelievethat2017salesproportionsofactively-managedfundswereonlymodestlylower.Arelativelysmallnumberofhigh-rankingfundsaccountedforthemajorityofactively-managedfunds’newsales
13. Thehighestshareofindustrynewsalesofactivefundswasexperiencedamongglobalequityfunds(over90%in2016,somewhatlowerin2017),followedbybondfunds(largecapequityfundsexperiencethelowestshareduetosubstitutionbycoreindexfunds/ETFswithinwrappedassetallocationsandelsewhere)
FundLaunches/Liquidations:Strategic‘InvestinginTheFuture’/TacticalCostManagement14. Theindustrywitnessesslowingintroductionsofnewactively-managedfunds,selective
introductionsofETFs(manyfactor-based),andfasterliquidationsofagingorsub-scaleyoungfunds.Iexpectsuchaccelerationoffundlinerationalization/fundclosurestocontinue,asfundmanagementcompanies(andtheirboardofdirectors)remainfocusedonfundlinereviewsforfurtherclosuresofsmall,expensive,andunder-performingfunds
KnownUnknown:Cybersecurity
15. Top-of-mindconcern:Whatisyourplanforthe‘what-if?’Clientcommunicationprotocols,regulatoryreportingandaudittrails;SEC’sdatasecurityandreportingobligations;andmore
‘A99%Solutionto1%Problem?’LiquidityRiskManagementRule
16. Assetallocationandliquiditymanagement:investorsowninganassetallocationsolutionobserveNAVchangesofthe‘entire’portfolio(notasinglefund’sNAVdecline)duringvolatiledays.Thustheyarelesslikelytoredeemdefensively(Iauthorednumerousstudiesonactualpatternsofredemptionsduringmarketstress;oneispostedonAviNachmany.com)
17. ThankfullytheSECjustextendedtheLiquidityRuleimplementationdeadline;thisextensionoffersamorerealistictimelineforsuccessful,well-testedimplementation(requiring:staging,includesvendor’sassessment;vendorselectionandboardapprovalsover2-3meetings;implementations[subjecttovendor’slongqueue…]withmanymonthsoftesting…).Arelatedconcern:iftheindustrybecomesdependentononedominantthird-partyvendorforliquidity-relateddata,securityconcentration-riskmayincrease(andliquiditydecreasesduringvolatileperiods)duetotheincreasinguniformityofclassificationsrelatedtoliquidity
18. Akeyfactoronliquidityriskmanagementandplanningis‘concentration-risk:’howdiverse,heterogeneousarefund’sshareholders(vs.higherconcentrationofAUMsbyafew,homogenousinstitutionalshareholdersorplatform‘selectors’,thuspotentiallymoreharmonizeddecisionstoredeem).Fundmanagersregularlymonitorpocketsofhigherconcentrations(especiallyindiscretionaryaccounts),andanticipate/plan(attimescollaborativelywiththeplatformadministrator)forthepossibilityofrapidliquidationsinsuchpositions.Somemanagersalreadysharesuch‘concentration’reports–andtheirliquiditymanagementcontingencies-withtheirfundboards
19. Lookingto2019,beyond:aprinciple-basedruletoguideliquidityriskmanagementispreferabletoaprescriptive-basedrule.CanthepostponementoftheSECRuleimplementationdateopenawindowforfurthermodificationsalongtheselines?(interestingly,Germany’ssecuritiesregulatorBaFinjustintroducedprincipled-basedguidelinesforliquiditystresstest).Inmyview,SECRuleis‘a99%solutiontoa1%problem.’Naturally,managementcompaniesrecognizethenecessityofplanningfortherareperiodsofextrememarketliquiditystress;doesRulecurrentprescriptionsofferareassuringpath?
Planningfor2025
• Planningforthenext5-10years:astheindustrymaturesandisgoingthroughtransformativechanges,moreboardsmaybeinterestedtolearnwhatistheinvestmentmanager’sstrategyforAUMgrowth,profitabilityandtalentretention,andrelatedstrategicissues,suchas:
• WhatdistributionandinvestmentopportunitiesexistbeyondtheUS?HowcantheinvestmentmanagerincreaseAUM(andretainitsprofitability)?Shoulditexpanditsinvestmentvehiclerange,ordistributionfootprints?Howwillitprotectitstalent’sdepthandrange?Howcanituseextraprofitsfromsurgingstockpricestore-investstrategically?
• Ourinauguralmutualfundresearchreport(1986)wastitled,‘MutualFunds:InvestingInTheFuture.”Thismottopersiststoday,asglobalwealthcreationexpandstotheemergingworld.Yetthechallengesofgrowth,inamaturingUSfundindustry,remainsignificant.
AboutAviNachmany(Readmore:AviNachmany.com)Ihavebeenanindependentconsultantoverthepasttwoyears,following30yearsofprovidingthoughtleadershiptothemutualfundindustryastheco-founderandresearchdirectorofStrategicInsight.Icontinuetoofferanindustryperspective(inconferences,educationaldiscussionswithfundboards,andelsewhere)intheareasofdistribution,pricing,andfeetrends;productevolution;compliance,andstrategy.I’mavailabletoexpandonthethemescoveredabove,ifrequested.
Iamalsolookingtojoinamutualfundboard,wheremyexperienceandknowledgeiscomplementarytothatofotherfundtrustees.(Myresume:HERE)SelectedresearchstudiesonAviNachmany.com:
1. APerspectiveonMutualFundShareClassDevelopments2. KeyForcesShapingtheU.S.MutualFundIndustry2017(PowerPointpresentation)3. LookingBack,LookingForward4. MutualFundsandSystemicRisk:TheReassuringLessonsofStabilityAmidPastPeriodsof
HighFinancialMarketsVolatility(submittedtotheSEC)
AviNachmany,NewYorkCity,December2017