Outcomes making fund management a hard-knock life

If there were a word cloud generated from the on-stage panels at the Investment Company Institute’s annual meeting last week, the word “outcome” would stand in stark relief. Money managers employed the term to refer to the idea that investors are looking for fund managers to deliver more than just great performance.
Robert M. Keith, head of the global client group at AllianceBernstein, who moderated a panel at the event in Washington, said he counted the phrase 15 times during just one of the conference’s sessions. Then his panelists talked about it even more, taking skeptical questions from the audience about the idea that investors are really concerned about more than returns.
But Colin Moore, global chief investment officer at Columbia Management Investment Advisers, says clients’ needs since the 2008 financial crisis are truly different. His company, the 11th largest U.S. mutual fund firm, is trying to reverse a trend of outflows in five of the past six years. On the sidelines of the conference, Mr. Moore told InvestmentNews that portfolio managers are being challenged to deliver more customization, alternative investments and practice management — and says great-performing funds are no longer enough.
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InvestmentNews: You’ve said that advisers are doing more complex financial planning but fund managers are stuck selling product. Explain the disconnect you see.
Mr. Moore: Advisers are engaging more and more in full life cycle planning, not just with individuals, but with their families. That sets up a broader liability profile: kids going to college, retirement, health care planning. It’s quite a detailed and sophisticated plan that comes out of all of that.
So say you’re that adviser. A wholesaler approaches you and says, Do you know that our growth fund has become five star? Do you want to buy it?
That statement doesn’t, in any way, correlate to what the adviser is trying to look for, which is a balance of investments that helps get through that cash-flow liability profile. Individual product selling doesn’t tie into broader solutions.
An institutional plan run by one of the large states fired a fund manager because he just tried to get the highest return possible. Increasingly, what people are looking for is a reasonable return but with a controlled level of volatility around that because if you have to make a big cash withdrawal and that happens to coincide with a market setback, you just can’t afford that. You can’t recover from that so easily.
So the industry needs to change and think about what it is that’s in our palette that might help the adviser as opposed to pushing whatever our chosen focus list of products is at them.
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InvestmentNews: Is the industry struggling with the balance of customization of investment solutions with the ability to operate a fund management business at scale?
Mr. Moore: Once you get a thousand levels of variation, the cost of delivering a completely unique solution to each person is just too high, not just the cost of putting the investment teams together to do it, but all the reporting, etc., that goes with it.
Therefore, what happens is 10 to15 years ago you tended to get two or three solutions that were touted as being customized and now the evolution of that became the target date funds where you maybe had 10 variations — every five years you have a different solution. But it still implies that for people retiring in 2035, we all have exactly the same profile, which is patently wrong. But it’s better than what we had because it’s a little closer to being customized, but it’s not enough.
What has changed over 15 years or so is the understanding and the technology of how investing works. The technology is critical.
The reporting on a true multiasset-class portfolio is extremely complex, so technology is a big advance and the development or the risk analytics that go with that. It’s the sophistication of the database that holds all the information and then the tools that you build to show how you do the analysis of that. Without those, you can’t customize.
Ten to 15 years ago, we were on the one-yard line, we’ve maybe got toward the 40 to 50 yard line. We’ve gone from no customization to a reasonable number of opportunities now, but we’re still nowhere near true customized solutions, at least for the individual. You can do it for a large institution, but you can’t do it for the individual.
InvestmentNews: Are you seeing evidence that advisers are judging managers on more than returns?
Mr. Moore: The level of service is becoming increasingly important. And I don’t mean ‘I took you out to lunch and we had a jolly good time.’ Advisers want to see that you understand their practice and where they’re trying to take that practice and what are the needs of that practice. Then they’re asking, ‘How did you come back to me with whatever you’ve got to help that happen?’ That’s a very different thing than you just happen to be the five-star large cap growth fund.
So I would say increasingly they’re beginning to think of performance within parameters coupled with the risk profile and then there’s the service level, which is how did you help me grow my practice or retain my clients by getting to understand what we’re doing. Again, I’m not talking about taking them out and buying them a few beers.
InvestmentNews: So wholesalers are getting a more technical skill set and portfolio managers are getting a softer skill set?
Mr. Moore: Both are true. We definitely need the technical expertise of the people selling our products because you’re moving away from companies with lists where you get to know six or seven products really well and you can go out and tell the same story all the time. I call that the Henry Ford selling method: you can have any color you want, as long as it’s black.
People who sell funds have to understand practice management and customized portfolios – how to twirl a Rubik’s Cube to the perfect pattern – which might look different for each investor. How do you do that? I don’t even call those soft skills. Some of them are highly technical. But I still think they are deficient in the marketplace.
InvestmentNews: With the shift toward more benchmarks beyond returns, how does that change the fund manager’s job?
Mr. Moore: It’s increased the complexity quite a lot. If you were structuring a portfolio in the past, you simply aimed it at beating some particular benchmark. It’s fairly easy to measure where you’ve taken those bets. Now, because of the multidimensional nature of portfolio construction, you might be putting a product in where you don’t expect a high return, but because it actually significantly reduces volatility.
A good example at the moment is managed futures. Everyone’s now saying managed futures are dead because they haven’t performed very well for a while, but they’re actually in there partly because they don’t perform well when the market goes up. They only perform well when the market comes down. So you’re seeing these insurance techniques coming in more and more, where you build in this hedging into your portfolio construction.
It’s easy for someone like me to say, but that’s actually a very technical role for the portfolio manager to perform. And then imagine you’re the provider of the solution. So each cube with in the Rubik’s Cube needs to be managed to a certain promised volatility and correlation, and then how do you bring that together into this really big matrix of analyzing how that total cube will act. Not just the individual pieces but how the whole Rubik’s Cube will look. It’s driving a huge amount of tech spend on risk and attribution analysis.