Have big asset managers strangled innovation in our industry? In late November, Graham Steele of the Stanford Business School wrote a paper demonstrating the monolithic dominance of the three largest asset managers—BlackRock, Vanguard, and State Street—who together controlled more than 80% of all investor money during the last decade. The same three firms manage between 73% and 80% of all exchange-traded funds.
Steele argued that the big players have established a monopoly position that stifles innovation and that they ought to be broken up. Yet these three firms provide a real value to the market, offering the low-cost, scalable passive products that have become the backbone of global asset management. Their rise has come at a time when asset managers have largely abdicated their role in portfolio management, leaving financial advisors to make both asset allocation decisions (as they always have) and investment choices, largely by selecting passive managers.
However, these same advisors are actively looking for niche investment strategies that meet their clients’ needs, and asset managers, by and large, are not providing them. The solution is not to break up the one element of asset management that’s working, but rather to expand the availability of value-added niche products that advisors need and will allocate. For instance, here are three product categories that have immediate appeal to advisors and their clients. They’re all in very short supply at the moment.
Investing in Innovation
2020’s best performing companies are innovators—whether they’re developing technology to enable work from home or seeking vaccines that will end the COVID-19 crisis. Through the first three quarters of 2020, for instance, information technology stocks have outperformed all other sectors, up 29%, while more hidebound sectors like energy slipped 48% and financials were down 20%. But this is not an entirely recent phenomenon. A research paper from Duke’s Fuqua School of Business in 2007 found that total market returns to what it defined as “innovation projects” were 13 times higher than average returns. Yet to date there are very few strategies focusing specifically on innovation.
One exception is ARK Invest, a boutique asset manager whose entire investment process is designed to capture the rewards of disruptive innovation, whether in robotics and autonomous technology, genomics, cryptocurrency, or other sectors of the economy. ARK's portfolios continued to attract assets even during the worst months of the COVID-19 pandemic. In March 2020, their ETFs had net inflows of $511.4 million for the month, including $408 million in net cash flows for the firm’s flagship ARK Innovation ETF. Full disclosure, I own all of them.
Investing for Yield
With interest rates close to zero, investors are on a hunt for yield, and in many cases taking on more risk than they can withstand to obtain it. Retirees are switching to high yield bonds for an income bump that hardly makes a difference and exposes them to significant default risk. Asset management firms that can offer consistent, above-market yield without such an increase in credit risk—via real estate and targeted REIT investments, preferred shares, direct loans and absolute return strategies—all of which aare in high demand.
Mass Niche Strategies Like ESG
Demand for sustainable and socially responsible strategies continues to grow, even during the pandemic. Morningstar reported that $20.9 billion flowed into these funds during the first half of 2020, at nearly double the pace for 2019. Institutional investors have led the way into ESG, but advisors and individual investors are now looking for these types of strategies as well.
ESG is also evolving from pure negative screening into a more nuanced and activist discipline, where managers may engage with companies in nearly any industry to reward and incentivize progress. The most innovative ESG managers are attracting assets fast—and those who aren’t offering these capabilities may well be left behind.
If You Build It, Make Sure They Come
All of this goes to show that even if the big three have locked up basic indexed investing, there are still plenty of opportunities for boutique and mid-sized asset managers. They can start by developing the niche strategies most in demand from advisors and their clients. However, they can’t stop there. Simply having an attractive product will only get you so far.
Instead, asset managers need to be just as innovative about marketing their investment strategies as they are about developing them. They need new digital tools to find the appropriate, most receptive audiences for their products (read a data-driven approach), to reach them with targeted messaging, to qualify them and to close the sale. The evolving marketplace favors the bold, the innovative, and the digitally adept. You can’t beat the mega-firms on price, or at the mass, passively managed end of the market, but you can succeed in the specialized market segments that they ignore.
Andrew Corn is the CEO of E5A Integrated Marketing, a systematic, data-driven investor-acquisition-focused agency that assists firms with raising assets or capital. Previously he was the CIO for E5A Funds, a firm specializing in alternative investments and after-tax alpha strategies.