tjbresearch.com
Tuesday, December 6th, 2016
the investment ecosystem

I first wrote the phrase “the investment ecosystem” in one of these postings more than eight years ago.  It has appeared often since then and, when counting emails, presentations, and meetings, the total number of times I have used those words is well into the thousands.

In my consulting business, I work with a variety of investment organizations, including asset managers, institutional asset owners, investment advisory firms of various kinds, research organizations, consultants, etc.  By doing so, I get a multidimensional view of that ecosystem and of its evolution over time.

We are at an important stage of that evolution.

Over the past several decades, the investment industry has thrived.  Despite some significant hiccups along the way, the market environment has been relatively benign, with a secular trend of disinflation leading to the low interest rates and generally high equity valuations that we enjoy today.  Globalization, favorable demographic changes, the democratization of investing, the information revolution, and the adoption of modern financial theories and practices have all provided tailwinds for the markets and for those managing other people’s money.

Over time, we are conditioned to adapt to our environment.  Investors (professionals and amateurs alike) respond to what has worked in the past by adopting those successful strategies, and the longer something has worked the more entrenched it becomes.

Similarly, organizations acclimate themselves over time.  Action by action, they develop as they do because of the environment in which they operate.  A process of adaptation occurs.  The organizations are not “optimized” for the environment — that’s an unrealistic assumption for any collective activity of human beings — but they are conditioned by it and responsive to it.

That is to be expected, and it’s all well and good until the environment changes in dramatic ways, especially if it happens quickly.  Then it becomes clear who was prepared for that changing environment and who wasn’t.

It seems to me that the conditions are ripe for that to occur.  Throughout the investment ecosystem, the stresses and strains are increasing.  Expectations regarding achievable results for the ultimate owners of assets are generally out of whack with relatively low prospective returns.  Costs throughout the system are too high given the outcomes that are delivered.  Principle-agent problems abound; whether they will be addressed by regulatory actions or market forces remains to be seen, but they are unlikely to be ignored.

Consider asset management firms, arguably the central and most powerful players in the entire ecosystem.  The use of passive portfolios has been rising slowly for decades, but has accelerated markedly in the last few years.  Factor investing (most commonly referred to as “smart beta”) has also gotten quite popular.  Those methods of investing are direct threats to active managers, of whom there are more than enough in existence, generally earning very attractive margins while in most cases delivering mediocre results to clients.

There are some signs of change already, including price pressure in certain areas and evidence of an increased volatility in assets under management.  But, while asset management in general seems to be on a migratory path from a high-value-added service to a commodity one, there hasn’t yet been the degree of disruption that is likely based upon industry dynamics.

To dive into that realm in particular, I will soon release the first of several white papers focused on The Investment Ecosystem™.  It will deal specifically with the changing environment for fundamental active managers and will provide practical guidance for leaders of those organizations to prepare for and survive the challenges ahead.  (If you would like to receive that paper or future ones on other parts of the ecosystem, please sign up for notifications.The Investment Ecosystem™ | The email address will only be used to provide updates regarding The Investment Ecosystem™.  I am also offering consulting services and doing presentations on the topic.)

The years to come promise to be exciting ones.  But they will likely bring about a much different investment ecosystem.  Will you be ready?