In a 1958 interview with CBS radio, Stanley Kubrick said the following about the impact of television on Hollywood:
“I think that despite the unhappy financial upheaval it has caused in the movie industry, it has also provided a very invigorating and stimulating challenge, which has made it necessary for films to be made with more sincerity and more daring”
Advances in technology and society have always created upheaval in established industries and, like the entertainment industry in the 1950s, investment management is going through its own phase of profound change.
These developments are undoubtedly good for end investors. Innovation has meant that investment managers are able to work at lower cost, and more importantly, competition has put pressure to lower fees and improve service. In September the Morningstar Global Investor Experience Study showed that fund fees continue to trend downward.
To survive, many established active investors will need to do more than reduce costs; product innovation will be key. Fortunately, just like the entertainment industry, the history of the investment is one of constant innovation, and the lessons from that history will be critical in adapting to the new environment.
The ghost of active management past: the democratisation of investment
Before being challenged by television, film had been one of the main outlets for entertainment to be brought to a mass audience.
In the same way, the first mutual funds were created to offer ordinary households easy exposure to a broad basket of investments. Ian Fairbairn at M&G played an important role in launching the UK’s first unit trust with this aim in 1931, and David Hopkinson (who died last month) did much to make investment products more accessible to the UK population.
Prior to this, only very wealthy investors could have owned such diversified baskets, and genuine indexed funds were still some way off. It was not until 1976 that the first index fund would be launched in the US.
However, competitive pressures within the active management industry meant that even before index funds become available, it was clear that simply providing a diversified exposure was not enough. Competitive forces were already putting the emphasis on return
A variety of approaches were tried, and those which failed to deliver fell by the wayside. Others identified repeatable strategies for success, some of the most powerful of which could often be implemented relatively mechanistically and would come to be defined as factors.
The ghost of active management present: the founder of the feast
We are now at the point, several decades later, where technological advance and academic work is manifesting itself in the widespread adoption of passive products available to ordinary investors, in the form of ETFs and smart beta.
Last quarter in the US, assets under management in US passive products overtook those in active for the first time. Global data from Bloomberg illustrate the persistence of the shift of investor flows over recent years:
In fixed income, despite somewhat greater challenges in creating passive products, there is a similar trend over the last five years:
The very index and factor exposures that were developed out of the innovations of the active industry and now forcing that industry to evolve once again.
The ghost of active management yet to come: death, or rebirth?
How will active management respond to this pressure? In response to the threat from cheap and accessible television in the 1950s, Hollywood tried many avenues to innovate and compete: Cinerama, 3-D, ‘Smell-O-Vision,’ and importantly the use of colour. This journey saw both huge successes and crushing failures, and led to the death of the studio system. However, it was ultimately not the end of filmmaking, but a rebirth.
To complete Kubrick’s quote from the start of this post:
“If Hollywood lacks the colour and excitement of its early days – with Rolls-Royces and leopard-skin seat covers – I think on the other hand it provides the most exciting and stimulating atmosphere of opportunity and possibilities…”
Active asset managers too are having to provide something different, and this innovation is exciting. The rise of ‘ESG’ investing is part of this, as is the development of new asset classes and product structures. Perhaps most importantly, it is driving the rise of ‘solution-led’ investing, whereby outcomes can be tailored to specific client needs. We should also see other new forms of investment emerge in future that we are not even aware of today.
The active management industry will once again emerge from this upheaval looking profoundly different. Those managers that are able to survive this change will be those that are able lead it, rather than those seeking to rest on established positions.