Defining Active Management for the future
3 February 2020
Mel Bucher, Co-head of Global Distribution, on why active management has to evolve.
A Clear Value Proposition
Active management has experienced enormous disruption in the last five years. The rise of cheaper, passive, alternatives with lower risk and more certain outcomes has provided significant competition for funds. The debate that active managers have had with clients though, has often been ill-thought through, petty and still revolving around the dream that all active managers sell, after fees, alpha. Yet, for those with a long-term investment horizon, active managers offer beliefs, services, and relationships that can build genuine long-term partnerships that our passive competitors can’t compete against.
As with any services industry, the overall package that the end customers demand needs to evolve. As I write this article from the cabin of one of the more basic US airlines, I am reminded why I always prefer to fly with those airlines that offer me more than just a seat and altitude!
Those that offer a clear value proposition and that engage with their customers have emerged as preferred carriers. Indeed, the airline industry has experienced much of the same disruption as our own in the last two decades, with the successful players adapting to survive and, in some cases, thrive. As such, learning from other industries can be a particularly helpful exercise for active managers.
Learning to Evolve
In the era preceding smart beta and factor investing, the debate was a simple one: alpha. Active management generated alpha and index trackers could not. Yet quantitative management has pulled the legs right out from under this argument – excess returns are achievable with lower levels of risk and lower fees. Passive, active, quantitative, smart beta – call them what you want – have all collided to deliver a crescendo of change for our industry. The long-term winners will be asset managers that recognise this fact, learn from how other industries have evolved and adapt their offering.
Our clients’ values change and evolve – as in any industry. Understanding those values and learning how to partner with clients to deliver a better customer experience is how active management can differentiate itself from the poorly defined offerings of today’s investment industry. For instance, how an active manager considers and engages on climate change is as much a consideration for some asset owners as how they research securities.
To begin with, the active industry must align its offering with the very long-term interests of those that it serves and not its employees or shareholders. Innovating on fees is a sensible starting point. Rewarding clients for long-term behaviour with time-weighted fee structures provides a source of differentiation and alignment. Performance fees which share excess returns over the passive style alternative ensures clients pay for true long-term alpha.
Finally, ‘lock-up arrangements’ where clients pay a low base for retained capital also helps ensure alignment. Rather than arguing to defend their current ad valorem fees, active managers should be more innovative in how they structure fees for clients. Offering fee structures that work for both clients and managers with risk more equitably shared, is the definition of a more partnership-based relationship.
Our clients’ values change and evolve – as in any industry.
Stewardship a differentiator
A second key differentiator is stewardship. Our role as stewards of our clients’ capital with the attendant ability to invest, engage and influence on their behalf for the benefit of society and mankind carries a heavy responsibility.
As long-term investors we accept this readily. We not only aim to understand the impact that investee companies have on their key stakeholders and the world in which they operate, but engage with and influence them to drive more responsible business practices. We invest to improve lives. As such, we must invest in partnership with our clients to understand and achieve this magnificent ambition. Active equity management must clearly articulate a purpose and effectively use its influence over the behaviour of corporate management to deliver this. If successful, impact investors – a solitary group at present – will soon find their world collides with thoughtful, traditional active managers.
How we report on the impact of the companies that we invest in and the impact of our engagement with management on ESG and long-term sustainability, can also shift the narrative forward for active managers. Conventional reporting needs to be disrupted. For too long active managers have reported positions in a conventional manner relative to an index, while the breadth of criteria that clients are interested in has expanded. For example, reporting on the carbon footprint of a client’s portfolio, business risk or cyclicality of a portfolio will all lead to a far more meaningful discussion with clients. The capture and use of fundamental data will enable these deeper insights and will lead the active industry to move forward.
What matters to many clients is whether we can report and illustrate to them clearly the contributions and exposures of their portfolio to issues such as climate change, job creation or resource use. This is a journey. In many cases, company disclosure is still lacking, but the UN Sustainable Development Goals (SDGs) have presented an opportunity to better articulate impact and provide a potential framework to do so. The goals also provide a framework for effective engagement with company management to understand the role that individual companies play in achieving these ambitious goals. Active managers should respond accordingly. Managing concentrated, long-term portfolios can clearly demonstrate to clients the impact their portfolio is having, but they need to illustrate this in a manner that is relevant to stakeholders.
Neither should the role of the active manager end with constructing portfolios and delivering alpha. Consultative relationships with clients delivering original thought leadership and advice of how to navigate the financial markets must become part of the fee we earn and our value.
Active management can provide greater insight, candour and advice on how, where and when clients should deploy their capital. Building partnerships requires trust and managers need to earn the moniker of ‘trusted adviser’. This will require an approach to business management that puts building long-term partnerships at the heart of the business and aligning incentives and activities with a client’s purpose and long-term investment objectives.
Active management can learn from other industries that have faced periods of disruption – by engaging, listening and innovating. Building long-term partnerships through a more complete value proposition is how active management will increase its value and move the debate away from what it isn’t about – which is price.
Active management can provide greater insight, candour and advice on how, where and when clients should deploy their capital.
This information is issued and approved by Martin Currie
Investment Management Limited (‘MCIM’). It does not
constitute investment advice.
Market and currency movements may cause the capital value
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