Column: Here Comes Customization…

From aiCIO Magazine's February Issue: The old world—where portfolio managers could scale, where client service was somehow less about intellect and more about bonhomie, where alpha was always just within reach—was a vastly preferable one for asset managers.

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It is a truism that we often fail to see what is in front of our eyes. As of this ­moment, the margins of institutional asset manage­ment are being impacted by new strategies and new thinking, and even the most stouthearted believers in long-only alpha cannot fail to have noticed the sands shifting ­beneath their feet. But, as we try to decipher what this all means, it seems to me that we’ve missed the most obvious and far-reaching implication of all. The fact is, all these disparate strategies—investment outsourcing, liability-driven investment (LDI), implemented consulting, risk transfer, custom target date funds, and personalized hedge funds of funds—have a single characteristic in common: customization.

What each and every one of them represents is a retreat from what has been the pre-eminent characteristic of the offerings that asset managers have brought to their institutional clients these last decades—scalability. That is the unwitting genius of the modern asset manager, whether managing a mutual fund or a separate account. Pick a portfolio of stocks or bonds, and scale it: A hedge fund manager with solid performance can break even at $500 million in assets, buy yachts at $5 billion, and a G5 at $10 billion. It takes little more to manage $20 billion than $5 billion. That simple math explains why so many people have made so much money running institutional portfolios.

Consider, if you will, LDI. On the face of it, it is just another cutting-edge fixed-income strategy. In fact, it is anything but, which is why the biggest bond firms and virtually everyone else have struggled so much with it. LDI, done properly, is intensely customized; It involves careful liability analysis and matching, which in turn demand analytics and client service at a level that most asset managers can’t countenance. LDI is hard—each client has its own fingerprints, and off-the-shelf solutions simply don’t apply.

As another example, take investment outsourcing or implemented consulting. There can be no more customized play. Each client requires enormous amounts of intellectual and practical energy—liabilities have to be understood, assets allocated, managers picked, and problems fixed. Not much of this is truly scalable. It is the business of the future, but it places a premium on good management, risk systems, and client service.

As for defined contribution portfolios, how vastly preferable it was from an asset management point of view to talk your clients into making a scalable mutual fund target-date fund their default option. The only problem with that was how the mutual fund target-date funds performed when the markets tanked. Today, the more sophisticated plan sponsors want their own highly customized target-date funds; this will be better for them and for their participants, but not as beneficial for the mutual fund complexes.

All of these trends are secular. The clients have changed. Asset managers, of course, have not. The old world—where portfolio managers could scale, where client service was somehow less about intellect and more about bonhomie, where alpha was always just within reach—was a vastly preferable one for asset managers. But it’s a world that is disappearing on us, although perhaps there is just enough left to lure the less nimble asset managers into thinking the game has still some way to run.

It has not. The truth is that world has now run its course. To thrive in this new world, asset managers are going to have to bring much more talent to the table, specifically client service skills. They are going to have to share analytics and intellectual capital with their clients in a way that few have done before. Off-the-shelf offerings will no longer cut it; Asset-owners need and want customization, and are going to seek out the asset managers who can give it to them. In short, we’re in a new world of customization. In it, asset-owners might finally be about to get their money’s worth out of their asset managers.

Charlie Ruffel—founder of aiCIO and Asset International’s other media brands—is a global authority on retirement, asset management, alternative investments, and securities services issues. He is now Managing Partner at Kudu Advisors, which provides M&A and strategic advisory services to institutional asset management and global asset servicing businesses.