Understanding trends in the investment management industry can be problematic if the question is framed in terms of 'old' managed funds versus 'new' robo-advice.
For starters, it gives the false impression that the only source of innovation resides outside the industry. Although the industry is known for being conservative, that doesn’t mean it is not evolving.
And given its enormous size, its evolution is having a much bigger impact on the state of investing than the alternatives we’ve seen recently, including robo-advice.
At the heart of investment management industry is the concept of the managed fund — a pool of money formed by participating investors and managed by the professional managers.
For decades it has been the way for people to invest collectively, while delegating investment decisions to someone having the relevant expertise.
This concept has served generations of investors well. In the 1980s, it was the only way of investing available to those who could not afford expensive stockbrokers.
Investors did not have to worry about researching, picking, or trading stocks.
Everything was done for them by the professionals. And though investors had no say in which investments were made on their behalf, they were uninterested, to be frank.
It was the only game in town until the arrival of separately managed accounts (SMAs) a decade later. How are they different from managed funds?
With managed funds, the investment manager oversees the pool of money, making decisions on how much to invest, and where.
With SMAs, each investor has their own portfolio and the investment manager oversees the virtual (or 'model') portfolio.
Rather than deciding how much to invest, he determines the allocation of funds across several stocks. These allocations are then applied to each investor’s portfolio.
Transparency and direct ownership are often cited as the main advantages of SMAs. What is often overlooked, however, is that SMAs broke down the monolithic nature of managed funds by decoupling investment expertise from investment administration.
It is hard to overestimate the significance of this change. In comparison, it is similar to the shift from the old telecom monopolies to a variety of mobile networks, allowing customers to easily switch from one network to another.
Collective investing remained pre-eminent, but investors now had many more choices — they could easily switch from one provider of investment expertise to another.
SMAs brought to life new types of businesses: those who specialise purely on managing model portfolios and those who specialise on administration of investor portfolios.
I believe that the potential of SMAs is yet to be fully realised. Why bother thinking about new possibilities? Nokia’s executives thought along similar lines and missed the boat with the emergence of smartphones.
The current stage in the evolution of collective investing, defined by SMAs, is an important step forward, but the current arrangement does have its limitations.
Although investors may have many model portfolios to choose from, they are restricted by the choices offered by their investment administration provider who invests on their behalf.
The investment industry has evolved from investment managers investing on behalf of investors (managed funds), to investment managers telling someone else how to invest on behalf of investors (SMAs).
Perhaps the time has arrived for investment managers to tell investors what to do, directly, with no intermediaries?
I believe that providing direct access by the public to model portfolios, in combination with do-it-yourself investing, will be the next evolutionary step in the investment industry.
Eugene Kaganovitch is the co-founder and director of Synchronised Investments.
