The future of asset management

Changes in regulation, technological advances and an increasing focus on costs are reshaping the industry in Europe.

Traditional models of long-term saving are feeling the strain. Savers have to contend with rising life expectancy, increasing personal liability for funding retirement, and lower interest rate and return expectations compared with historical standards.
As a result, people have to move from being savers to being investors as they bear greater responsibility for securing their own financial futures. Our industry’s future success depends on how well we can service and support these individuals.

Beyond these demographic and macroeconomic shifts, there are also secular changes afoot in the industry that are beginning to dramatically influence how investors interact with asset managers.

As investors in Europe look ahead to what this new industry landscape might mean for them, one positive sign for the future is that many countries already have a solid savings culture to build on. For example, in some countries, such as Germany and Switzerland, a large part of the population are already strong savers. However, many of these savers are still not getting the best use of their money. The challenge is to help these savers transition to higher-return long-term investments, including low-cost index funds, that can better help them reach their future goals.

Regulatory forces and distribution models

A key catalyst for change in the industry is regulation. Investors tend to benefit the most in markets where the regulator is highly engaged with market participants and motivated to make reforms. One area where regulators have demonstrated particular power in driving change for investors’ benefit is in shaking up traditional distribution models.

The distribution commissions that are built into many products have grossly inflated the costs of investing. When new regulation eliminates the incentive for advisers to advocate higher-cost funds, investors are the winners. A number of supervisory bodies in Europe have already conducted reviews into commissions in order to improve investor outcomes. Some watchdogs, such as those in the UK and the Netherlands, have banned advisers from earning commissions. However, banning commissions outright is not necessarily the solution in every case, as positive change is also possible without the direct intervention of regulators. In the US, for example, there has been a large decline in commissions without an outright ban, as the interests of clients and their advisers have become more aligned.

We believe investors should have the right to choose how they want to pay for the services they get. The problem is that in many markets, they don’t know what they’re paying. Regulatory engagement that drives greater access and transparency around commissions can therefore be as constructive for investors as total commission bans. Once the cost of distribution is transparently separated from the cost of the asset management itself, the overall cost of investing goes down significantly.

This evolution of distribution models will ultimately lead to lower costs for investors.

Focus on costs – the only factor you can control

The impact of fees on long-term investment returns is increasingly a focus for European investors. After allowing for costs, the aggregate performance of investors is less than zero sum, and as costs increase, the performance deficit becomes larger. Consequently, many investors have embraced low-cost funds, both passive index funds and actively managed funds.

Index funds in particular have experienced huge growth over the past decade, thanks to the opportunities for lower-cost, more diversified portfolios they offer investors. Index fund assets under management in Europe have risen from around EUR 241 billion at the end of 2008 to more than EUR 1.34 trillion by the end of 2018 (all data from Broadridge). Despite the rapid rise of passive investing, there remains considerable scope for further growth. Index investing still only makes up roughly 14% of all assets under management in Europe, and around 24% globally (source: Broadridge).

As more European investors come to recognise that the only certainty in investing is your costs, the demand for low-cost solutions will grow. The role of index funds and ETFs is set to fulfil a large part of this need in the future, helping investors to continue to have better outcomes as they lower their costs of investing over time.

Shifts in technology mean shifts in behaviour

Developments in financial technology, or fintech, are also helping to drive down costs. What’s more, they are increasing transparency for investors around what they are investing in.

One of the most exciting uses of technological advances in asset management is in advice. Here, new technology is changing how advisers interact with their clients and ultimately the kinds of products they recommend.

Innovations in automation and artificial intelligence have led to the emergence of so-called robo-advisers. Rather than replacing human advisers, robo-advisers can potentially enhance the value human advisers offer clients, helping them leverage scalable technology to more efficiently deliver advice.

Our research shows that a large part of the alpha traditional advisers generate for clients comes from behavioural guidance. This is a crucial role of advisers, and includes helping clients stick with their investment plan and stopping them from selling during periods of market volatility. According to our research, sound behavioural coaching can add around 150 basis points of value a year to the average investor’s total return (Chart 1).

Chart 1: The future of advice: Shifting value from portfolios to people
Chart 1: The future of advice: Shifting value from portfolios to people
Source: Francis M. Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, Yan Zilbering, and Donald G. Bennyhoff (2016), ‘Putting a value on your value: Quantifying Vanguard Advisor’s Alpha®’. Valley Forge, Pa.: The Vanguard Group

However, around 40% of the time the average adviser spends with clients is purely focused on tasks such as product selection, portfolio rebalancing and being tax-efficient in the asset location and drawdown. These activities, while important, are rules-based and require little creative thinking. Advisers who continue to focus on these tasks are likely to find themselves competing with technology that can deliver this side of advice more effectively and cheaply. Advisers should, therefore, rather devote more of their time and energy to the uniquely human aspect of advice that can’t be replaced by technology.

Shifting the focus to people, not just portfolios, can help advisers build more loyalty. It also enables them to develop more customised solutions for their clients. This significant change has implications for portfolio managers, investment analysts and fund selectors who create the portfolios and funds for advisers.

The emergence of ETFs

Within this fast-changing industry environment, the emergence of exchange-traded funds (ETFs) is helping investors meet many of the new challenges they now face. For one, their role as flexible building blocks for a portfolio makes them an ideal fit for the new world of fintech and robo-advice. And as investors and regulators become increasingly focused on fees, low-cost ETFs are increasingly winning converts among investors who traditionally favoured individual stocks and high-cost mutual funds. In a lower-return world, investing costs matter even more as fees erode a larger share of returns than they have in the past. What’s more, their structure is suited to the evolving regulatory landscape and new business models. Many European investors are therefore beginning to embrace ETFs for a large part of their investment exposure, benefitting from low costs, broad diversification, and, ultimately, better outcomes.

Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid-offer spread which should be considered fully before investing.

Other important information
This document is directed at professional investors and should not be distributed to, or relied upon by retail investors.
The material contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
Issued by Vanguard Asset Management, Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
© 2019 Vanguard Asset Management, Limited. All rights reserved.

Commerzbank Disclaimer
The views expressed in this article are those of the author and may differ from the published views of Commerzbank Corporate Clients Research Department, the communication has been prepared separately of such department. No representations, guarantees or warranties are made by Commerzbank with regard to the accuracy, completeness or suitability of the data.