The 2029 roadmap for funds management

Cyrus started off by isolating deflation as the defining macroeconomic challenge of not just the next ten years, but the rest of our lifetimes: 

Technology, ageing populations, and globalisation will continue to exert a deflationary effect on the world's economy. The lower for longer environment that we've been living in for a while may become the lower forever environment, or at least for our lifetimes. I predict that deflation, not inflation, will be investors' biggest challenge. 

Technology is going to transform every aspect of the asset management industry and the investment lifecycle itself. The reality today is that data and computing costs have been improving much faster than we as an industry can use the full potential of those changes, that will change. Simply put, deploying data and technology successfully is the new arms race, and that's going to determine which asset managers rise to the top in the next 10 years.

It's estimated that assets under management in China will grow at 17% annually over the next five years itself. The Chinese mutual fund industry has already quadrupled since 2013. It's 1.7 trillion today. It's expected to grow to 3.2 trillion by 2022, and keep in mind those Chinese mutual funds hold only 8% of personal financial assets in China today. China's full emergence into the global capital markets and the rise of Chinese mega asset managers is going to be the biggest regional shift in the history of asset management. By 2029 the largest asset manager in the world will be Chinese. 

#6: ESG ratings will be as important as credit ratings

Environmental, social and governance (ESG) ratings provide a measure of the corporate behaviour of companies, and standalone funds are set up explicitly for investors wanting to invest in them with a clean conscience. Cyrus predicts that:

In 2029 we will no longer be talking about ESG as stand-alone investment strategies. Instead, the quality and consistency of ESG data and analytics will advance to the point managers will just fully integrate those metrics into their investment processes across all asset classes. ESG value drivers will become part of mainstream investment analysis, security selection. A company's ESG rating will be as important as its credit rating. 

Leveraging technology in fundamentally different way, investors of the future should be able to choose from a very wide range of invest ment choices to create highly personalised portfolios that dynamically adjust not only based on asset price shifts, but even their own personalised risk parameters, their own time horizons, their wealth balances, and even their thematic preferences for things like clean energy or gender diversity.

This kind of bespoke asset personalisation is possible now of course but is labour intensive and thus expensive. Leveraging tech to deploy the same offering to millions of investors would offer a highly valuable UX and give the provider a massive edge. 

#10: The biggest challenge of all is climate change

Calling it the biggest challenge, not only for the asset management industry but for life itself, Cyrus singled out climate challenge:

10 years from now I can imagine a world in which the value of an investor's holdings would be significantly depleted if not ravaged due to climate change and the associated destabilizations. Think of freshwater shortages, crop failures, climate driven disease, and mass migration. That might happen, or I could envisage a world in which the largest market cap company in the world in 10 years is the one that's managed to create game changing technologies needed to sequester carbon on a massive scale, or improve the storage power of batteries. In some ways this wild card around climate is the most important prediction that we just can't make with any degree of certainty, but it's important to underscore investors have genuine opportunities to deploy capital in ways that support climate change and long-term value creation. I believe we need to embrace these opportunities fully and quickly.

Full transcript of presentation

Thank you, Robin and good morning. So I'm honoured to be here today to talk about the future of the asset management industry, and speakers like me are contractually obliged to start these state of the industry kind of speeches with some sort of reference to the industry facing an historic crossroads, right? Robin talked about this. In fact, I'm reminded of the old line about crossroads. One path leading to despair and utter hopelessness, the other to total extinction, and praying that we have the wisdom to choose correctly.

Now, that may sound a bit hyperbolic, but faced with slower inflows if not absolute outflows as well as price compression on one hand and rising costs on the other, it does seem that the asset management industry right now is locked in a Darwinian struggle like few times before, if not never before, and we are seeing that shakeout play out right before our eyes.

So think of it this way. 1980, financial services sector made up a little under 5% of GDP in the US. 5% of GDP in 1980. 2017, the sector represented 7.4% of GDP, or a 50% increase. So, it's not crazy to imagine an industry shrinking back by a third back to those 1980 levels. So, think about yourself, think about the person sitting to your left, on your right, only two of you will be left standing. Now, you decide if the situation is desperate or just serious, right? It's that old definition of an economic crisis: If an economist’s neighbour loses her job, it's a slow-down. If the economist herself loses her job, it's a depression.

So I'd like to take the next 30 minutes to talk about some of these big forces that are shaping our industry, and I want to give you my 10 for 10. My 10 predictions for asset management in 10 years time. The good news is it's going to be hard to get a report card back on me for at least 10 years, and by the way, I'm actually less interested in getting these predictions right than I am about envisioning how some of these structural forces could play out over the next 10 years and what that means for how we need to be thinking about our priorities today.

Bill Gates once said, "We often overestimate the change that will happen in the next two years, yet underestimate the change that'll happen in 10 years." And that's easy to do, right? In the world we live in right now, there's so much focus on the right here, right now, and we're distracted by all manners of noise. But for us at State Street Global Advisors, thinking about the world many years into the future is part of what our role is as long-term investors.

Our clients, and most of your clients in this room, have long-term liabilities which they need to meet, whether it's a retirement plan, and endowment, insurers, sovereign wealth funds, or financial advisors on behalf of retail investors, right? And our job is to maximise the probability of generating those attractive long-term returns so that they can achieve their objectives. I think you'd agree with me that that undertaking is only becoming more complex and more challenging as a host of these structural forces transform our industry, and dare I say the very art of investing itself.

So let me give you my 10 predictions for 2029 and again, reminder, I'm not trying to get them all correct. I'm just trying to provoke, I'm trying to spark your imagination on how things could play out, and unlike David Letterman's top 10 list, I'm actually going to start with the two predictions I think are most important.

Prediction #1

So my first prediction is that technology, ageing populations, and globalisation will continue to exert a deflationary effect on the world's economy. Lower for longer environment that we've been living in for a while may become the lower forever environment, or at least for our lifetimes.

I predict that deflation, not inflation, will be investors' biggest challenge. Warnings of a prolonged secular stagnation seem even more relevant today than six years ago when folks like Larry Summers first raised the alarm on this.

Here are some stats that I find quite troubling. We've had the longest economic expansion in the history of the United States, but wage growth remains limited and productivity growth is inching forward at a stubbornly slow rate, 1.3% in 2018, 1.1% in 2017. Compare that with historical productivity growth rates of about 3%, and yes, we are seeing historically low rates of unemployment in developed markets, but the more important long-term indicator shows a continued decline in the workforce participation rate, especially in the United States.

1954, 2% of men in the United States between the age of 25 and 54 were not working, 2%. By 2016 that number now is 12%, and economists say that by 2050 we're likely to see that number go to a quarter of prime age men not working, and some say given increased automation, that number could be as high as 30%.

So despite more than a decade of massive, extraordinary monetary stimulus, central banks around the world are still trying to figure out how to meet inflation targets. All of this to me suggests that global growth will continue to struggle to meet what we call escape velocity, which has dogged us since the great recession.

So this slow, low, no environment is setting the macroeconomic backdrop for asset prices and investors over the next decade.

Today, a quarter of global debt is trading at negative rates, a quarter. What if that rose to 50% by 2029? What does that will look like? Savers will face an increasingly difficult challenge more than they even do today. Underfunded pension plans will see an even greater duration mismatch between their assets and their liabilities as the present value of those liabilities moves higher, and most significantly I believe it means that investors will continue to take on more risk, more complexity in their portfolios to achieve their objectives, and the risk of leverage induced bubbles will be far higher. The focus among investors on our industry's fees will be greater than ever, as every basis point will matter more and more.

So if secular stagnation is the defining macroeconomic challenge of the next decade, then technology has to be regarded as one of its main catalysts, which brings me to prediction number two.

We will be living in the age of man and machine. Technology is going to transform every aspect of the asset management industry and the investment lifecycle itself. From how we research companies, how we trade securities, how we build portfolios, how we run our operations, our distribution channels, how we interact with clients, how we define talent profiles, and ultimately what will separate the winners from the losers in our industry.

Now, I get it. Saying that technology will be a big disruption is barely a provocation, but I do think the industry still underestimates the extent to which technology will change everything.

The reality today is that data and computing costs have been improving much faster than we as an industry can use the full potential of those changes, that will change. Simply put, deploying data and technology successfully is the new arms race, and that's going to determine which asset managers rise to the top in the next 10 years.

It's true that costs in all forms matter more than ever for investors in this lower for longer environment, but fee compression is not just a product of lower for longer backdrop, right? Fee compressions also result of technology driven transparency around how much of an investment return truly is the result of market exposure or beta, how much is the result of smart beta or factor based premia, what's really derived from genuine idiosyncratic skill-based manager alpha, and I believe technology is helping the industry, providing investors with exposure to markets in a much more cost efficient way. That's the real innovation of ETFs and the enduring drive behind the shift from active to indexing and fact-based investing.

So I believe data and technology will increasingly shift the power between traditional stock pickers who can dig deeper and deeper to find industry winners and the new data-driven systematic approaches that can scan a far wider universe of securities and generate exposures that reflect a more precise set of investor preferences.

10 years from now, we will see some pure AI driven offerings as the automation of automation takes hold and machine learning advances, but our view is that machines will not broadly supplant human beings. Instead, there's going to be a greater hybridization of humans and machines in investment advice, design, and implementation.

I think it will also change the skill sets we will need to be successful. Data scientists and software engineers will eclipse finance and economics graduates. Indeed, we are already seeing that start to play out, but in a very limited way.

Quick show of hands, how many of you in this room are data scientists or software engineers? Quick show of hands, please. I see one, I see two, three. I think in 10 years you're going to be the bulk of the audience. We will really be competing in a very different way with Silicon Valley than we do today, and I know we all talk about it today, but as the poll just showed, it's not a big thing today.

Prediction number three is that the rise of Asian, especially China, will completely shift the balance of power in the industry. By 2029 the largest asset manager in the world will be Chinese.

2029, the largest asset manager in the world will be Chinese. Now, most of you are saying that's a heck of a stretch given the huge leads that North American asset managers have today in terms of assets under management, but I believe the time, scale, and momentum are on China's side.

It's estimated that assets under management in China will grow at 17% annually over the next five years itself. The Chinese mutual fund industry has already quadrupled since 2013. It's 1.7 trillion today. It's expected to grow to 3.2 trillion by 2022, and keep in mind those Chinese mutual funds hold only 8% of personal financial assets in China today.

The shadow banking system in China, which holds an additional 4.5 trillion is likely to see placement in funds as Chinese regulators try to clean up and limit the scope of the shadow banking system. Also, digital disruption is going to be a much greater catalyst in terms of the industry's evolution and I would not underestimate the ability of China's fintech companies to leapfrog their Western competitors.

Companies like Ant Financial and Tencent who are going to move increasingly from money market funds and deposit products into the very heart of asset management. Ant Financial's money market fund became the world's largest money market fund in four years. The world's largest asset, largest money market fund in four years. Think about that. It's also not inconceivable that a Chinese asset manager could scale even more quickly by acquiring one or more non-Chinese asset managers. So that gives me even more conviction in my prediction, and I predict that China's emergence, full emergence into the global capital markets and the rise of Chinese mega asset managers is going to be the biggest regional shift in the history of asset management.

Prediction number four. The next blockbuster outcome-based solutions product in the industry will be retirement income. I think we all know the trend as the world continues to shift from defined benefit plans to defined contribution plans. We are putting more and more of the onus upon the individual to generate sufficient income, and also not run out of money before they die, and I confess that in 10 years, this word retirement may have a completely different meaning than the way we know it today. But let's keep with the word as it's currently configured, and I believe life spans will have extended well beyond 120 years, which means we as an industry need to help our ultimate clients think about retirement years that'll double from about 20 years to over 40 years.

As an industry, we've done a much better job when it comes to asset accumulation, right? And let's use the defined contribution example. We've done a pretty good job. We have auto enrollment, auto escalate, we have target date funds, not bad. Then you get to decumulation...

Somebody says, "I followed all your wonderful guidelines. Here I am. I've saved my half a million dollars, which is more than I ever dreamt I would be able to save. I'm 65, what do I do now?" And we sort of mumble about the 5% rule, then we get a little nervous given where the environment is and we say, "Well, maybe you should try four." Then some of us say, "Maybe 3.5%." And that's the best we got as an industry.

I believe in the next 10 years we're going to see an extraordinarily different set of retirement income solutions that's going to combine some combination of the liability driven investing techniques applied to individuals' nest eggs, dynamic drawdown strategies, greater use of immediate and deferred income annuities to cut off that longevity tail, maybe governments will even step in and create new securities to hedge longevity risk. We are going to see behavioural economics supplied in much more innovative ways and I believe new technology is going to personalise these solutions for each individual, which is the current challenge we face.

Prediction number five. By 2029 the balance of assets and index-based strategies including ETFs versus active strategies will flip. So today it's about 25% index versus 75% active assets under management globally. That proportion is going to flip. The majority of assets will be in index strategies and the trend to indexation will have spread well beyond equities and certainly well into fixed income as well.

Now, I know, many of you are sitting there and saying, "What else is he going to say?" Here's the CEO of the third largest ETF provider in the world and the third largest index manager in the world, so I get it, but let's just consider the momentum.

Today the tools to disaggregate the sources of returns that I talked about earlier are much more readily available. Investors are much more likely to be able to see how much of their active manager's return is true skill-based alpha. In 10 years those tools are going to get even sharper, razor-sharp.

Active managers who sell beta dressed up as alpha or who hug a benchmark are going to be disrupted out of existence. Again, we've been talking about this for quite a while, but I would tell you if you look at the proportion of the industry's revenues today that are still represented by, forgive the pejorative term, benchmark hugging or closet indexing, it's still a pretty high number.

The demise of such closet based closet indexing strategies in the next 10 years will actually be good for the active managers who survive because it will improve the overall quality and the reputations of those active managers who survive.

Meanwhile, I believe that as technology makes markets and access to information much more efficient, asset allocation will be the new alpha. Asset allocation will be the new alpha. Portfolios will be constructed with a combination of exposures to traditional beta, long-term and durable factor premia, as well as true sources of idiosyncratic alpha, and in fact, I believe idiosyncratic alpha will become even more scarce and will demand a higher premium.

Prediction number six. In 2029 we will no longer be talking about ESG as stand-alone investment strategies. Instead, the quality and consistency of ESG data and analytics will advance to the point managers will just fully integrate those metrics into their investment processes across all asset classes.

ESG value drivers will become part of mainstream investment analysis, security selection. A company's ESG rating will be as important as its credit rating.

Company's ESG rating will be as important as its credit rating. A company's ESG score will be particularly important to long-term investors since so many of the ESG risks and opportunities are really slowburn issues that have very asymmetric outcomes.

Prediction number seven is that over the next 10 years, both investors and the investment managers will embrace the wisdom of taking a long-term perspective, and a patience premium will become a more common feature in the industry.

Investors will reward companies that demonstrate a long-term focus, which is more aligned to the long-term nature of the investor's investment goals, and they'll penalise companies who focus on short-term financial engineering to boost stock prices.

Quarterly earnings guidance, not to be confused with quarterly earnings reporting, will be phased out. We'll see more companies aligned with assets, with capital allocation strategies and compensation incentives with the focus on the long-term, and I believe it will also spread to investment managers who will promote a patience premium and may even offer investors enhanced commercial terms for staying invested in a fund or a strategy for a longer period of time.

Another important shift that I predict over the next 10 years is that regulations will adjust so that individual retail and defined contribution investors will be able to gain access to private market opportunities that have so far eluded them. Now, why is this important?

For a long, long time, mainstream investors have benefited from the transformation of tech startups into commercial behemoths on public exchanges. Amazon, Google, Facebook, and Netflix, those four companies alone created more than $1 trillion of wealth for individuals who invest in public markets once they went public.

But recently that opportunity has diminished. Private markets have become the preferred source of capital for companies of all types and sizes. Private offerings in the US have raised five times the equity of IPOs. The US today is home to almost a 100 unicorns or privately financed startups with valuations of more than a billion dollars, and these startups are staying private longer or deciding just never to go public.

At the same time, the number of public companies in the United States have fallen over the last 20 years by half. There were 8,000 public companies in 1997, it's less than 4,000 today.

So I call this in a world that's increasingly moving to define contribution, the deep democratisation of investing as we see it today.

The good news is by 2029 I believe that access to these high growth private companies will be made much more easily available to individuals, both in their retail accounts as well as their defined contribution accounts, and they can invest just as a defined benefit plan or an endowment today can access the private markets. I believe 401(k) plans will move to quarterly or even annual pricing. I mean, does anybody really need to trade their 401(k) every single day? And the ability to invest in illiquid private capital investments through tokenization will become far more common.

Prediction #9

Ninth prediction is that private investments will be just one building block of much more customised and targeted portfolios that will become the norm in 10 years.

Leveraging technology in fundamentally different way, investors of the future should be able to choose from a very wide range of invest ment choices to create highly personalised portfolios that dynamically adjust not only based on asset price shifts, but even their own personalised risk parameters, their own time horizons, their wealth balances, and even their thematic preferences for things like clean energy or gender diversity.

Advisers that can provide such a level of personalization at scale leveraging technology will have a competitive advantage.

ETFs will continue to eclipse mutual funds and experience strong growth as the preferred building block for these customised portfolios, and by the way, I'm not naive. I do believe that at some point in the future there's probably some new vehicle aided and abetted by new technology that might even disrupt and replace the ETFs. I don't see that in the next 10 years, but I do see that somewhere out there in the future.

My final prediction is a real wild card. It involves the biggest challenge, not only for our industry, but dare I say for life itself as we know it. That wildcard is climate change.

Not whether climate change is happening, I think that question is mostly settled at this point, though there's still uncertainty around the pace and the extent of the change, and rather I think the issue is whether our industry will take seriously the value destruction potential from climate change, which if scientists are to be believed, it will begin to geometrically increase within 10 years.

Our industry has begun to take some action. We have efforts like the Task Force on Climate-related Financial Disclosure, and I know many of us in this room are very engaged with companies and how they are thinking about carbon pricing and the implications of a warming world on their business strategy.

Central bankers like Mark Carney and Christine Lagarde have been sounding the alarm about the financial and economic destabilisation that climate change poses, but on the whole, I think our industry is still looking at climate change far too much just as a matter of client preference and not enough through the lens of investment value, not values, value.

10 years from now I can imagine a world in which the value of an investor's holdings would be significantly depleted if not ravaged due to climate change and the associated destabilizations. Thinking here of freshwater shortages, crop failures, climate driven disease, and mass migration.

That might happen, or I could envisage a world in which the largest market cap company in the world in 10 years is the one that's managed to create game changing technologies needed to sequester carbon on a massive scale, or improve the storage power of batteries.

That could also happen. In some ways this wild card around climate is the most important prediction that we just can't make with any degree of certainty, but it's important to underscore investors have genuine opportunities to deploy capital in ways that support climate change and long-term value creation. I believe we need to embrace these opportunities fully and quickly.

Summary

So in closing, let me emphasise that despite all of the industry's current challenges around fee compression, rising costs, we also face unprecedented opportunities to promote a more sustainable and inclusive future. Those of you who can successfully leverage opportunities that technology, demography, geography, and climate change mitigation offer will have a very bright future. Banks continue to retrench. Asset managers are more vital than ever in the efficient allocation of capital. In the world in so many countries and so many governments are turning inward, global capital flows are inherently outward looking and perfectly suited to address some of these cross-border challenges like climate change, like technology disruption, like ageing populations, which we as an industry need to face head-on.

So let me go back to that joke about historic roads, crossroads, one path leading to despair and utter hopelessness, the other to total extinction. I do believe and predict there's a third path that will lead for those of us who embrace it to a bright future for a subset of today's asset managers. Many aspects of that path are going to look very different from the current path most of us are on, and I believe this is our moment as an industry to show the true value we can bring to the future of investing, the future of our industry, and at the risk of sounding just a tad grandiose, the future of our planet by embracing the shifts in the way we operate as an industry. Thank you.