The financial services industry have been provided a number of reasons to be wary of technology just in the last year.

It either has come to represent operational risk, as increased digital dependence has made companies more vulnerable to cyberattacks; or a business challenge with real impact on the bottom line, characterized by the advent of low cost, passive ETFs, or possible competition from digital-first firms and robos offering innovation and alternatives to traditional business models.

Despite these concerns, the biggest risk is to pretend that technological innovation can be ignored and assume business can still continue as usual, says Robert Arnott, chairman and CEO of Research Affiliates.

"People who are complacent and coasting will continue to harvest good profits as their market share and margins erode," he says.

"They have to be content with making that choice. They shouldn't grumble about it. No whiners please."

Fintech startups, though largely focused on innovations in payments and digital wealth management, are beginning to develop models to disrupt every segment of financial services, including the fund industry.

New fintech firm Dream Forward Financial, for instance, is positioning itself as a low-cost 401(k) provider, which its founder says will offer better digital services and operational transparency than traditional providers.

"We see a big part of the reason why the retirement system is so flawed is that Americans save via retirement programs that are really expensive and confusing," says Grant Easterbrook.

Some incumbent firms have been proactive. In response to the rise of automated investment services, Vanguard created its own. Without any advertising, assets in its Personal Advisor Services rose from $755 million in 2013 to $10.1 billion at the end of last year.

The fund industry has been particularly persistent in its fear of an Apple or Google getting into asset management.

Both tech giants are actively investing in financial technology and currently are concentrating development of mobile payment services. What would prevent these firms of taking the further steps of adding financial advice and then asset management?

Google denies having current designs for entering asset management, but industry experts see how an Internet giant could become a force in distribution and prove difficult for even the biggest firms to counter.

In its forecast for what asset management would look like in 2020, PwC predicted that a company like Google either through partnerships or acquisitions would find a partner as a means to enter the industry.

"A social media firm such as Google, Facebook or Twitter or product providers such as Apple (through iTunes) or Amazon could, for example, provide front-office services, and partner with, or even buy, a back-office servicing firm to create an integrated AM structure," the report says.

Arnott's Research Affiliates embraces the rise of low cost ETF strategies, and recently launched six new equity funds with Pimco.

In an interview, Arnott says the financial services industry has to change its mindset toward innovation in order to remain competitive.

For instance, he says, firms can embrace innovation with the acquisition of a young tech firm or ETF provider, a tactic some insurance providers and traditionally active management firms have adopted.

Any discussion about technology and innovation elicits all sorts of reactions from executives across the financial industry, the asset management sector included. But it would be fair to say that most of it is negative.

Why groan when we're in one of the highest profit margin businesses on the planet, with one of the fastest growth rates on the planet? You're going to have competition. Get with the program. And competition keeps us sharp!

With companies such as Apple from the technology side entering this market, they present an X-factor? It's hard to predict what they will roll out?

Right. Disruptive competition is always the most interesting, and by its nature it's very disruptive. By its very nature it helps define who’s on their toes, who is ready for a challenge and who is complacent and coasting.

And the people who are complacent and coasting will continue to harvest good profits as their market share and margins erode. They have to be content with making that choice. They shouldn't grumble about it. No whiners please.

One reading of The Innovator's Dilemma though would suggest that by the time innovation surfaces, it is too late for a firm to respond.

It's not too late to respond. There are innovators. There are fast followers. Apple has been an innovator in the past and Microsoft is a classic fast-follower; both massively successful.

The people who ultimately lose are those who have a sense of entitlement because they're a major player or a dominant player, and feel entitled to remain such without a need to stay sharp, stay on their game and continue innovating.

You can choose not to continue innovating. You can choose to sit on your large profit margins; they will erode over time. But that can be a highly profitable choice, rather than spending your money on additional, new innovations; rather than risking cannibalizing your business. Leave others to cannibalize it, which is okay. It's a conscious choice; and it's a completely legitimate conscious choice. If you're not prepared to cannibalize your own business, don't whine when others do.

What is providing the opportunity for disruptors with their products or their different strategies than what's currently in play?

We're an odd asset manager in that we manage no money. We partner with others for doing the heavy lifting of running the money and handling distribution. We're product innovators and folks can see us as an extension of their product development efforts, an extension of their product earnings, and we share in the revenues when people like our ideas and decide to embrace them and launch them.

It's been a good business model. Basically, that means that we partner with the folks that have made the conscious choice; we want to innovate, we want to create and launch products that are disruptive, we want to take on new ideas even at the cost of potentially cannibalizing some of our own business -- because if we don't do this somebody else will -- and this co-branding model works for us because we're combining the reputational capital of two organizations, both of which have good reputation, credibility and respect.

So, the business model has worked very well for us. It hasn't been done before as far as I know and it won't work for everybody, of course.

In the sphere of potential disruptors of the asset management industry, for instance, where does Google fit in?

First of all, I haven't talked to Google and I haven't studied the situation closely. Secondly, like everyone else on the planet I'm an active user of Google.

So, from a totally uninformed perspective; if they go down this path they will likely go down this path aggressively with meaningful resources and will pursue an extremely low cost, product delivery, which will be a disrupter to the industry. I would see it as being a threat to the FA community and a threat to the Vanguards of the world, if they decide to enter into the marketplace.

What can institutions do to be more responsive to disruptors as well?

The main thing is to welcome the competitive challenge that disruption provides and to welcome the fact that this forces them to up their game rather than decrying the disrupters or hoping they will just go away. They won't.

There are always disruptors in every industry -- not a lot of them, but it doesn't take a lot of them.

Cars versus horse-and-buggy. Electric lights versus whale oil. Things change, and they change in massive ways.

Rather than hope it doesn't happen, you can A: recognize that it will; B: embrace it and try to figure out how to work with and potentially profit from it; C: choose not to work with it; or D: resign yourself to the fact that it will happen and choose to embrace the path of keeping costs to a minimum, profits to a maximum in a fast eroding market share -- which is a perfectly legitimate choice.

There are also two things the industry can do. One is to partner or acquire an innovator, right? So you head off the challenge by simply adding it to yourself; you swallow it rather than embrace it. If it's willing to be swallowed.

Maybe one of the smaller entities; I'm not thinking Google, but if there was a young startup with an innovative idea, would that be a smart move to make?

It can be, but the question is: does the corporate acquirer extinguish the innovation engine? That frequently happens. And then another disruptive innovator comes along and you've accomplished very little.

We get wooed from time to time by folks that want to acquire us, but we're not very interested in that sort of thing. The loss of autonomy, the loss of creative spark swamps the financial implications.

How does regulation slow the innovation process? It's probably the one thing Wall Street is grateful to have the SEC around for.

It just does. Regulatory capture is a reality and the regulators talk at length with the biggest players in any industry to make sure that they understand the industry, to make sure that the biggest players understand the regulations and to seek input into the regulations.

If the biggest players are influencing the construction of an interpretation of the regulations, it will be at the cost of squeezing out the little guy.

So, it's anti-competitive, it's a form of crony capitalism and it's the antithesis of free markets. So, it's not healthy, but it's reality. 

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