Technology adoption by managers is being driven by the need to become more operationally efficient, client demands for bigger returns and the peril of falling behind of regulator demands, says the head of one asset management firm.
There's also a thematic change happening in financial services due to technology that firms should heed, says Maz Jadallah, who founded San Francisco-based AlphaClone in 2008 to provide retail investors access to hedge funds and institutional investors. "The big, over-arching trend is democratization of access and democratization of data, knowledge and information for the end-investor," Jadallah says.
In a conversation with Money Management Executive, he discusses how this trend is playing out among asset management firms.
What has been the general takeaway from this year when it comes to advancements in industry-focused technology?
It's interesting to note a lot of the information around technology is coming from outside traditional wealth managers.
It seems like that's a trend. Innovations around mobile banking started outside the industry. Innovations around account-linking and personal finance started outside the industry, which is curious.
Robo advisors are obviously the hot topic and I think they are a great service for a lot of investors. I don't think they are perfect. I think robo advisory services basically miss two things; one is that they're investing in passive investment vehicles, which means that they have to accept the returns of the passive asset class for better or for worse. Often people focus on the better and not the worse. It's an interesting time to talk about that now because asset class returns are forecast to be anemic, if not negative, whether you are talking about equities or bonds.
The other thing robo advisory misses is the lack of insulation from behavioral risks. Robo advisors claim that the way they manage risk is by diversification. Anyone who has lived through 2008 knows diversification is not enough in terms of risk management. So, there is no active downside to risk mitigation within most of the robo advisors.
Why did it take so long for robos to become an in-house product?
I think it's that there was a category that was created in the start-up world and it focused folks on that kind of service. I think robo advisory, as offered through a lot of these start-ups, is not new. I think you'll see there were technology tools around asset allocation being used in a wide-spread way amongst wealth managers. It just wasn't packaged as a robo advisory service and it wasn't being offered with a discreet price point.
Another form of robo advisory are target date funds; arguably the original version of robo advisory where it automatically adjusts annually for a fee and you never have to touch it - you pick a retirement date and there you go. I don't think the concept is new, I don't think the service is new, I don't think the idea is new. I just think it is packaged and labeled in a particular way and priced discreetly.
What is trending in asset management right now?
I wouldn't point to one thing. I think the big over-arching trend is the democratization of access and democratization of data, knowledge and information for the end-investor; that's essentially what you're seeing across the board. Another big trend though is the explosion of ETFs. If you think about ETFs as a technology, which is essentially what they are - an ETF allows you to integrate with the broker-dealer systems of everybody in the world instantly. That's a pretty powerful type of technology.
ETFs are now increasingly being used for strategies that are looking to outperform the market, not just match it. And I think that's a huge trend because historically investors who wanted to outperform the market unveiled themselves by using mutual funds and hedge funds. Now, you have ETFs that are looking to do the same thing, but in a more efficient, more tax-efficient, more accessible, lower fee and more liquid package. I think that's a very powerful trend, potentially even much more disruptive than robo advisory services if you think about the trillions of dollars being managed by active managers around the world.
What are some of the new developments in ETFs?
We're in that sweet spot of using ETFs to offer investors what we call the best of both passive and active. For us, it's not about man or machine, it's not either a robo or human advisor; it's man and machine. We leveraged both. AlphaClone uses hedge fund public disclosure; that's sort of the human part of our process, but then we put those through our technology platform and analyze them using computers - and that is sort of the computer side.
Our brand of strategy-based ETFs are going to become more and more prevalent and give both hedge funds and mutual funds a run for their money because of a whole host of reasons - they are more tax efficient, they are lower fees, more liquid, accessible and the list goes on and on.
The interesting thing through is there is a lack of education amongst investors around ETFs. Even savvy financial professionals sometimes don't really understand how ETFs work. All due respect to the industry, I lay the blame on that to the traditional large ETF providers. I don't think they're doing enough to educate investors around the efficacy of the ETFs and their benefits. And it's curious.
These are very large organizations and in many cases they have large mutual fund or hedge fund businesses. So, these large ETF issuers are captive inside even larger asset management firms and in some ways I feel like the fact that it is true may be one of the reasons they're not spending more money educating people around ETFs. I think it's an opportunity for independent ETF issuers like us, with obviously very limited resources, to try and step up and do the education.
How have asset managers evolved their marketing techniques this year?
One of the cool things about ETFs is that you can really take the message to the people. The ETF channel is a lot less intermediated than either the mutual fund or hedge fund channel, so it sort of gives you the opportunity to promote your message to the end investor, and that's our strategy.
The benefit of starting from scratch is you can build a very digitally native marketing infrastructure, which is what we're doing, and take your message directly to the investor.
We're not saying we're not paying attention to the financial advisor, we certainly are - we have a sales team that supports and talks to financial advisors in the intermediary - but our marketing message is largely directed at the end investor. We do that in all sorts of ways. Companies our size will say public relations and content marketing are probably one of the most effective ways that you can do it within the budget that we have, but as we scale we will look to use other tools, whether it's general advertising, television advertising and more traditional marketing tools in order to get the message out.
Either way, though, whether it's digital or traditional, we're building this 'marketing machine' that automates everything from lead capture, to lead scoring, to lead nurturing and all of the things you can do because you are building the machine from scratch.
How has risk played a factor in the firm's strategy development?
There's manager risk; we have a high degree of conviction in our scoring methodology but that doesn't mean we put all our eggs in the highest scoring manager. We pick at least 20 managers to aggregate high-conviction ideas around, largely because we want to mitigate all of the managers' associated risks. Blow up risk, performance risk fraud risk, data risk; all of them get mitigated when you spread your eggs across multiple managers.
The second risk is market risk. We don't believe it makes sense to be long only all the time. We certainly don't think it makes sense to be long-short all the time. So, we have this dynamic hedge in our strategies that allows our strategy to vary from long only to market neutral based on a simple non-proprietary technical trigger: the 200-day moving average for the S&P 500.
And in that way, what we are trying to do is align the strategy to whatever the market is doing over a multi-month period. You can still suffer 15% or 20% drawdowns in our strategies, but we think those kinds of drawdowns, investors can recover from. What we're trying to isolate and prevent is the 30%, 40% or 50% drawdowns from which investors cannot recover. This is one of the things that robo advisors miss. There is no active downside protection in their strategies.
The last risk is behavioral risk. And that's a really important risk because it trips up most investors - the tug of fear and greed of doing the wrong things at the wrong time in the market - and because our approach is 100% rules-based, we can put our strategy in passive vehicles like ETFs but still go for outperforming the overall market.
That rules-based construction means that no matter how I feel about China or Greece or Europe, the rules are the rules and the strategy follows the rules religiously - which means that the strategies are isolated from a lot of the behavioral risks that trip up investors. That's our approach and we think it's novel because it combines the best of man and machine, the best of active and passive, we're using ETFs which are infinitely more tax-efficient than mutual funds and hedge funds.
Have regulations become any more of a challenge than in previous years?
Well I don't know if they are any more of a challenge now than they have been historically. The rules are the rules and they're pretty transparent. This is a regulated industry and that means it's a step function in terms of fixed cost in business that you have to step up to, especially when you're deploying funds like mutual funds or ETFs. So, we do that by holding ourselves accountable around knowing what the rules are.
For example, I am the chief compliance officer for AlphaClone, but also it means unveiling ourselves as support.
We've hired outside compliance consultants that help us develop our policies and procedures, help us monitor them, help us keep track of what we're doing and I think those things are absolutely critical. We also have an administrator on our ETFs, and a custodian, and the statutory distributor on our ETFs is Quasar, which is owned by U.S. Bancorp, or our administrator on the funds, and anything that rises to the level of being fund to marketing has to go through Quasar review.
While that can be tedious and sometimes frustrating, it's necessary.