Financial Dinosaurs - Ripe for Disruption

I am going to make a bold prediction - we are on the verge of a mass extinction.
And as any doomsday prophecy, it is going to be a long one, so brace yourself for a long post.
 

Late Cretaceous

I have spent most of my financial career on the buy side or, as it is formally known, in asset management. And with every passing day my conviction growth stronger that majority of the firms in the sector are dinosaurs waiting for some calamity to wipe them out.

They are not your T-Rexes, those two-legged predators were more like investment banks, but rather lumbering giant sauropods. The biggest ones has grown so huge that they are confident their size alone makes them invincible. And the smaller ones think they are sufficiently different from the rest to thrive in their own niche. But they share the same environment, and as tectonic shifts reshape it,  all of them are affected.

Mini-Asteroids Waiting to Fall

1. Overcrowded market and lack of genuine product differentiation
2. Outdated business processes
3. Track record is all too often meaningless
4. Reliance on face-to-face interaction in digital age
5. Financial theory underpinning the industry is out of touch with reality
6. Red tape is suffocating and counter productive
7. Accounting standards struggle to reflect intangible value and are no longer adequate

It would take a few books to properly describe all of these problems, so I will address a couple of points only. Let's start from the top.

Too Many Too Alike

There is simply way too many investment products out there. Let’s concentrate on mutual funds. In the US, there was 8,078 mutual funds in existence at the end of 2018, according to Investment Company Institute's fact book, a total value of USD 17.7 trillion. That's almost as much as the US GDP in the same year (USD 20.5 trillion, World Bank)! According to a report by EFAMA (European Fund and Asset Management Association) EU domiciled funds are even more fragmented - there was 33,570 UCITS funds at the end of 2019 Q1, worth combined EUR 10 trillion.

Mutual funds invest in a multitude of asset classes like equities, bonds, real estate and things far more exotic, but almost all of them promise to deliver outperformance against a certain benchmark (absolute return funds fight with LIBOR or something of the sort). So basically, all these products have a label saying “give me your money and I will give you more back” without giving any reassurance that they actually will. And for a good reason - very few do. More on that later.

To bring mutual funds to real world, imagine walking into a supermarket with 33 thousand toothbrushes on the shelves, all of them in slightly different wording promising to "aim to make your teeth cleaner over the long term, amount of plaque on your teeth can go up as well as down, enamel at risk". Do you actually benefit from this variety?

Read any fund's presentation and most of them claim to "utilise unique approach", have "highly experienced team", and other laudable qualities. Yet if you read the more detailed explanation of how they strive to produce returns, all too often there is almost no difference between products in the same category. For instance almost all equity value investment strategies will use similar processes and similar lingo, despite their claims to be unique.

In summary, you get 33 thousand toothbrushes of different colours, but essentially same design and practical effect on your teeth. We simply don't need that many.

Cutting Edge Technology … from the 90s

Financial industry has spawned a myriad of systems and applications, but what are the two most used on a daily basis?.. I haven't come across any statistics, but from my experience I can confidently state that the prise goes to Microsoft Excel and to Bloomberg Terminal. While both of these tools have evolved over time, they go back to 1990s. Oh, I still remember the mystique of MS Excel when I first got to use it in the late 90s! Took me some more years after that before I got my eyes on Bloomberg for the first time, but even then its black-and-orange colour scheme looked somewhat antiquated, not to mention that they were still struggling to integrate mouse interface into the system.

But the investment products are being managed with sophisticated software, right? This maybe right for Black Rock with its Aladdin system, and a handful of other very large and tech savvy managers, but the majority of analysts in the rest of the industry build their valuation models, wait for it... in MS Excel. Excel is a fairly powerful piece of software, as long as you use it for your own tinkering. But once you try to maintain a complicated model in a team setting, the limits of Excel's change tracking functionality become apparent. Not to mention that working with external links is a nightmare.

I am obviously not the only person noticing this. There is a reason why fintech is a buzzword within and beyond the financial industry. For example New York based start-up System2 is aspiring to revolutionise investment modelling by putting models onto a platform and integrating live big data into them. And alternatives to Bloomberg are coming both from the ranks of old school data providers and new technological solutions like Sentieo.

Message to the Aspiring Money Managers

So my take is, the industry will not exist 10 years from now. At least in its current shape. 10 years may seem like a long time, but for the young people starting their careers this is the most important 10 years they will have, as they will be building their core skill set over that period.

My advice to them - don’t join asset management. Wait for the great extinction. New, more nimble players will emerge, much like mammals did after the dinosaurs cleared the stage. They will have different business models, different, more customised approach to their clients. If “managing money” still excites you then, join them instead.

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