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Declining Margin Trends Signal Maturing Industry

By Eric Daugherty

In prior blog pieces (see here) we have looked at quarterly margins and seen that they are largely driven by movement in the markets. However, over longer periods, it becomes clear that our industry, like other maturing industries, is experiencing margin compression.

Using the earnings results of publicly-traded asset managers, we examined the operating margins (operating income/revenues) and net margins (net income/revenue) since 2000. While the firm-to-firm margins vary wildly over these spans, industry margins have come down. Note that at both the beginning and end of this period the broad market Wilshire 5000 has been near the same level. However, industry operating margins have decreased from 39% to 29%, and net margins have declined from about 27% to 20%.

This compression is exactly what we would expect to see in a maturing industry. Competition and a shift from easy growth of the market, to fighting for a share of a slower-growing pie, mandate shrinking margins. It happens in all industries eventually and will continue in the U.S. financial services industry.

So, what can/should firms do about it? There are a few options:

Prop up margins by:

a.) Focusing on higher revenue products, geographies, or segments

• Differentiated products with believable alpha stories that sustain higher fees


• Go international, into less mature markets with less price competition


• Focus on market segments where the firm has a competitive advantage (e.g. retirement, where no one is an acknowledged leader)

b.) Cutting costs at a given level of revenue, like using the Web to drive efficiencies

Live with decreasing margins, and make money on volume (we've been talking about scale a lot)
a.) Compete on price on commodity-like beta products
b.) Get scale via acquisitions and organic growth of core funds

Long-term, there will be a shakeout, as stronger firms survive and thrive, while others wither. This may not happen for ten years, as making 30% operating and 20% net margins is still fairly attractive. Short-term, we expect firms to fight to maintain margins by ramping up marketing and striving for organic growth. However, the tea leaves are clear - margin compression has begun.

Industry Margins Retreat a Bit as Market Bounces Up and Back

By Eric Daugherty

Second quarter operating margins for the publicly traded asset managers retreated just a bit to 28.1%, from 28.6% in the 1st quarter. Average AUM for these firms shrank 2.5% in the quarter, as the equity markets measured by the Wilshire 5000 advanced 5% in the first quarter, then rose another 3% in the second before falling 18%. Positive cash flows cushioned the AUM decline. Revenues for these firms gained 4%, but expenses rose 5% from the prior quarter, compressing margins slightly.

Source: Yahoo! Finance

Firms continue to be clustered in a pack, with a few margin stars popping out of the top of the cluster and a few firms still struggling to get back into the pack.

Given the decline in markets over the course of the 2nd quarter, we should see narrower margins again in the 3rd quarter as average quarterly AUM declines (unless, of course, we get a big market surge).

As you'll read about in a blog piece coming soon, even more interesting than the quarterly meanderings of margins is the slow erosion of them over time. We extended our analysis back to 2000 and found evidence of a maturing market with margin compression, which holds significant implications for asset managers.

Newsflash: Industry Margins Are Driven By...

By Eric Daugherty

...market performance! Some findings are surprisingly unsurprising. The 1st quarter saw a huge dip in the markets, then a huge rebound. On balance, the stock market rose a few percent. So did asset manager margins.

We realize that margins are correlated with the markets. How strong the correlation is was reinforced by the graph below, which maps asset manager margins and overlays the average level of the Wilshire 5000 Index by quarter.

However, just because industry margins rise and fall with the markets does not mean that all firms succeed and fail equally. As you can see below, there continues to be a big cluster of firms earning between 25% and 32% operating margins, but a few firms do better, and a few worse.

So, if firms' operating margins are driven by a largely uncontrollable markets, how do they maximize value? By continuing to rationalize their structures even (and especially) when times are good. All firms cut costs during the downturn, but how many of those cuts will stick? In our Costs of Compensation study last year, we found that firms were split in how they were reacting to the financial crisis - some were in denial, some reactionary, and some making thoughtful, opportunistic change.

Firms who want to boost margins above the industry average need to recognize that, even though immediate crisis in the markets has passed, the opportunity and need to continue intelligent rationalization of cost structures remains. Those firms wanting to earn superior margins should be maintaining fiscal discipline, not just hoping for favorable markets to prop them up.

How to Create a Successful Strategic Alliance

By Rubesh Jacobs

One of my clients has entered into several strategic alliances. They have the product and access to the customers. They needed the advisory services in order to grow their business. Consequently, they inked agreements with premier advisory firms.

Similarly, firms in good financial health are looking for effective and profitable ways to grow. Clearly industry merger and acquisition activity is on the rise. However, gaining access to products and markets through alliances is just as effective for growth as an acquisition.

In the asset management industry, the business models of firms such as BNY Mellon and Nuveen are based on strategic alliances.

More often than not, strategic alliances in the asset management industry meander with no focus or fail to deliver on their objectives altogether. Several of past and present clients have alliances that could be very profitable, but sadly are not.

Instead of dwelling on why they fail, let me point out the key questions to ask when planning a strategic alliance.

Strictly speaking, only Joint ventures, Equity alliances, and Non-equity alliance are strategic alliances. However, in the spirit of accommodating a wider array of agreements that are generally called strategic alliances, I encourage you to think of scenarios where firms agree to exclusivity, or a key client is treated differently because of the volume of business.

1. What is the driving reason for the strategic alliance?
Objectives can range from association with a credible brand, access to a distribution channel, access to products, and access to international markets, to eliminating the risk of outright acquisition. Regardless, the company has to determine why a strategic alliance is the best structure to execute its strategy. Here lies clarity for the objectives of the strategic alliance. This is also the source of the value from the alliance.

2. What constitutes the foundation of the alliance?
Legalese notwithstanding, the company has to decide which of its resources and capabilities (assets) are valuable to potential alliance partners. Is it high-performing mutual funds (products)? Is it a fantastic brand? Is it market share (access to distribution)? Remember, this is what you are selling to a potential suitor. Get the facts straight.

Keeping in mind the answer(s) to #1, what are you willing to give up in order to get what your alliance partner has? Be very careful about what you are asking for in return. Specificity is critical.

The risk of moral hazard (partners providing resources and capabilities of lesser value than represented) is high when the stakes are high.

3. What are the performance goals for the alliance?
Have a crystal-clear view of what you expect to see from the alliance. As with any other business venture, draw up a business plan to support the theory behind the alliance. The short and long terms goals of the business plan are they key milestones of the alliance. Revenue targets, profitability, productivity, market share, and other metrics will be the key indicators of the health of the alliance.

4. Who is the right partner(s)?
Treat selection and due diligence of target partners just as you would an acquisition. Not all potential partners are good alliance partners. Their culture may not fit with yours. They may have skeletons in the closet. The risks may outweigh the benefits.

As with mergers and acquisitions, this is where most strategic alliances start going down the tube. Once close to the "deal," walking away become very difficult.

5. How will it be managed?
Read day-to-day management as well as governance. Who from each firm is accountable for the smooth running of the alliance? How will key decisions about the alliance be made? How will periodic reviews be conducted?

6. How to exit?
If the performance criteria are not being met, then it is time to exit. There is generally little exception to this rule.

Ironically, the exit has to be planned during the setup. While it's impossible to foresee the future, there is sufficient information and experience within your legal team to determine why and how to exit gracefully.

Partnerships are an important and cost-effective way of growing a business. I know a few foreign asset managers who made acquisitions to enter the U.S. market. The post-merger results have been lackluster at best. One of our clients is considering options on how best to enter the U.S. market. Among the options we recommended is a strategic alliance. Why? It is a way to learn about the market and its nuances, hedge against incorrect valuations, post-merger integration challenges, and cultural fit. Moreover, you could still structure an agreement that includes an option to acquire.

The point is this: strategic alliances are a great tool for growth, but they have to be crafted and executed intelligently.

Should Schools Bribe Kids? Should Asset Managers Bribe Better?

by Mike Ma

I know I am on this purpose and mastery-driven compensation kick in the last few months month, but it's everywhere I look. Time's cover story this month, "Should Kids Be Bribed to Do Well in School?" has a lot of interesting implications for our industry.

They cover the controversial work of Roland Fryer, a Harvard economist, who is testing the effects of paying kids for school performance.

Fryer ran different experiments in paying kids to learn across the in 4 cities. The results are summarized in this graphic:

While I don't want to start a policy debate (Fryer himself has received death threats), it is very interesting to note that the classes in Dallas and Washington had more favorable results. For instance, the Dallas kids had reading scores that went up by .4 standard deviations, the equivalent of 5 extra months of schooling. Why? Because they are incentivizing behaviors, not results.

Kids may respond better to rewards for specific actions because there is less risk of failure. They can control their attendance; they cannot necessarily control their test scores. The key, then, may be to teach kids to control more overall -- to encourage them to act as if they can indeed control everything, and reward that effort above and beyond the actual outcome.

Or this nugget form says Joshua Zoia, who founded the much publicized KIPP Academy:

Our ultimate goal is to get kids to be intrinsically motivated. But we have to get kids hooked in. We have to meet them where they are.

In short, what if we substitute the word "kids" with "employees," can we learn something? Could we do something different in our compensation plans this year or next? To paraphrase Dan Pink, it's scary sometimes to look at what social science knows, and business ignores.

Please feel free to call/write to discuss!

4th Quarter Margins Flatline, but Closer Look Shows Most Asset Managers Continue to Recover

by Eric Daugherty

A few months back, I portended an earnings rebound for asset managers, and the 3rd quarter seemed to bear that out. Now that 4th quarter earnings are in for all the publicly traded asset managers, what do they tell us about the state of the industry?

S&P 500 Level

With a backdrop of largely rising markets (see level of the S&P above), the universe of publicly-traded asset managers collectively managed margins that were only equal to the third quarter. And, full-year 2009 margins still fall well short of 2008 margins.

However, a closer firm-by-firm look shows that most companies' margins bottomed out in the first quarter and continue to recover. This chart show operating margins for all fourteen publicly-traded firms.

Aside from a few aberrations, firms continue to improve their margins as the market environment improves. The few exceptions are Alliance Bernstein (taking a step back this quarter), BlackRock (which incorporates massive BGI figures for the first time), and Legg Mason, Waddell & Reed, and Invesco, who continue to trail the pack. Legg Mason and Alliance Bernstein were the only firms to see assets under management decline in the quarter.

Looking forward, I amend my prior forecast. Previously, I thought that rising markets and aggressive cost-cutting would lead to margin bonanzas. However, recent market events and financial figures lead me to believe that markets will hold steady and the industry will not continue its rationalization of costs and structure. Even if there is a "new normal" per Bill Gross, of lower growth and suppressed asset returns, the pain is too recent and rationalization is too hard to continue unless crisis demands it. A few aggressive opportunists will continue the hard work; everyone else will take a deep breath.

Firms need to continue to focus on rationalizing their structures. The threat of another downturn remains. In addition, regulation, industry maturation, and increasing consumer focus on fees portend eventual margin compression. Firms that prepare now will be set to thrive in an increasingly competitive future - in particular, smarter distribution, use of the web to drive marketing and efficiency, and leveraging emerging channels like social media will increase asset managers' ability to preserve healthy margins as long as possible.

Wholesalers Find Success by Focusing on Fewer Advisors

by Steven Miyao

On average, asset management companies' wholesalers currently cover 3.4 states, totaling about 1,550 advisors. These wholesalers average only 1.57 visits per year to each advisor they meet with. Our research has shown that this is problematic for two primary reasons:

1. Many advisors go without any wholesaler visits
2. It doesn't enable the wholesaler to maximize their meeting to sales ratio

Our FA Vision data shows that there is virtually no difference in advisor advocacy when a wholesaler meets an advisor 0-2 times. However, there is a 29.6% increase in advocacy with 2 to 3 meetings, and a whopping 75.9% increase with 2 to 4 meetings.

This data clearly shows that it pays for a wholesaler to see an advisor at least four times per year and that this substantially helps the wholesaler to build a strong relationship with the advisor. On the flip side, it doesn't pay for a wholesaler to meet with an advisor less than 2 times a year.

Wholesalers are pressed for time and have too many advisors in their territories. If wholesalers need to meet with advisors at least four times per year to get a higher yield for their meetings, wholesalers can't cover more than 200 advisors.

To maximize productivity, firms need to identify focus firms and focus advisors within territories and ensure that wholesalers are directed to spend their time with these key 200 advisors. 63% of firms currently incent their wholesalers on focus advisors, while 47% of firms incent wholesalers to spend time with focus firms.

ETFs and Mutual Funds: What is the real relationship?

by Drew Maniglia

One does not need to have an ear to the ground to notice the ubiquity of Exchange-traded funds in today's asset management industry. The ETF makes frequent appearances in industry journals and articles and can even be found advertised atop New York City taxicabs. But, despite the to-do, I am not convinced that the lay investor, and perhaps even experienced financial advisor, truly understands the difference between ETFs and other types of investments, specifically Mutual Funds.

Recent articles in Ignites have discussed the ETF's entrance into new platforms like 401ks and annuities. Furthermore, throughout both 2008 and 2009, the ETF's market share continued to expand while Mutual Funds experienced negative net flows. Hordes of new ETF products continue to appear on the market, and more fund companies have stepped into the arena. Many advisors surveyed in the 4Q:2009 FA Vision Benchmarking survey mentioned their satisfaction with and preference for ETF products in the qualitative response sections.

But, do investors and advisors understand how to appropriately use all of the available investment tools? To many, the ETF looks like a Mutual Fund that can simply be day traded; in this respect, it appears to be the "better" Mutual Fund, or a Mutual Fund with added benefits. Perhaps ETFs and Mutual Funds are not meant to be used interchangeably, though. Asset management companies should be sure to carefully distinguish between these tools. A campaign to turn the public's attention towards the burgeoning ETF should be accompanied by an educational campaign to highlight its intended applications and distinguish it from the Mutual Fund. This presentation from iShares is a good example.

If investors and intermediaries are to yield maximum value out of the myriad available investment types, it is integral that they should understand the specific purposes of each.

Retail + Institutional = 2010 Priority... for real this time!

by Mike Ma

Last week, I delivered a keynote address at the Institutional Investor Institute's Senior Delegate Forum, and I wanted to share the slides with our blog community. My message to this audience, consisting mostly of people from the institutional side of the business, was clear. Given that our blog's primary readers are retail, let me summarize my points and why they should matter to you.

1. The merging of retail and institutional is happening now and you need to care
2. Retail is responding to this but it isn't happening fast enough
3. Real financial and organizational changes are happening right now
4. Institutional organizations are well-positioned to move in on this opportunity

My desire is not to create internal competition. My point is that the walls between these organizations should come down if they want to get in on this opportunity before someone else does.

I would love any comments, or thoughts from the community. Please call or email me to discuss!

Show Clients What They Need: Assets Are Nice, But Income Pays the Bills

by Eric Daugherty

e-Business teams have a huge opportunity to drive improvements in content that clients see. Specifically, when it comes to thinking about retirement, firms do not yet make it easy for clients or advisors to make sense of how their holdings translate into retirement income.

I do not really care about my financial assets - I only care about what they can buy. Asset management firms thus far are not progressive enough in helping investors like me make the connection between assets and future income. In December, this article pointed to a logical starting point - a Senate bill called the Lifetime Income Disclosure Act, which would mandate (for 401(k)s) a calculation of annuity income, similar to what the Social Security Administration does with its annual statements. This would be great, but is only a start.

Most of us have up to three buckets of assets from which we will draw in retirement - and each of the three buckets will have different tax treatment:

1. Pre-tax income; 401(k)s, non-qualified plans, defined benefit plans, for example.
2. Post-tax assets; Roth IRAs and other vehicles on which we have already paid tax.
3. Combination assets; Traditional IRAs and taxable accounts, in which we have some tax basis.

For example, say a couple has $2 million in assets. Sounds great - but is this enough for them to retire and enjoy the standard of living they want? It depends, and requires converting the assets into prospective income streams.

Here's where asset management firms can help. Firms holding these assets have all the information necessary (except the taxpayers' tax rate, which could be asked or assumed) to convert assets into an income stream. Here is how it would work:

This end result (in the Brady's case, $63,420 of annual income) is what investors care about. This is the money they will need for vacations, health care costs, utilities, and food. But most investors will not understand the analysis above, nor will they get it right on their own. They need help - this language of pre- and post-tax assets and annuity streams is foreign to many, and firms should help investors translate this into what matters to them - income. e-Business teams should be thinking about presenting content like post-tax retirement income streams. Even more than slick videos and market commentary will, giving investors content they need will foster loyalty.

2010 Predictions

by Steven Miyao

These are interesting times in asset management. Aside from ups and downs in the markets, we have seen significant changes in the economy, industry product trends, distribution and e-business. So, I will lay out a few prognostications in each of these areas:

Industry trends:

1. Bond flows continue to dominate (>70% of flows) early in the year. Flows into equities dominate (>70% of total) the 2nd half of the year, after definitive data says that the economy is improving. Continuing a long-standing trend, investor flows follow performance. Strong equity flows replace bond flows after the stock market surges and after interest rates start to rise and bond prices fall.

2. Net flows continue to go predominantly to low fee shops, as the miniscule total returns of the past 10 years magnify the importance of fees. Those shops without low fees only draw net flows if their products are truly differentiated.

3. From a trough of 18% in the 1st quarter of 2009, gross profit margins for firms climb back above 30% again (2008 margins were at 30% for publicly traded asset managers). The ultimate winners will be those who maintain their focus and fiscal discipline even after assets recover, setting themselves up for sustained, intelligent growth.

Strategy and product:

4. M&A picks up, in number if not in dollar terms. Firms have shored up balance sheets. Those in the best financial shape look to acquire in order to expand international presence, shore up product gaps, bring on an attractive brand name, and gain scale. Small to mid-size firms with entrenched brand names or specialized product expertise are attractive targets. While we don't expect to see deals of the size of BlackRock/BGI, we do expect to see a handful of mid-size household names change hands.

5. Guaranteed income products become hot, both in and out of retirement plans (albeit hotter in retirement plans than outside). Limiting downside risk in portfolios continues as a focus for retail and institutional investors.

6. ETFs continue to proliferate and gain market share. Advisors continue to gravitate clients from open-end funds to ETFs as advisors understand how to optimize usage of ETFs and firms continue plug product lineup holes with all possible flavors of ETFs.

Distribution:

7. Wholesaler compensation continues to recover. Average total compensation for external wholesalers, which was $372,000 in 2007 and dropped to $295,000 in 2008, fully recovers to 2007 levels. While the ample supply of talent looking for work should suppress wages, firms' healthier financial positions, their desire to take care of their best performers, and renewed positive net flows puts upward pressure on total compensation.

8. Ten of the top 20 firms in assets have hybrid wholesalers by the end of 2010. The cost-effectiveness of hybrids is being proven by the early adopters. Additionally, advisors indicate more willingness to deal remotely and less time to meet face-to-face, both of which point towards internals and hybrids becoming more important.

9. Firms continue to leverage technology by experimenting with video, audio, and web conferencing capabilities to deliver 1-to-1 (wholesaler-to-advisor) and 1-to-many (interactive Q&A with in-house experts) interactions.

e-business:

10. Social media becomes mainstream in financial services, but the level of commitment is varied, some firms diving in with both feet, some much more cautiously. Progressive firms experiment with different media in both B-to-B and B-to-C arenas. By year-end, 18 of the top 20 firms in assets have dedicated pieces of their budgets to social media.

11. Firms begin to move away from considering their websites as the central repository of content and towards supporting broader distributed content (e.g. SlideShare, Scribd). As print costs skyrocket, advisor only content becomes outdated, and people are free to distribute content anyway, firms will decide to make this as easy as possible by making their content portable and omnipresent. One major firm takes the leap, and spends as much on managing and facilitating data and content in the "distributed arena" as they do on their own website.

Industry Margins Almost Back to 2008 Levels - With Assets Down

by Eric Daugherty

Last month I wrote about the industry earnings rebound. Now that earnings are in for all the publicly traded asset managers, what do they tell us about the state of the industry?

kasina Revised Forecast for Industry Operating Margins

Firms included: Alliance Bernstein, BlackRock, Calamos, Gabelli Asset Management, Pzena, Affiliated Managers Group, Legg Mason, Franklin Templeton, Invesco, TRowePrice, Eaton Vance, Janus, Waddell & Reed, Cohen & Steers.

Here are some observations gleaned from the latest earnings:

Retrenchment has worked - while we are not all the way back to 2008 operating margins on a full year basis, it's likely that 4th quarter number for 2009 will be even stronger than 2008 figures. Fairly rapid cost cutting and prioritization have combined with the market recovery to land firms in very strong shape financially. Psyches may not have healed yet, but balance sheets have.

It is too early for complacency - our prior forecast was for 3rd quarter operating margins of 31.6%. Actuals were 27.5%. What changed, primarily, was that 3rd quarter operating expenses for these firms were up 6% from the 2nd quarter. With a closer look, this $200M expense increase was mostly driven by three firms, and half of it derives from higher revenue-based costs (e.g. commissions). Another 20% of it appears driven by one-time severance and legal settlements. So, this increase is not cause for alarm, but it is worth watching, as a 6% increase per quarter is clearly unsustainable.

Size matters - we have been talking about the importance of scale for the last six months, and believe it will matter greatly in the future. One notable aspect of the industry financials is that the biggest firms have the same margins as other firms. We know that the biggest firms sell product for lower costs, so they must be leveraging size to effect lower unit cost structures as well, which makes sense. When I split the group into the largest four (Monsters), middle five (Mediums), and smallest five (Minis) by assets, there is little difference in operating margin. The largest firms are just making these healthy margins on a much larger base of assets, creating huge profits.

Not all are thriving equally - among all sizes, there are winners and losers. Of the fourteen public firms, three have operating margins less than 20%, and two have operating margins greater than 40%. These firms' performance persists from quarter to quarter.

Look for more M&A activity - everyone suffered in the downturn. Firms are now returning to thinking about the future. With the industry experiencing improved financials, those firms still underperforming will stand out, and may look for white knights. Given our maturing market and the challenges associated with organic growth, firms with strong balance sheets and a desire to grow will look to prey upon the laggards, particularly those with healthy brand names.

Here Comes The Earnings Rebound

by Eric Daugherty

BlackRock's earnings are a sign of what is to come. While we might not be back where we started in the market or with investors trusting the industry, we are close to claiming a return to healthy industry profitability.

kasina looks at industry profitability quarterly, using data available from the publicly traded asset managers, and triangulating with news and other insights. Starting in the second quarter, things began looking better for the industry.

That earnings started to rebound in Q2, 2009 is no surprise. In our industry, earnings are a function of assets under management and cost structures. While we took huge earnings hits in Q4, 2008 and Q1, 2009, companies responded by cutting their cost structures, with roughly a one quarter lag to the market turmoil. By the April/May timeframe, most of the cost cutting had been done - right in time for a healthy market rebound.

We anticipate that the drag of 1Q and 2Q, 2009 will still leave full-year 2009 average margins at about 27-28%, shy of 2008 (29.7%). The good news is that the industry is prepared to capitalize on the market rebound and skinnier cost structures and have robust earnings in 3Q and 4Q that are equal to or better than they were prior to the market meltdown. We anticipate 3Q operating margins averaging 31-32% and net margins of 22%, both numbers better than full-year 2008 margins.

With healthier balance sheets and P&L's we anticipate that firms will return to a focus on growth opportunities, particularly M&A and selective product innovation. It is a bit premature to declare that we are out of the woods. Certainly we need to learn lessons from the recent turmoil, there is still downside risk in the market, and there are challenges to regaining public and investor trust. However, it does appear that industry profitability is back on solid footing.

Investor to Financial Firm: How To Earn My Trust

by Eric Daugherty

A colleague whom I met recently is thinking of starting a web-based business aimed at young investors. She asked me how to build a "trusted" brand. This got me thinking about what investors would say to financial firms regarding building trust. Here's what that would sound/read like.

Dear Financial Firm, Advisor, or Broker,

There is a lot of noise in my ears from talking heads on TV, market updates, friends at the water cooler. It is hard to know whom to trust. I want to trust you. I need to trust you. There are very few people I need to trust . Trust only matters if:

• We're dealing with something important; and
• I cannot easily and quickly verify the value proposition I receive over time and ascertain whether I got a good deal.
• In other words, I only really need to trust my wife/husband, my doctor, the folks who made my car, and my financial provider.

The good news is that earning my trust is easy. Aside from the obvious aspects of a customer/provider relationship that are givens (answer my calls, do not make errors on my account), here is what will engender my trust:

1. Be clear on what I get for my money. How much do I pay and what does it buy me? What is the value proposition in plain English? I am a smart person in my field, but that field is not finance, so talking about basis points, double reverse inverted ETFs, and straddles based on the VIX just makes me feel overwhelmed. Help me understand what I will pay, in dollars, for what I receive.

2. Tell me how you make your money. Shed some light on your incentives. I am suspicious unless I understand what's in it for you. I don't mind paying a fair price and you deserve to make a profit. If you charge more than others, tell me why. What is different about your product or service that warrants a higher price? If you don't share this information, I will presume that you are hiding something.

3. Don't play with the truth. Burger King sells me on taste and convenience. If they tried to tell me that my Double Whopper with cheese was good for me, I would be angry. If Walmart tried to convince me their clothes were high-end, I would not trust them. Yet brokers try to convince me that I need to trade stocks to make money, and closet index funds try to charge premium prices with no additional value provided to me. If not dishonest, this is at least disingenuous.

It's as easy as that. I want to trust you. Tell me the truth. Explain in plain English what I get for my money and what's in it for you. Serve me well, and I will be your loyal investor for years to come.

Sincerely,
Joe or Joanne Investor

Is it Easier to Service the RIA Market Today?

by Deb Wetherbee

Historically the RIA market has been a challenging channel for asset managers to cover for many reasons. Generally speaking, RIAs do not like wholesalers, do not feel asset managers contribute to their value proposition, have fickle, "entrepreneurial" personalities, and are located in disperse geographic locations. This makes coverage models frustrating and expensive. However, there are clear signs that RIA receptivity to asset managers is changing.

The current market environment has led many advisors to change firms and to shift channels altogether. In addition, RIAs core investment philosophies were tested over the last year. These facts, combined with asset growth in the channel, make the RIA channel very appealing. More than 70% of RIA's new assets are coming from full service firms, according to a TD Ameritrade survey.

By some accounts, it appears that RIAs may even be eager for your advice. We saw this in the wirehouse and independent channel as early as last December. Our partner, Horsesmouth had a record number of financial advisors seeking out content, asking for advice on how to talk to their clients, and simply looking for a place to share the horrors of the day. These sentiments were echoed at kasina's recent Distribution Summit by Ron Fiske, EVP at Fidelity, as he discussed the Registered Investment Advisors that his division services. After selling to RIAs in the late 1990's myself, it was refreshing to hear that the time may have come for RIAs to willingly accept information from asset managers. RIAs are looking to understand and to provide clients with explanations. Whether economic, portfolio related, or tax-centric, it appears that your thought leadership will now be well received.

This paradigm shift, in conjunction with the fact that RIAs appreciate web-based communication, makes servicing them a profitable proposition. Our FA Vision research shows that 61% of RIAs prefer web / e-mail based communication over the more expensive phone and in-person service. There are many successful hybrid teams servicing this channel, which is a much more efficient distribution model.

As you develop your 2010 plan and focus on profitability, think about the RIA channel. Keep in mind that you may finally be able to leverage your existing content. Review your economic and portfolio manager content and communication strategies, and think about webinars and hybrids. It is even likely that an existing business-building program is perfect for this audience. The strategy to grow your RIA business could be a profitable one for a change.

Excessive Fee Case - Earthquake or Tremor?

by Eric Daugherty

Look for the Supreme Court to send a message to the fund industry, but not to support fee caps or other interventionist measures. Even if the Court does not find in favor of the plaintiffs in the Jones v. Harris case (for background, see this Wall St. Journal online article), firms should anticipate continuing scrutiny around fund simplicity, independence, and transparency going forward.

It is remarkable enough, and a sign of the troubled times in the financial industry, that the Supreme Court is going to hear a case on excessive mutual fund fees. What will the outcome and lasting implications be for the asset management industry?

The case hinges on the fairness of fees and the independence of the directors that set those fees. With all the focus on executive compensation lately, the case has drawn attention to the level of executive and Board compensation and how those costs can inflate fees.

The precedent in question in this case is the so-called Gartenberg standard, which indicates that an advisor breaches his fiduciary duty only if fees are so disproportionately large that they bear no resemblance to fees that could be negotiated on an arms-length basis.

Fund industry veterans know that fees are unjustifiably high for some funds. It is clear that not all fund directors are truly independent and that boards take most of their direction on fees from management. However, one is hard pressed to say that investors do not have choices or that competition does not drive expenses lower . Fund flows are increasingly going to lower cost funds (laid out here - and this trend continues today).

So no matter how egregious the fees of a fund, investors have plenty of choice and can take their money and turn to lower-expense funds at will - and they do. That is competition. As such, while I am not a lawyer, I do not see the Court deciding for the plaintiffs in this case.

However, I do think the Court will find a way to send a strong statement to the industry: SIT! In this case, SIT stands for Simplicity, Independence, Transparency. The system we have in place for investors to invest in mutual funds works, but only if products are simple enough to understand, boards are independent enough to undertake strong oversight, and communication is transparent enough for all to see what is going on. Don't expect an earthquake of change and reform to germinate from this case, but there will be some tremors resounding after it is over. Asset managers should be anticipating these tremors, and should be thinking now about how to position their products to meet the SIT test.

SEC-FINRA Warns Investors

by Eric Daugherty

If your Uncle (Sam) is your (Big) Brother, are you better off? And, how much should governent be doing to protect us from ourselves? These questions arose from the joint SEC-FINRA alert regarding leveraged ETFs and sparked debate in our office last week. On the one hand, some of us are anti-government-intervention and pro-free market. Do we really need Uncle Sam (or in this case Uncle Sam AND the industry) playing Big Brother and telling us what is suitable for our portfolio? On the other hand, the last few years have shown us that there is too much complexity and opacity in financial products, and American investors hold too much in their portfolios that they do not understand.

We will certainly continue to see more of a push for transparency in product details, which is needed. Leveraged ETFs are a perfect example of how a seemingly great idea can actually be a wolf in sheep's clothing. In theory, leveraged ETFs may make absolute sense for investors who are willing to expose themselves to magnified gains or losses. If I am 30 years old, rich, smart, good-looking, and charming (hey, if I'm claiming to be age 30, might as well embellish across the board), believe in the market going up over my 50-year investing horizon, and am willing to accept additional risk, why limit myself to an arbitrary 0-100% stock allocation instead of investing in a 2X market portfolio? This was once vein of the argument in our office.

In concept, it made sense. Then we delved a bit deeper. It turns out that we didn't full understand the intricacies involved in these products. Specifically,

• Even over long time horizons, ETF returns can significantly decouple from the benchmark return
• To maintain the leverage ratio, the ETF must buy into rising, and sell into falling, markets
• Almost by definition, they have high transaction costs, leading to high expense ratios See this slightly dated, but readable (and pro-leveraged ETF) article here that does a decent job of laying out the mechanics.

We have blogged before about the need for certain, innovative products. We hold products up to a litmus test that asks:

• Does the investment fit a particular investor need or solve a problem in a compelling manner?
• Is it reasonably low cost?
• Is it simple, transparent, and understandable enough for the average investor?

All three points here are vital: leveraged ETFs can say yes to the first, but not to the remaining two.

It would be ideal if investors and their advisors would do all the due diligence required to evaluate investment products fully, or learned quickly from being burned. Until then, though, expect this new age of oversight and industry/government collaboration to stick around for a while.

Crisis = An Opportunity Not to be Missed

by Eric Daugherty

There is a silver lining around the turmoil in the financial markets over the last nine months: people are paying attention and taking things seriously. Yet some asset managers are not capitalizing on this unprecedented opportunity to be pioneers.

In 1999, I attended a contingency planning conference where the organizers polled attendees. Question: What needs to happen for contingency planning to be taken more seriously in your organization? The #1 answer: A real disaster.

Contingency budgets ballooned after the tragedy of 9/11, and there was a laser-like focus on contingency planning. The parallel to the current financial markets meltdown is clear. Investor engagement in financial affairs is at a peak not seen since the Great Depression. A Money Management Executive article from July states that more retirees are worried about their finances and that 61% are working with a financial adviser (up from 56% in 2008).

"Turbulence is life force. It is opportunity. Let's love turbulence and use it for change."
-Ramsey Clark

There is a huge opportunity for asset managers to seize the day. Some firms seem to realize this; others do not. Over the last three months, we have spoken with senior managers and executives at most of the asset management firms. Their reactions to the markets crisis fall into three clear categories:

• Denial - the thought process here is, "This too shall pass. If we just duck and cover, conduct business as usual, and let time lapse, we will wake up in 2010 and the world will be right again."
• Defensive - "This is too serious to ignore. Clients and regulators expect us to be doing something. So, let's do what we can to avoid being labeled as the bad guy, and make some cursory changes in communication, product lineups, and management to show that we are part of the solution."
• Opportunistic - "The world has changed. There is an opportunity for innovative solutions and products and there is a dearth of communication and trust. We will fill that gap. Now is the time to be bold. We are here to help our clients and to lead them to greater financial security by being a trusted partner."

Note that these attitudes exist not just for companies, but for divisions, departments, and individuals. This is important because any person or entity can drive a discussion around which of these paths to take. For example, we spoke to one sales manager who said (paraphrased), "My team cannot afford to deny that the world has changed, and we cannot wait around for our clients, our competitors, or our firm to impose change on us. We must redefine what role we play, how we play it, and how it adds value to our firm in the new reality. My job as a progressive leader is to drive that redefinition."

Now more than ever, people are looking for straight talk, simplicity, products that meet their unique needs, and advice. There will be winners that emerge from this crisis. The winners in our industry will be the ones who take the opportunistic approach to confronting the crisis and meeting it head-on.

Top Mutual Fund Brands - American, iShares, and Ivy

by Lee Kowarski

Today, we announced that our recent FA Vision survey found that the mutual fund companies with whom advisors associate the most positive brand attributes are American Funds, iShares, and Ivy Funds. The results are based on the industry's largest-ever (to our knowledge) survey of financial intermediaries: 3,129 responses gathered from April 2nd and April 20th.

The firms with the highest Brand Association Score in the FA Vision survey are:

1. American Funds
2. iShares/Barclays
3. Ivy Funds
4. PIMCO/Allianz Funds
5. Vanguard Group
6. Franklin Templeton Investments
7. BlackRock
8. Fidelity/Fidelity Advisors
9. JPMorgan Asset Management
10. Natixis Funds

While many of the traditional intermediary-distributed fund companies are viewed positively by advisors, we are glad to see that the hard work of some newer players is being recognized as well. American Funds has certainly established itself as a leader in several areas, including consistency, dedication to advisors, ease of doing business, and trustworthiness. Other firms were also well received, particularly in certain niches. iShares and Ivy Funds, for example, were viewed as exceptionally innovative, PIMCO as especially sophisticated, and Vanguard as the least expensive.

The FA Vision Brand Association Score is an average of evaluations of a firm's brand by advisors who do business with that firm regarding each of the following attributes:

- Consistent
- Dedicated to Advisors
- Easy to do Business With
- Ethical
- Global
- Inexpensive
- Innovative
- Socially Conscious
- Sophisticated
- Trustworthy

If you haven't already done so, sign up for the FA Vision "Nugget of the Week" newsletter to continue to receive insights from FA Vision.

Source: Horsesmouth and kasina: FA Vision

Inflation and Tax Management Will Become Paramount for Investors

by Eric

There is a large first-mover branding opportunity to be had, but we are not hearing much about it yet. A quick word association test:

ETFs = Barclays.
Index funds = Vanguard
Bonds = PIMCO
Tax management = Ummm
Inflation protection = Well...

No one seems to own the inside track on inflation protected or tax managed products, yet they are bound to become critically important to investors over the next twenty years. Here is why this opportunity is ripe for the picking.

Fast forward twenty years (2029) and tell me if this stretches the imagination:

• Rampant deficits from the 2007 - 2011 recession have left national debt at astronomical levels


• While President Obama spoke of fiscal restraint after the deluge of spending during the 2007 - 2009 financial crisis, his successors never scaled deficits back to pre-crisis levels


• Medicare is defunct


• Social Security is bankrupt, returning twenty cents on the promised dollar


• Given all of that, tax rates have gone up across the board. The top marginal rate is 50%, capital gains are now taxed the same as ordinary income, the preferred rate on qualified dividends has been abolished


• Partially as a result of printing money for a half-decade to prevent a depression, inflation has spiked from a relatively sanguine 2%, to a consistent 5%

To simplify, there are only three ways the U.S. can get the money to pay off debts:
1. Grow the economy rapidly enough that foreigners pay us for products we make or services we offer
2. Collect more in taxes (more profitable if we do this in addition to #1)
3. Print money to pay off the debts

If we cannot grow fast enough to pay off debts and we cannot let debt grow forever, then we are left to raise taxes or print money, which ultimately drives inflation.

Should any or all of the bullets above come to pass, investors will need to worry far more about inflation protection, tax costs, and after-tax returns than they do today. Because we can anticipate more modest asset returns going forward, investors and advisors need to start paying attention to this now for two reasons: (1) costs of any sort silently but steadily erode the growth of nest eggs over time; (2) rebalancing into tax-sensitive, inflation-protected, lower-cost funds can be difficult and costly to do in taxable accounts.

All of this means that asset managers and advisors have an opportunity to be at the forefront of these topics. Asset managers should tailor more of their products to address these needs (recent inflation-protected fund launches from Wisdom Tree and PIMCO show that they anticipated this) and start (or continue) talking to advisors and investors about them.

While the above theoretical scenario is twenty years in the future, the company that will be the industry leader in this space has already started addressing the issues. Which company will it be?

Death of the 401(k) - Misplaced Blame?

by Eric

It seems that many are wondering whether the 25-year run of the tax-deferred retirement savings vehicle known as the 401(k) is over. I believe that 401(k)s are here to stay, but need to be viewed and used in the proper light.

In a recent "60 Minutes" appearance, Rep. George Miller lambasted 401(k) plans as being opaque and rife for excessive fees. They can be. To the financial novice, these plans are complex and confusing. Certainly, more scrutiny is needed to insure that investors understand what they hold and are paying a fair price. This scrutiny will benefit investors, as more transparency will demystify retirement investing and lower fees will enhance returns. Of course, fee cuts will come out of the pockets of asset managers, but those asset managers with reasonable fees and transparent communication will survive this added attention just fine.

Separately, others are saying that losses in 401(k) accounts since the market meltdown proves that 401(k)s have failed as an instrument. This line of thinking strikes me as absurd, akin to my blaming the hammer when I slam my thumb. The tool has not failed. If anything has failed, we as users have. As Alicia Munnell points out in a fantastic piece here, 401(k)s were designed as a supplementary retirement savings vehicle. In addition, they were primarily designed (arising in the early '80s, when Baby Boomers were in their twenties and thirties) to be a tax-deferred accumulation vehicle.

That many sit today with insufficient savings to generate retirement income is more a testament to low savings rates, inappropriate expectations, and user error than to faults of the tool itself. With the additional transparency and fee pressure suggested by Rep. Miller, the 401(k) will still be here to stay as a perfectly good accumulation vehicle. However, they are not the sole solution to investors' needs. Higher personal responsibility and savings rates, and products geared towards retirement income generation, the transition from accumulation to decumulation, and risk reduction are needed to supplement 401(k) savings for many Americans.

Improving Your Distribution Strategy Based on Advisor Data = Advisor Vision

by Lee

As you may have read in Ignites this morning, kasina and Horsesmouth have partnered to launch Advisor Vision, a new service that provides executives with the information that they need to evolve their intermediary distribution strategy into one that is more profitable and sustainable.

Given the amazing amount of changes in the financial intermediary space due to the markets, broker/dealer mergers, etc., asset management firms have an increased need to understand what financial intermediaries are thinking and doing. At the same time, distribution executives are looking for guidance on how to improve the allocation of their resources in an effort to maintain profit margins, which are shrinking from an average of about 35% to 15% or less.

Recognizing these challenges, Advisor Vision taps into the Horsesmouth community of over 70,000 financial intermediaries from 300+ firms on a daily basis and provides asset management firms with detailed, actionable recommendations that are dictated by their business strategy. The frequency of the surveys and the transparency of the data are unparalleled in the market today. Along with the uncensored survey data, Advisor Vision provides clients with a level of customized analysis and recommendations that makes Advisor Vision a necessary tool for all forward-looking distribution executives.

More details are available online or e-mail me to set up some time to discuss our new offering.

Regaining Investor Confidence

by Eric

Investors' primary concerns these days are twofold: (1) is my money safe? and (2) does investing still even make sense? Asset managers and advisors used to have to prove the superiority of their products and services. Since the market meltdown and abuses of investor trust, though, the importance of stacking up versus the competition fades to a distant third after the two questions above. If asset managers are to grow and thrive post-recession, they need to face these two questions head-on.

The first of these questions is fairly straight-forward. Investors have heard enough about Madoff and Stanford to be very wary of turning over their money to just anyone. Discerning the real good guys requires some diligence. Ultimately, reputation, track record, social media, feedback loops and ratings, client loyalty scores, and redemption rates will all signal to investors who is trustworthy and who is not.

The second question for the industry is far tougher. Many investors regret having invested their savings over the last ten years (the "lost decade"). Investing in the markets, once taken for granted as a smart thing to do, has yielded poor returns for many investors. However, there are two ways for investors to react to the results, and the difference between these two viewpoints is vital for asset managers.

Some investors infer that they made a bad decision to invest at all. Others see the results as bad outcomes of good decisions, which happen from time to time. This is not just an academic distinction, because it has implications for future decision making. To hammer home the point, offer me an even-money bet based on the roll of a fair die: I win if it comes up 1, 2, 3, 4, 5; you win if it comes up 6. We roll the die, it comes up 6, and you win. Did I make a bad bet? No! I took a risk and made a rational decision that did not work out, one that I would take again as many times as you offered it.

One cannot always infer the quality of the decision merely from the nature of the outcome. Investing in the markets the last ten years did not work out too well, but that does not mean the decision to do so was poor. Inferring that they made a mistake may cause investors not to invest going forward, and this would be a mistake. Over the long haul, substantial evidence indicates that broadly diversified and regular investing in productive enterprises increases wealth. However, how one does so may change.

Some investors have learned that their risk-tolerance is not as high as they thought. For those clients, new products or services may be in order. Structured products with downside protection (e.g. principal protected notes), annuities, or portfolios including diversification beyond the standard long-only style box coverage may give some investors peace of mind and the courage to continue investing.

Asset managers and advisors recognize that investors are emotional. It is human nature to blame decision making for poor results; this minimizes the role that risk plays and leaves us feeling more in control of our destiny. But our rational mind knows that randomness plays a role in determining outcomes.

Therefore, if asset managers and advisors want to continue to thrive, they need to convince people with assets that investing still makes sense, and that investing the last ten years was a good decision with a bad outcome, not a bad decision. Only after making a strong case for their own trustworthiness and the sensibility of investing at all will asset managers and advisors be able to move on to discussing their particular products and services.

Getting Away With Insane VA Guarantees Does Not Make Them Right

by Lee

The big news today was that The Treasury Department has decided to extend TARP funds to a number of insurance companies. Whether you feel that government intervention is necessary or not, my primary concern is that companies won't be forced to learn from their mistakes. One of the main reasons that many of the insurance companies have gotten into trouble is by providing overly-aggressive guarantees in their variable annuity businesses.

Back in March of 2008, insurers were already struggling to maintain profitability when volatility hit a five-year high and the 10-Year Treasury Rate was around 4%. With volatility at significantly higher levels, and 10-Year T-Bills at less than 3%, radical change is necessary. While some insurers have suspended or scaled back their VA guarantees over the past few months, I am worried that many firms will take today's news as a signal to reintroduce outlandish guarantees as a means of attracting assets. I caution firms against this and encourage them to rethink their product development efforts.

While guarantees are attractive to the ordinary investor (particularly in this market), advisors are rightfully concerned. A recent survey found that more than 70% of Merrill Lynch advisers were worried about the risks that insurers have taken on with guaranteed-minimum VAs - and nearly a third said they doubted the insurers themselves understood those risks.

Industry wide, LIMRA reports that VA sales dropped 15% in 2008 and 30% in the last three months of the year. The key to turning this trend around is not higher guarantees, but rather a rethinking of the product - from product development to sales to marketing.

How Will Structured Products Evolve From Here?

by Eric

As recently as the Fall of 2008, structured products (SPs) appeared on track to be the new darling of the investment world. New products were popping up seemingly by the day, and sales had more than tripled from 2003 through 2008, to over $100 billion. Then came the credit crisis and subsequent massive aftershocks to the financial system. Which raises the question: how will structured products evolve from here?

"Structured products" refer to a wide array of packaged investments that generally link fixed income vehicles like notes or CDs to the performance of equity, commodity, currency, or other indices. The allure of SPs to investors is their flexibility to accommodate personalized risk/return profiles and to access strategies previously only available to bigger, more sophisticated investors. For advisors and asset management firms, SPs constitute a new, differentiated, and appealing revenue-generating product.

Now, in the wake of all the turmoil of the last six months, there are some clear factors that point to SPs becoming more prevalent and important in asset management going forward. Other factors indicate the opposite. These factors are summarized in the tables below.

The allure of making institutional investing techniques accessible more broadly and customizing risk/return profiles to suit investor taste is unlikely to diminish. Products like Principal Protected Notes, which allow upside participation in the stock market while retaining downside protection, are well-suited to serve the growing demographic group thinking about retirement income and risk reduction while needing to maintain an opportunity for portfolio growth.

However, the drawbacks that SPs face in the current environment are not trivial. Investor distrust of "the system" is at an all-time high. Any opacity or complexity in a product will be treated with skepticism. Product proliferation and the availability of nearly infinite varieties of SPs risk confusing the market. Low yields on fixed income products, combined with the volatility-driven high cost of options, make pricing SPs attractively a challenge. And, more government oversight, regulation, and added compliance costs are a virtual certainty in the future.

Balancing all the factors, we believe that SPs are here to stay. In the short term, the SP market will continue to grow, driven by demographics (demand) and what advisors think they can sell (supply). Ultimately, however, product proliferation will reverse, and new cash flow and existing assets will consolidate into a few widely available and easy to understand structures (for example, PPNs and leveraged index vehicles that magnify returns). The likelihood of increased regulation and oversight, as well as investor trepidation and distrust, will mandate that SPs evolve to be more transparent, low cost, and standardized.

Live Presentation - Marketing Improvements Through Web 2.0

by Anu

On Tuesday at 5pm (EDT), kasina is participating in BrightTalk's first inbound marketing summit - free to any registered participant. The entire summit is held online through an interactive Web 2.0 tool that features not only presentation, but also dialog, voting, questions, and a rating system.

We'll investigate topics such as wikis, blogs, and mashups as low-cost, rapid-deployment client engagement tools. Questions I will pose and lead a discussion on include:

• Will financial advisors comment, rate, & discuss asset management topics?


• What are the compliance ramifications of user-generated blogs?


• How can firms present a modern brand with the use of Web 2.0?

Please feel free to send a direct message through twitter or an e-mail if you'd like to see additional questions explored

We're looking forward to the discussion, and hope you can attend live. If not, the presentation will be available on brighttalk's Web site.

Looking Inside to Grow Defined Contribution Outside

by Anu

In a recent discussion with a client, we were pondering "How do you leverage your firm's internal groups to help support your DCIO business?"

The anti-Mike answer works: "it depends." The first three areas we discussed included:

• Institutional Investment Consultant Group: Why? Well, this group specializes in working with intermediaries. In an institutional mandate, the consultant is not too different than the Third-Party Administrator or Recordkeeper. Therefore, this group will have knowledge and methods to deliver for a TPA.


• Marketing: Why? Outside of business-as-usual support for DCIO, Marketing organizations allocate resources to support wholesaler efforts with financial advisors interested (or not) in the firm's investment products (e.g. mutual funds, separate accounts, ETFs, etc). Marketing can provide data on past programs, conferences, and campaigns that provided marketing lift. The DCIO team can leverage these "lessons learned" to improve meetings. At one firm, the DCIO team reviewed Marketing's mutual fund value-added programs only to realize at least two make great "lead ins" to defined contribution discussions.


• e-Business: Why? Defined contribution plans are complicated and difficult to understand. Advisors want to know on which platforms your funds have placement. Are you part of The Hartford's Aviator Program, because I use that? Building a simple site sub-section to list platform placement, includes press releases of large (and small) business won, and detail R share pricing facilitates an advisors selection process.

We're in an exciting time for Defined Contribution and there's significant growth opportunity. The first step is looking within and maximizing internal strengths.

Beware Focusing Heavily on the High End Advisor in a Downturn

By Mike Ma

In the downturn, I have talked with a number of distribution executives who are turning their attention to the high-net worth advisor, many of them RIAs. I urge some caution before getting too enamored with this strategy and I'd like to present an alternative.

Although this path is often argued to be attractive, we have to be realistic about the historical difficulty asset managers have had selling to this market in good times. Few firms have the products that these advisors want, and if they do, chances are they are already working with them. Advisors will call the manufacturers, not the other way around.

Clearly, creating a viable market entry strategy for high-end advisors is likely to be a mess if you are starting from square one in 2009.

I'd like to present a better alternative in times of near nuclear-level restructuring of the advisor market - to figure out mid-market sub-segments of advisors who will be around after the nuclear fallout, and get there first. An outstanding article in this month's Harvard Business Review that echoes this point, Value-for-Money Strategies for Recessionary Times (free).

The article highlights some best practices, and a good deal involve intelligent segmentation strategies that may hit the low end.

• Haier, a low-end player in the appliance market, cornered a significant, profitable portion of the refrigerator market too by catering to the needs of wine enthusiasts.
• Zhongxing Medical crippled GE and Phillips with low-end product and pricing strategies on mid-market radiology imaging machines.
• Acer Computers focused their laptop marketing toward airport business travelers while Dell is still taking out ads in newspapers.

While the examples outside of our industry go on and on, we might consider similar strategies we are hearing in our industry. Comments made during Steven's panel at NICSA by Bill Dwyer, President, Independent Advisor Services at LPL, indicated that they are focusing on a lot of advisors in non-urban areas were these advisors are very important to that community and they can be profitable in their model, even with production less than $300,000. Theory is that these could be forgotten targets that could withstand the storm ahead.

Finding these advisor segments are more likely to produce long-term value for money to the shareholder, and frankly as an asset manager, at least thinking for a bit outside the high-end advisor box might bode good things and long-term success.

Irrationality and Investor Decision Making

by Corianna

Check out Dan Ariely's presentation (see this link; you have to select Ariely's name from the "video" dropdown). And no, this isn't just because he's on faculty at my alma mater.

Here's why Ariely's presentation is worth 20 minutes of your life: Ariely's work is about human decision making - the driving force behind our economy, and the current economic crisis.

In his presentation Ariely describes how people's decisions are affected by the structure that their options are presented in. For instance, in one study researchers found that, when confronted with a simple decision - delay a scheduled surgery to see if ibuprofen would solve the problem, vs. perform the scheduled surgery - doctors are likely to act "rationally," and chose to delay the surgery. However, when the decision circumstances become more complex - delay the surgery to test for the effectiveness of ibuprofen and an additional medication, versus going ahead with the scheduled surgery - doctors chose not to delay the surgery.

So, why does this matter to asset managers? The key to surviving this crisis will to understand and anticipate investor decisions, which are not always rational. It's a well accepted fact that the structures of 401k plans (for instance, automatic enrollment), have a dramatic effect on levels of participation and the quality of investment decisions made by participants. Now is the time to take these lessons further.

Breaking the Buck, Shadow Pricing, and Other Money Market Concerns

by Lee

As many firms are re-examining their money market business, those that remain in the space will need to change their monitoring and reporting processes and also begin defining their capital support plans. At the NICSA Annual Conference this week, I had several discussions about money market funds and cash collateral vehicles and have tried to capture what is likely to happen in the business, along with an overview of the issues and considerations in this confusing and evolving space.

Money Market Overview

When the NAV of a money market fund falls below $1, it is said to "break the buck" - something that has only happened twice (in 1994 and this past September). Breaking the buck happens when the fund's investment income does not cover operating expenses or investment losses. The funds, which total nearly $4 trillion in assets and represent nearly 40% of all mutual fund assets, are reeling from historically low interest rates, frozen credit markets, subprime exposure, and a crisis of confidence. Although there is no requirement that a money market fund under Rule 2a-7 avoid breaking the dollar, there is tremendous potential reputational damage

The Future of the Money Market Business

• Exits: Given how difficult it is to make money from money market funds with short-term interest rates where they are, many firms are likely to exit the money market business altogether. For example, Janus announced last month that it "plans to exit the institutional cash management business" by April 30, following similar announcements by Munder and others. Typically, the cost of running money market funds is greater than the fees charged and since the difference is usually small, the funds are able to pick up profit on excess yield. Without that excess yield, firms may question whether they can stay in the game.
• Changing Regulation: The Group of 30's recent report included two key recommendations related to money market funds which are, in my view, unlikely to come to pass as written, but represent the overall direction that the industry is heading:
  
  
  1. Stable NAV Funds: funds wishing to continue to offer "bank-like services" (notably an assurance of a stable NAV) should be "required to reorganize as special-purpose banks, with appropriate prudential regulation and supervision, government insurance, and access to central bank lender-of-last-resort facilities."
     
  2. Floating NAV Funds: funds remaining as money market mutual funds should "only offer a conservative investment option with modest upside potential at relatively low risk." These funds should offer "no explicit or implicit assurances to investors that funds can be withdrawn on demand at a stable NAV."
     
  
  

  A detailed take on these recommendations is available from Stradley Ronon.

• Daily Monitoring & Increased Reporting: in order to ensure a money market fund's viability, firms will need to move to daily mark-to-market and yield monitoring from traditional weekly monitoring, review failed trades carefully, and increase reporting to senior management and the fund Board from quarterly to weekly (or at least monthly), including mark-to-market deviations and detailed portfolio characteristics.
• Capital Support Planning: In order to prevent a fund from breaking the buck, firms have several options - the most common of which is a Capital Support Agreement. CSAs are agreements obligating an entity to make investments in another company given a certain set of circumstances, and are often used to ensure the viability of a fund and its $1 NAV. Other options for firms include cash contributions, affiliated purchases of securities, and standby letters of credit. Regardless of the individual decision that is made, every firm that is in the money market business should work now to create a plan for capital support that considers their options and establishes funding guidelines.

Outcome Oriented Funds

by Steven

My last couple of days at the NICSA annual conference got me thinking about the viability of 40 ACT absolute return products.

Many baby boomers who thought that they were well diversified have seen their retirement goals slashed or erased by the current financial crisis. This has triggered distrust among investors towards traditional investment approaches causing assets to move into low-return cash-equivalent investments. Some asset managers are responding by providing investors with outcome-oriented products that mitigate risk, generate income, protect principal, and/or guarantee at least modest returns.

This year's NICSA conference was filled with heated debates on how to tackle the current financial crisis. In his keynote address, Philipp Hensler, CEO of DWS Scudder Distributors, pointed out that the nine Morningstar boxes are too highly correlated to provide sufficient diversification for investors to sustain the current drop in the financial markets. A theme emerged around the importance of using product innovation to better accommodate the changing landscape. The financial environment has changed and investors are now realizing that they were not sufficiently diversified.

Some firms have responded to the lack of protection via the Morningstar box diversification by creating 40 ACT products that move away from relative to absolute performance. Unlike relative return funds, which measure themselves against market indexes, absolute-return funds are designed to always produce a positive return regardless of the directions of the market.

Two examples of funds that fall under this category are:

• Putnam's Absolute Return Funds


• DWS's LifeCompass Protected Fund

Putnam's Absolute Return Funds is a family of target absolute-return funds that seek annualized total returns of 1%, 3%, 5%, or 7% above those of Treasury bills over a period of three years or more. The funds include two global bond funds and two multi-asset funds.

DWS's LifeCompass Protect Fund is an asset allocation fund with a10-year maturity that is designed to protect principal, limit down-side risk, and lock in gains on a daily basis. At maturity, shareholders will be able to redeem shares at the highest NAV of the fund. Different from Putnam's product, DWS has an actual guarantee that they are able to fulfill through a third party financial warranty. The warranty assures that shareholders will receive an amount that is at least equal to the highest NAV on the maturity date. The fund utilizes an enhanced constant proportion portfolio insurance ("CPPI") investment strategy in managing the fund.

These products have clear advantages:

• The investor can plan their retirement around these products because of their certain outcome


• Fees tend to be much lower than hedge funds and lower than variable annuities


• They fall under the same strict compliance rules as traditional mutual funds

Actively managed mutual funds will not be able to survive in this market environment if all they are able to do is outperform their competitors in a style box, but still manage to lose their investors money. The mutual fund industry needs to go the direction of absolute returns in order to combat low cost ETFs, as well as annuities.

Are Hybrid 401(k)s the Retirement Savings Vehicle of the Future?

by Lindsay

The 401(k) business, as it currently operates, seems unsustainable. Despite all of the regulations put in place around Qualified Default Investment Alternatives (QDIAs) over the past several years, and the subsequent mass migration into (supposedly safe) lifecycle and target date funds, 401(k) assets were down by more that $500 billion in 2008.

While most sophisticated investors understand that these losses will eventually be recouped when the markets rebound, the uncertainty around when this will happen is creating an awkward situation for anyone that has encouraged employee contributions over the past several years, particularly for those employees nearing retirement.

In the short term, firms are struggling to find appropriate strategies for communicating with employees about their dwindling 401(k) balances, but the larger issue is how this business will evolve to meet the needs of the market over the longer term.

Apparently, the product development teams at a number of asset management and insurance companies have been working on this issue, and the result is hybrid 401(k)s. These products combine the properties of traditional 401(k)s -- employee contributions to tax-deferred investment accounts -- with annuities in order to provide what amounts to a floor for potential losses, and an income stream upon retirement.

Though these products have met limited success thus far, I think we'll be hearing more about them in the future. Firms aren't going to go back to offering pensions to all workers (and they shouldn't -- just look at GM), but pure defined contribution plans without insurance aren't doing the trick either. Plus, hybrid anything just sounds cutting-edge: hybrid cars, hybrid wholesalers... hybrid 401(k)s! I like it.

What We Sell: Investment and Distribution Professionals

by Mike

I was on the Royce Funds site last week. Tooling around, one tidbit generated a strong reaction from me.

Chuck Royce manages or co-manages fifteen open and closed-end funds. Fifteen!

A few questions immediately popped into my head:

• How can he effectively manage fifteen portfolios? I know his firm has a small cap focus and employs 29 investment professionals, but I wonder how Mr. Royce's expertise can be fully applied across fifteen distinct products.
• Do financial advisors realize this and/or care? Financial advisors might only know if Mr. Royce manages the products they utilize, not the full scope of his responsibilities. Or maybe they know, but primarily value having the man that is the brand attached to their clients' assets.

Let's table the issue of portfolio manager scale (though it will be revisited). After my initial questions, I spent more time thinking that this situation presents an important a marketing question.

As an industry we speak in the language of products: new ones, ones that close or merge, and, of course, ones that are performing particularly well or particularly poorly.

What I like about Royce's site and brand is that it is first and foremost about people. The assets under management included in the firm profile hasn't been updated in more than a year. But the profile for Charlie Dreifus has already been updated this month to reference his recent 2008 Morningstar Manager of the Year award.

This prioritization is something most firms miss. Collateral and Web sites focus on products. Performance figures (not a guarantee of future results, of course!), Morningstar/Lipper rankings, and stock photos of retirees and middle-aged professionals walking the beach are the stock of our marketing trade. PM profiles are typically non-existent or minimalist and dry, including nothing about what makes them interesting as people.

Aren't people what advisors and investors are buying? The asset management vehicle is one that packages the ideas, expertise, and personalities of people who oversee and distribute them. I mean, is there a Head of Distribution out there who wouldn't argue that a vital reason for a firm's success lies in the wholesalers, who last I checked make zero investment decisions?

It's cliche, but people are firms' greatest, and in many cases only, asset. And while balance is needed to minimize the damage of turnover and other personnel issues, this asset needs to be more of a focal point when it comes to marketing. And not just the investment management talent, but everyone.

A switch to selling people, not products, suddenly makes attaching Chuck Royce's name to fifteen portfolios seem pretty savvy.

Twitter comes to Asset Management

by Anu

Twitter began in March of 2006. In two years (only had data up to March 2008), the service has gone onto significant success with nearly 3 million "tweets" each day.

Michelle already brought up twitter versus yammer last week.

This week, kasina joined Twitter at http://twitter.com/kasinaUS. Visit and "follow" our tweets as we share insights from consulting, research, and beyond. We look forward to fellow "tweeps" "nudging" us. If you have any questions about how to use twitter and want to start with an e-mail, send your question along.

Happy New Year

by Steven

I hope all of you had some time over the holidays to catch your breath. I caught mine in Chile, enjoying the beautiful climate and wonderful wine. But, coming back to NYC has not been easy. The financial climate has not gotten any better and the industry is still facing major obstacles. Here are my thoughts on how the current crisis is transforming our industry's distribution landscape:

Getting the Most From Your Wholesalers in 2009

by Lee

In our latest report, "Maximizing Advisor Interactions: Dos and Don'ts for Wholesalers," we lay out a series of recommendations for wholesalers based on insights from an extensive survey of 343 advisors and a series of in-depth follow-up interviews. The key steps, which most wholesalers fail to take today, are:

• DO Focus on Segmentation: A one-size-fits-all wholesaling model does not work. 80% of interviewed advisors believe that most wholesalers do not segment their advisor bases or attempt to customize their messages based on what is relevant or of interest to the advisor. At firms where advisor segmentation is being used, wholesalers should be given extensive training on how to use information on the segments to tailor their approaches going into advisor meetings. Whether or not firms have holistic segmentation strategies in place, however, wholesalers should be using all resources at their disposal to learn about each advisor's business before going into a meeting, in order to make the meeting as relevant and useful to the advisor as possible.
• DO Be a Product Consultant, Not a Salesman: While 91% of surveyed advisors said that it is helpful when wholesalers recommend specific products, 100% of interviewed advisors cited product "pushing" as their biggest wholesaler pet peeve, so wholesalers need to know the difference and be capable of doing the former without doing the latter. An advisor should feel that he is receiving customized advice on what products will meet his particular needs, rather than the same generic product pitch that the advisor before and after him is receiving. Wholesalers should assess an advisor's current needs, concerns, and knowledge gaps, and then be honest in their recommendations, saying if their firm has a product that can fill a specific niche, but admitting if their firm does not, or if a competitive product is a better fit. Winning an advisor's trust is more important, in the long run, than any single sale.
• DO Provide True Business Building Support: 74% of surveyed advisors said that whether or not a wholesaler "understands and helps me with my business-building needs" is either "very important" or "somewhat important" in determining whether they continue to meet with that wholesaler. However, many wholesalers today continue to simply drop printed copies of value-added programs on advisors' desks without helping the advisor to apply the program's tenets to her business or providing tailored support based on the advisor's specific business needs. Wholesalers should help advisors with their prospecting, client communication, and client retention efforts. Additionally, the movement of many advisors toward the independent channels presents an opportunity for wholesalers to provide advice on managing an advisory practice without the infrastructure and support that they previously received from their employers.
• DO Continue the Dialogue Between Meetings: After meeting with an advisor, wholesalers should make sure to follow up. Interviews with advisors revealed that many are dissatisfied with the lack of follow-up from wholesalers after their quarterly or semi-annual meetings. As one advisor put it, "If the only time I spoke to my clients was during meetings, they wouldn't be my clients for very long." 91% of advisors do want wholesalers to follow up via their internals, and 55% expressed a preference for e-mail follow up from internals. In keeping with the universally expressed desire for a more consultative wholesaling model, maintaining an ongoing dialogue between the firm and the advisor is essential to building a productive and enduring relationship.

If you can institutionalize these steps and ensure that your wholesalers follow them, you will stand a far greater chance of hitting your targets in 2009.

Presentations on Why e-Business is Sales, and Sales is e-Business

by Mike Ma

I've made this point many times, but I wanted to share some recent client presentations that demonstrate clearly why now is the time for e-Business initiatives, not retraction.

Let me know if you'd like me or someone from kasina to talk you through these points.

I Am Mad At Me

by Anu

For some ridiculous reason, I've started watching the talking heads on cable television. Why? I can't really say. Somehow, I want the news of the day distorted and contorted. Anyhow, why do any of us make these choices?

Simple, we're emotional and spontaneous. Yet, firm after firm seems to desire rote, tabular methods to market and sell financial advisors on the merits of their products. Firms will always get this wrong if they don't appeal to the emotions of the financial advisor in some way. Does the advisor worry about large-scale losses in client accounts? Does the advisor want to be seen as a hero to her clients? Do you know? Do you assess? Last week, Steven mentioned our proprietary research showing advisors are not panicking to move assets away from mutual funds. But are they shifting to funds with an emotional appeal to safety in times of duress? What decisions are advisors making?

Think about yourself and the decisions you make. Advisors have emotions and act on them. Look for kasina to bring more cutting-edge research in 2009 that connects emotions and decision-making.

What Makes a Good ETF Site?

by Johanna

During the research for the 2008 Top Web Sites for Financial Intermediaries report, I had the opportunity to review a number of prominent ETF provider Web sites, which got me thinking: What are the important differences between ETF and mutual fund (or other product)-focused Web sites? How does the criteria for an excellent ETF site differ from other types? A few key distinctions came to mind:

Importance of the Index: In addition to including information about the past performance and the goal of the ETF, it is also important to provide in-depth information about the underlying index. For example, Van Eck has a section within each product profile dedicated to index information. Especially with more products and varied product themes, understanding the inner workings of the underlying index becomes important for transparency and product differentiation.

Retail and Intermediary focus: Few mutual fund advisor sites have a section dedicated to "What is a Mutual Fund" or "Mutual Fund 101," even though this type of basic education is important for investors (who are an important Web audience). Furthermore, for newer products within the ETN space, the basic product education becomes paramount because many advisors really don't know what ETNs are or how to use them effectively.

Data Availability: Some mutual fund-focused firms pride themselves on the historical breadth and depth of pricing and performance information. On some sites, advisors can choose the historical time period to call up whichever combination of information data a decade or more back into the past. What about ETF sites? Given that the surge of product development didn't really get into full swing until after 2000, historical information really won't help. Instead, ETF sites do (and should) focus on presenting the data they have in interestingly visual ways. For example, ishares.com has charting tools for index error tracking.

Of course ETF Web sites cannot simply focus on the differences in products and audiences. Universal characteristics such as comprehensive site search and intuitive navigation, in addition to detailed and comprehensive content, are mandates for all product provider Web sites.

Are Retail Fund-of-Funds the Next Product Development Wave?

by Lindsay

When kasina wrote about the Future of Distribution at the end of 2007, product development emerged as a key issue at or near the top of most distribution executives' minds. While the vast majority of funds available to retail investors currently reside within one of the nine Morningstar style boxes, 73% of interviewed executives indicated that 2008 product development efforts would be focused on products not available in the market today (November 2007).

It's now September 2008, and the wave of new, differentiated products has yet to hit the market. Exchange-Traded Products (ETPs) have continued to proliferate, structured notes and 130/30 funds trickle out, but truly differentiated product offerings are few and far between.

One bright light in the product development landscape, however, is Janus' recently launched Janus Adviser Modular Portfolio Construction Fund (JSMPX). This Fund of Funds couples many product types popular with institutional investors, such as ETPs, alternatives, and derivatives, with more traditional mutual funds to provide exposure to investment vehicles usually unavailable to retail investors, while maintaining adequate diversification for a retail investor.

As fund companies try to lure risk-averse but performance-hungry investors back to the market, well-diversified funds with exotic components may turn out to be the products that strike the right balance. I suspect some copy cats will show up on the scene.

Net Promoter Score for Wholesalers

By Steven

Wholesaler performance is easily measured by looking at incoming sales. The difficulty lies in determining a course of action when both performance and sales are low. How can we judge whether the problem rests in the wholesalers and their processes, or if the products themselves are impeding positive sales?

As the result of recent discussions with our clients, I have started to judge wholesaler performance using more than the obvious metric of sales performance. I have also begun asking advisors this question: How likely is it that you would recommend the wholesaler to a friend or colleague?

The responses to this single question generate a Net Promoter Score, a concept that was first introduced in a 2003 article in the Harvard Business Review. Based on their responses to this question, customers are categorized into one of three groups: Promoters, Passives, and Detractors.

Promoters are valuable assets. They drive profitable growth through repeated or increased purchases, loyalty, and referrals. Detractors, however, are liabilities. They destroy profitable growth with their complaints, reduced purchases, defection and through negative word-of-mouth.

The Net Promoter Score is calculated as follows:

% of Promoters - % of Detractors = Net Promoter Score (NPS)

In this volatile market environment, the Net Promoter Score can effectively measure and motive wholesaler performance.

The No-Traveling Salesman

by Mike McLaughlin

"Within five years, technology will obliterate the need for business travel." - an entry in The Big Idea series from Fast Company

The assertion is easy to dismiss, and would probably draw laughs in many of the traditional intermediary sales organizations in our industry.

But as I dined on my knees folded into an "economy-minus" seat for six hours on a recent cross-country flight, I began to think the idea has some teeth. Consider:

• Travel continues to be less appealing. Elevated oil prices have triggered rising airfares, not to mention ancillary costs, and a decline in driving across the country. Time spent in traffic has nearly tripled over the last two decades. And decent legroom in coach doesn't come free.
• Technology continues to improve. A wise former employer of mine is just one company using cutting-edge videoconferencing technologies to save millions and improve the quality of remote interactions.
• Companies increasingly think green. Nationwide cut its carbon footprint by 80% over five years in part due to reduced travel, and Calamos has constructed a certified green headquarters.

Less travel. Enhanced technology. Positive environmental impact.

The proliferation of hybrid wholesaling is just one way that these trends are manifesting themselves when it comes to selling to financial advisors. Maybe it's just the start.

It Takes a Village

by Lee

Last week, Barron's wrote about Trader Mark -- a.k.a. Mark Smith -- whose blog, Fund My Mutual Fund, has helped him raise $3 million towards a $7 million goal and the potential launch of a mutual fund. The article has all the juicy details about Mark's Rising Tide Growth portfolio, but what I found most interesting was one of the social networking sites mentioned: Marketocracy.

Using community input to guide investment decisions and providing higher levels of transparency are nothing new -- Metamarkets comes to mind from the late '90s -- but Marketocracy takes this to another level. The firm boasts over 55,000 people managing over 65,000 model portfolios. Based on the 100 best investors each month, Marketocracy creates the m100 Index, which is in turn used as input for Marketocracy Capital Management's investment decisions in their mutual fund. They have even signed research contracts with about 500 members of their community.

Listening to individual investors' ideas about individual securities is not going to be the right research approach for every portfolio manager, but I do think that every firm can learn from Marketocracy and from Mark Smith: in the never-ending quest for alpha, firms must get creative in their investment approaches. Online communities are only one piece, but they can be a valuable tool in identifying product or investment trends and in identifying and recruiting investment talent.

Funds Cannot Get Sued Over Sudan

by Steven

The investment situation in Darfur illustrates why it's good business for mutual funds to be more socially conscious.

When I go to the grocery store, I look for three things: quality of produce (taste and health benefits), cost, and the environmental impact of the produce.

Should fund firms let social awareness determine which companies they work with, or should they just focus on getting the maximum return for their investors?

A recent SEC ruling provides a "Safe Harbor" for mutual funds that divest from Sudan. This ruling provides certain legal protections to funds that divest from companies (PetroChina, Sinopec, India's Oil and Natural Gas Corporation Ltd., Petronas, Schlumberger, and Tatneft) doing business with the Sudanese government. Under these legal protections, the fund firms cannot be sued for making investment decisions based on divestment criteria.

Divesting in companies that do business with the Sudanese government is a choice--there are other, alternative, socially responsible funds companies can select instead.

Additionally, it's simply good business to avoid companies that engage in "bad" corporate citizenship. Engaging with the Sudanese government, for example, puts companies at risk. Not only are they risking exposure to negative public opinion, but they are also linking themselves to a highly unstable government.

Consumers are very powerful, and their demand has made organic products a huge category within stores. Similarly, investors, specifically institutional investors, are becoming more socially aware. No doubt, we will see more fund managers adopt some of the social screens that the SRI sector has utilized for years.

Mirror, Mirror on the Wall: Self-Reflect Before Going Global

by Corianna

Are you an asset manager looking to break into a foreign market? If so, I suggest that rather than simply going after hot markets, or basing operations in regions where you already have pre-existing investments you take a good long look in the mirror. Ask yourself, does your brand or areas of expertise make you particularly well suited to serve a particular region?

In follow-up conversations after the Future of Distribution study we have begun to see some patterns emerging amongst our clients who are pursuing international expansion.

One common approach is:

• Step 1: Push to the EU through the institutional channel.
• Step 2: Layer on retail in Europe and push institutional eastward through Middle East.
• Step 3: Arriving in Japan.

Granted, to the extent that questions of market entry are about market size, international compliance rules and savings, all firms will come up with similar answers--access to data, government regulatory information, an excel document, and some simple equations are all that's needed to figure out which regions will be most friendly to asset managers in general.

However this does not mean that all asset managers should pursue the same markets. Rather than following the herd, why not pay attention to what makes your firm unique? Perhaps you are a company whose brand hinges on reliability and low-cost. Maybe your best bet is to start in Japan, where investors are particularly risk-averse, and go to Europe later. By focusing on what makes you different you may be able to throw the conventional expansion model on its head, and carve out your own unique empire.

A Return to the Age of Conservative Investing?

by Lindsay

While investors' quest for alpha, and subsequent interest in alternative investments, has been widely chronicled, there is another opposing force that will likely drive innovation in product development over the next several years: concerns about inflation and longevity risk pushing investors toward more conservative long-term investment strategies.

As reported by the Bureau of Labor Statistics last week, the Consumer Price Index rose at an astounding 7.9% seasonally-adjusted annual rate (SAAR) in 2Q08, and a 5.0% unadjusted rate for the 12 months ended June 2008.

The typical investor response to rising inflation, more aggressive investing, has also become a dangerous proposition, at least in the short term, as the Dow Jones Industrial Average has continued to bounce around over the past year, peaking at 14,279 in October 2007 and then plummeting to 10,731 just last week.

As reported by Ignites, several firms are taking a cue from the DB space and developing target date funds that use the principles of liability-driven investing (LDI). Essentially, these funds place greater emphasis on protecting investors against longevity, inflation, and currency risk to protect retirement income -- often at the expense of higher potential returns.

Is this trend enough to shift firms' focus from chasing alpha by developing the most obscure alternative investment vehicles to touting their safest, most-likely-to-protect-your-initial-investment funds? Will we all eventually go back to investing in utilities, like our grandparents did? It's hard to believe, but we might be going down that road...

How Big Will 130/30 Be?

by Mike Trapanese

Today, around $100 billion in assets are held in 130/30 strategies. Merrill Lynch envisions the worldwide market for 130/30 funds at $1 trillion in just five years time. More ambitious, the TABB Group doubles the estimate to $2 trillion and claims that 2 years should do the trick. Looking at recent growth, neither of these figures sounds outright unrealistic.

Research from Macquarie Capital Markets (Empirical Analysis on Active Extension Strategies, April 2008) shows that relaxing the long-only restriction can raise the transfer coefficient of a fund, thus increasing its information ratio and boosting excess returns. In an alpha-crazed environment, this helps to explain the 130/30 hype. As mainstream investors pour into long/short strategies, however, the cost profile of short trading is bound to change.

Short positions require borrowed securities. For an asset manager, a prime broker will locate lenders and facilitate an exchange. There is a natural limit to the number of shares on short offer, however, and this quantity is necessarily far less than the number of long shares on the market. Growth in 130/30, along with other long/short hedge fund strategies, will increase demand for borrowed shares and drive up the cost of borrowing them. Scarcity will enable both lenders and prime brokers to increase fees, eating away net returns.

At a recent NICSA conference, I heard a prime broker put a great deal of faith in his firm's ability to rehypothecate shares, effectively stretching the number of short shares currently available. When he was asked if $1 trillion was realistic, his answer was telling: "maybe."

Short trading will undoubtedly play a role in future fund innovations. In estimating the future market, however, we must be cognizant of the limitations of our current one.

Morningstar Takeaways

by Tricia

Back from the Morningstar conference in Chicago: The consensus from veterans of the Asian market is that Asian markets have re-priced themselves correctly following five years of unsustainable growth. Japan is interesting for the first time in a long time. Experienced managers continue to buy firms with long-term production capability, not short-term value, and advise others to hedge against Asian currency inflation. The main threat to global growth? Unredressed inflation. In other words, too much money chasing too few goods.

An interesting tactical note: In a room of about 150 financial advisors, about 2/3 held ETFs. Of those, one half said ETFs were a key part of their strategy. My question is, how can ETFs be so cutting-edge and innovative if so many people are already using them?

Overall, what I got out of the conference was this: The biggest challenge to globalizing your strategy is rarely operational; instead, the challenge usually lies in persuading people to see themselves as competitors in an increasingly complex global economy, and not to rest on their laurels -- a profound, and profoundly humbling, paradigm shift.

Wholesaling Darwinism

by Mike Mc

The lead story in Ignites from Monday, Wholesalers Face Scary Scenario as Advisor Ranks Fall (subscription), paints a grim, challenge-laden picture for today's sales organizations. The advisor population is shrinking; the average wholesaler lacks experience; the sky is falling.

It seems that rarely a day passes now where one wholesaling apocalypse or another isn't upon us. We sometimes dabble in it ourselves.

But lost amidst the constant rhetoric -- if I never read another article about product pushing externals, it'll be too soon -- is the fact that wholesaling is entrenched as part of distribution. It's here to stay.

What's more important (and more interesting) is how wholesaling is evolving. One such evolution, hybrid wholesaling, continues to be a dominant topic with our clients.

Like a fund reaching its 3-year anniversary, hybrid implementations industry-wide are finally establishing an identifiable track record. So, are hybrids here to stay, too?

We'll be releasing a full report on this later in the month, but early returns indicate that the answer is a resounding 'yes'. Based on our analysis, here are three key reasons why:

• Profits: for the vast majority of firms, hybrids have enhanced the profitability of their sales efforts, in some cases by more than 5%. In our research, no firms have indicated a decline in financial efficiency.
• Reach: where hybrids are placed and who they target varies dramatically across firms, but they are almost always focused on unexploited pockets of advisors (by channel, by geography, by behavior). With 300,000 advisors out there, wholesaling has elements of a numbers game, making it increasingly critical to find those shadowy corners of the advisor universe.
• Lifestyle: as hybrid positions have become established, they have become an important alternative for individuals who want middle ground when it comes to travel, and for firms who want to offer careers to salespeople that do not require endless time on the road. With field time ranging anywhere from 20% up to 70%, a hybrid role can provide a range of lifestyle options.

Given costs that are roughly 1/3 as much as a traditional external, hybrids will continue to play a key role in wholesaling evolution.

The landscape is changing, but the sky is staying right where it is.

The U.S. as a "Dying Proposition"

by Johanna

At a presentation on global trends in the mutual fund market I recently attended, I heard an interesting statement made about the U.S. asset management industry:

"The U.S. is a dying proposition."

Indeed, the U.S. financial markets are suffering a crisis, but the U.S. still has far and away the largest share of the global mutual fund pie. For example, in Q407 the Americas had 51% of worldwide mutual fund assets, whereas Europe had 34% and Africa/Asia Pacific had 14%. However, one of the factors mentioned got me thinking that such a morbid statement might have some truth to it. The idea centered on product innovation, and how it has moved overseas.

It's no surprise that the amount of regulatory hurdles in the US, which makes it difficult to bring innovative products to the market, puts this country at a disadvantage, so it's also no surprise that today many new product types are introduced abroad and then appear in a 40 Act version in the states a few years later. One recent trend that began overseas and is making its way to the U.S. marketplace is thematic investing -- such as funds centered on agriculture, climate change and anti-global warming, and financial global infrastructure.

Missing out on product innovation is one sign that the U.S. is falling behind other countries in the asset management market. Despite regulatory constraints and hassles, U.S. product providers must break from style boxes to remain competitive. The first step is to rethink product development processes and move further towards a "market needs" approach. As kasina posited in the report "Rethinking Product Development," instead of getting most product concepts from wholesalers or creating line extensions of current products, firms should do due diligence with advisors and investors to understand true market needs. The firms that succeed in translating those needs into new products (that likely won't fall in the style boxes) will have a chance of staying in the global fund game.

The Global Outlook: What to Watch For

by Tricia

Here in Chicago at the Morningstar Conference, the watchword is complexity. If I had to pick the most important thing to talk over with our clients, it would be the convulsive global environment.

The operating environment is almost completely reversed from what anybody would have dared to say even a year ago. The emerging markets are net creditors, and the US is a net debtor. The $350 billion dollars of market recapitalization came from the Asian central banks, not from the G-7. So did 60% of all global growth. Brazil's sovereign debt rating is higher than that of Citi's. The expectation is that the next massive recapitalization need will be that of the American consumer, whose resilience carried the global economy through the 1997-98 contagion.

That's nerve-racking. Consumer spending is about 70% of the American economy, and the American economy is about 1/3 the global output. In the last twenty years, Americans have had most of their equity stored in the value of their homes. We are right on top of the point where it will make sense for some people to drop off their keys and walk away from their mortgages. Certainly, for the first time in American history, homeowners are falling behind on their mortgage payments before they fall behind on other payments.

As we said in "Future of Distribution," the ongoing erosion to investible assets as well as to margins, makes a more compelling argument for global diversification (as if you needed another one) -- not just geographically, into the BRICs or "developing" (we're going to have to come up with a different nomenclature soon) Asia, but across commodities and industries as well.

Redemptions a Problem? Internals, the Cure

by Mike Ma

"We are beating benchmark by 1300 bps and we are suffering net outflows!"
"How do we stem redemptions from products that have good performance?"

This first statement was said by a good friend of mine I am vacationing with who happens to be a portfolio analyst of a high-profile asset management firm. The second question was also brought up in a call today with the head of marketing from one of the top 10 asset managers in the industry (I am on a working vacation ... lovely!) -- Two similar questions in 12 hours, so I figured a post was in order. My answer to both --

The internals.

Get the internals out there more, but do it with more intelligence. Two quick tips and thoughts, in order of preference and effectiveness:

1. If you own their own transfer agent ... - One of our clients has used the internal desk to call an advisor when a redemption order came through. You have T+3 before settlement and I'd bet you will be surprised at how many advisors you can talk off the ledge.
2. Or else ... use the Web reports - If you know which products are on your watch list make sure traffic reports or downloads of information about those products are promptly and delicately followed up on with by your internal desk on a daily basis. I'd like to reiterate the word *delicately.* You don't want your internals to come off as big brotheresque; rather, have these advisors be put into a regular call pattern with regular leading questions.

This is a situation best handled by people who can readily get to wherever they are needed. Who better than the internal wholesaler?

We just have to give them better tools.

Recapturing Margins through Measurement

by Lindsay

The asset management industry has reached a critical point in its evolution. The fat margins once enjoyed by not only the industry titans, but also the smaller, niche players, are slowly diminishing due to heightened competition, while top-line revenues at many firms are also being hit by asset outflows. So what's an asset manager to do?

The usual drivers of investors' and advisors' decision making, fund performance and product line-up, are difficult to change in the short term, and are largely out of distribution executives' control.

Distribution strategies and tactical implementations, however, are flexible, adaptable, and, most importantly, within the control of distribution executives. The asset management industry currently spends about 40% of incoming fees on distribution efforts, but most firms do not disaggregate the impact of individual initiatives and processes, preferring instead to look at aggregate sales figures.

One of things that really struck us while we were writing our latest report, Quantifying Distribution Strategies, was how much and how fast the asset management industry is changing. Not only do firms have to think of new products, new services, and new ways of doing business, but they must also re-evaluate, top to bottom, the metrics used to figure out how they're doing. Half of the executives we talked to said Sales is overvalued; the other half said Marketing is overvalued. The surprising part was that very few firms have mechanisms in place to find out, in any empirical way, who is driving what - so we outlined a few things the industry could be thinking about as it allocates valuable resources to different distribution functions.

It isn't accurate or useful anymore to treat distribution strategy as a monolithic entity; firms have to break it up into its component parts, and look at them individually. More than just the how-to of this is the 'have-to' of this: renovating business metrics is more important than it used to be. The money spent on distribution, and the lack of transparency around the results, exposes a compelling opportunity.

Investing in $ocial Networks

by Corianna

Cake Financial and SmartyPig are two social networking sites that have recently caught the attention of the press. The former is something along the lines of a huge online investment club allowing investors to track their portfolios, and the real time performance information of acquaintances and strangers alike. The latter lets individuals set savings goals and distribution plans and share them with friends, family, and loved ones.

On June 19th Cake Financial boasted the listing of over 5,000 new portfolios, and within two months of launching, SmartyPig had users in all 50 states. The success of these two sites suggests the turning of a new page in the story of online interaction. In particular, these sites:

• Excite competition between participants
• Allow people to learn from the experience of others
• Depend on people openly sharing financial information

The first two bullet points suggest that incorporating social networking capabilities into advisor sites might increase sales.

The third bullet point indicates that users are feeling more and more secure interacting and sharing personal information online. As users' comfort levels continue to increase, so will the demand for extensive online capabilities -- ranging from self-servicing tools, to ways to interact with others.

Where Have All the DB Players Gone? DCIO

by Sean

According to a recent study by Sway Research, "asset management firms are earning average margins of 25% on DCIO business versus roughly 18% in markets, such as mutual fund wrap and sub-advisory, and only 12% on the SMA business." As such, major defined benefit players such as BlackRock, Goldman Sachs, and PIMCO (among many others) are making a major push into the $1.7 trillion defined contribution investment-only business. In so doing, they'll be up against entrenched players like Capital Research, Fidelity, and Vanguard.

So what is it going to take for these firms to be successful? Here's the short list of things firms must consider:

• Establishing strong brand visibility among plan sponsors
• Gaining access to the large, open-architecture platforms
• Rolling out new products that meet plan participants' demands for income protection and generation over specific time horizons
• Increasing collaboration among historically channelized institutional and retail distribution and operations functions

In an environment where, according to kasina's "Future of Distribution: Stay the Course or Innovate," 90% firms are experiencing declining margins, firms with strong institutional investment management capabilities should take a hard look at the DCIO space.

The Growing Exchange Traded Product Buffet

by Johanna

Advisors are excited about ETFs. In a recent survey of over 800 advisors conducted by State Street Global Advisors and The Wharton School of Business, 67% of polled advisors said that the ETF is the "most innovative investment product in the past two decades."

Product providers are equally excited, and recognize the opportunity exchange traded products offer, demonstrated by the 300-400 ETF products awaiting approval with the SEC, and the prediction that 560 ETFs are going to be launched in 2008. Twenty-three products were launched last month alone.

With the mad dash to get a piece of the exchange traded product market, providers are in danger of overdoing it. In the survey, 21% of advisors listed "overwhelming choices" as the greatest disadvantage of ETFs. What does this mean for product providers?

Educational Support

Firms must support the growing market with value added content around the advantages of products like ETFs and ETNs, but also around the underlying indices and the various ways these products fit into an investor's portfolio. Clearly the Web comes to mind as a key lynchpin to supporting advisors and helping them choose between the myriad products on the market today and those soon to come. For example, advanced product selection tools and educational tutorials around less understood products (such as ETNs) will be increasingly critical in the upcoming months.

Differentiate

Furthermore, few firms do a great job of differentiating their exchange traded product offerings. ETF providers have differing philosophies on how to structure their ETF offerings. For example, WisdomTree uses core earnings or cash dividends to choose and weight companies in their ETF products, and Vanguard's ETFs are an additional share class of its existing mutual funds. Do advisors understand what this means when it comes to choosing products? Firms that are able to educate advisors around product fundamentals, but then also differentiate in this rapidly expanding space, are more likely to come out on top.

Product Development is Growing Up

by Anu

Recently, Paul Atkins, SEC Commissioner, spoke up for Asset Managers to develop a product czar. He specifies this role as a person with cross-divisional responsibilities. The czar would align ideas and trends from Investment Management, anecdotal input from Sales, market analysis from Marketing, fiscal concerns within Corporate Finance, flexibility and capacity within Trading and Markets, and other areas.

At kasina, we could not agree more. In our Rethinking Product Development research, few of the 20+ US and Canadian Product Development teams provide for this role.

Isn't this czar another step to improved enterprise-wide risk management? Instead of relying on alignment from water-cooler meetings and quarterly summits with over-packed agendas, a dedicated resource - with alignment goals - will reduce the expensive and potentially harmful launches of ill-conceived products. For a new product to have a chance at success, the firm needs alignment from numerous business units.

Additionally, the czar becomes the go-to resource on SEC regulations and processes for new registered products. And, over time, they would provides Sales, Marketing, and the Office of the CEO reliable and predictable dates for SEC approvals and therefore enabling properly timed sales training, on-time marketing development, and appropriate resource management. All this sounds like precise risk-management with an eye to lower overall new product launch cost, therefore saving the investor basis points.

Anyone have suggestions?

by Lindsay

Last week I played golf on a typical Florida course, wherein copious artfully placed, often hidden water hazards seemed to maliciously steal my perfectly executed (well, not quite) shots at every opportunity. As I was complaining bitterly about the clearly sadistic designer who had engineered this unforgiving course (forgetting, for a moment, that I was spending a long weekend in sunny Florida, while my colleagues were stuck in New York, staring at their computers), we drove across a long wooden bridge, traversing a large swamp between the 9th and 10th holes. In the midst of the reeds and about 15 feet from the bridge, was a box marked “Suggestions” perched on a tall wooden pole. It was clearly mocking us.

Golf analogies aside, the inaccessible "suggestions" box made me think about idea generation in the asset management industry, and how it differs from other industries. When executives at famously innovative companies, such as Apple's Steve Jobs, are interviewed, they often discuss the processes their companies have in place to encourage idea generation by employees at all levels. Tapping into the intellectual resources of all employees, rather than simply those employed in product development or creative capacities, they say, helps them continue to be thought leaders.

The asset management industry, on the other hand, often seems to employ a model more like the aforementioned golf course. Suggestions and ideas are nominally welcomed, but the effort that it would require to actually submit them (figuratively, swimming through the swamp and climbing the pole) doesn't seem worth it, so firms largely remain siloed, in this respect. I recently met with one firm that is taking small steps toward combating this issue. The firm has created a program through which its Product Marketing and e-Business teams actively solicit ideas from employees in call centers, and encourage participation by offering prizes for the best ideas. Anecdotal evidence suggests that the program has been successful, and that many ideas have been implemented since the program's inception.

Asset managers are often given a hard time for, with a few exceptions, playing follow-the-leader. For those who are not among the few industry leaders, tapping into the collective brain power of all employees could be a first step toward creating a creative, innovative culture and, ultimately, towared breaking from the pack.

Tangerines and the Art of Messaging

by Anu

This weekend, I took my four-year-old grocery shopping. We were looking at the fruit when I let out an exclamation: "Pixie Mandarins!" The Pixie is a relatively new tangerine -- it tastes like a jar of honey met freshly squeezed orange juice. My daughter was enthused, because I was enthused. The interesting thing about the Pixie is that it's exclusively grown in Ojai, a lovely farming community northwest of Los Angeles.

So I wanted to share my joy with fellow shoppers. To five people, I said, "Hey, these are delicious citrus fruits." And how many decided to purchase them? ZERO.

To another set of five people, I said, "Hey, have you had these? This is a Pixie Tangerine and I doubt you'll find it anywhere else in Brooklyn. It comes from this little, magical farming community called Ojai, just inland from Santa Barbara." And how many decided to purchase the citrus? FOUR.

What are we doing in our industry? Are we just telling advisors that there's "large-cap growth funds in aisle four" or are we describing the unknown value of a TIPS fund in volatile markets?

If you do nothing else, please look for those Pixies; they won't be around much longer.

Customized Search: Why Not?

by Johanna

In 2005, Google rolled out a customized search product. Basically, it's an engine that sits on top of the Google platform and allows the search provider (whoever is maintaining the Web site where the search is located) to restrict the domain. In short, the customized search engine cuts down the Web universe based on the search provider's specifications. Two examples include Green Maven's search of sustainable and environmentally friendly Web sites, and The Economic Search Engine, which searches over 10,000 economic-related sites.

Why don't asset management firms use this function? Firms could locate a customized search engine within news or commentary sections, and set that search engine to query both within the site as well as within selected financial services and news Web sites. The search could be product- or sector-specific, and labeled as the "Asset Management News" search, or the "Mutual Fund News and Research" search.

With the Google customized search tool, the search return pages would open in a separate window, but would display the firm's logo. While this option does commit the sin of sending advisors away from the firm's site, it provides a valuable service, and at least gives the firm a branding boost in the process.

Turning Services into Products

by Lee

A friend sent me a link to this video about Denmark's Jyske Bank. They have taken some impressive steps to turn their banking services into physical "products" that customers can explore in their branches. Customers can grab a box labeled, for example, "My First Car Loan," and pull out the brochures inside (as shown below). They can also take these product boxes to a "TestBar" counter and scan the barcode on the box, bringing up a video on a computer monitor showing a fun to watch presentation.

Jyske's results have been equally impressive -- they doubled their customer base within a year. It is a shame that more companies don't make it easier (and more fun) for customers to get to know their offerings.

No One Likes a Failure...

by Lee

Since many asset management firms do not offer closed-end funds ("CEFs"), you may not be following the mess that is going on with "failed" auctions in the municipal bond market. Here is my take:

Auction-rate securities have long been a way to offer borrowers a way to finance for the long term at short-term interest rates that are periodically reset at auction. Investors have recently soured on this part of the market, due to concerns about a lack of liquidity and questions about the bond issuers.

What is a failed auction?
When there are not enough buy orders to meet the quantity of sell orders, the auction fails. A failed auction doesn't necessarily mean a loss of capital will occur, but rather that a seller cannot sell in the auction.

So what?
When an auction fails, the issuer is typically required to pay a maximum (or penalty) rate. The maximum rate typically can be either a relatively high fixed rate, such as 10%, or a formula-based rate.

What does this mean?
As a result of failed auctions, the cost of leverage for common stock CEF shareholders has increased to the maximum rate until there is a successful auction. This can contribute to a reduction in net investment income available to fund shareholders and lead to fund dividend cuts. Additionally, the issuer sees their interest costs soar.

While the failed auctions do not directly affect the securities held in CEFs or the ability of the common stock shareholders to sell their stock, the higher cost of leverage is a serious problem and liquidity for preferred stock shareholders is impacted.

What's next?
Just today, the Securities Industry and Financial Markets Association asked the SEC to allow those who issue debt to buy it as a short-term fix. As the agency evaluates concerns about whether a borrower's participation in setting the clearing bid in an auction for its own debt would be market manipulation, CEF providers are scrambling for both short- and long-term solutions.

While the resolution is still foggy, it does seem like capital is harder to come by than it has been in a long time -- and this isn't likely to change in the near future. As this all sorts itself out, I wouldn't be surprised to see providers of CEFs take a variety of steps, some which may seem drastic today:

• Many firms are already looking to new partners for liquidity (banks, insurance firms, etc.)
• Some companies may delever funds and redeem preferred shares
• Some CEF providers may even be forced to liquidate some of their funds

BETA for cheap?

By Steven Miyao

In conducting research for our recent "The Future of Distribution" report, I found it interesting that none of the actively managed fund companies that we interviewed--23 of the top 50 firms by AUM--had any plans for getting in on the passively managed game.

New data from FRC shows that Vanguard surpassed American Funds in last year's fund flows. What is even more fascinating is that other beta players, such as Barclay's Global Investors and State Street Global Advisors, also did very well.

This has severe pricing implications. The distinction between alpha and beta performance is now more transparent than ever, and advisors are not willing to pay for actively managed products that are really just expensive closet beta funds. Instead, advisors are seeking cheap beta products such as ETFs. On the other hand, only true alpha players are able to command premium fees.

Surprisingly, our study shows how the firms in the industry are at the same time complacent and yet strangely confident in taking on competitors whose strategies, strengths, and weaknesses resemble their own. Their obsession with familiar rivals and products, however, has blinded them to threats from low-cost competitors such as Vanguard, BGI, and State Street.

Another Starbucks Question

by Corianna

In December, Lindsay wrote a blog piece inspired by Mark Penn's new book, Microtrends: The Small Forces Behind Tomorrow's Big Changes. Lindsay recounted Penn's comparison of "Starbucks economy" of today, to the "Ford economy" of the twentieth century. Penn argues that consumer attitudes have moved from the ideal of mass production to that off mass customization. Starbucks, with its crowded menu of caffeine, milk, and flavor combinations, is undoubtedly the poster-child of 21st century customization. Who, Lindsay asked, would be the Starbucks of the asset management world?

In some ways, the asset management industry, with its cornucopia of funds, already looks a lot like Starbucks' menu. Indeed, you might think that everyone should be able to find what he or she is looking for from the industry's innumerable offerings.

It's not that simple, though; offering many things is not synonymous with offering customization. Customization is about more than just options; it's about experience. I suspect that customers--advisors and investors alike--aren't exactly awash in waves of joy when they see long mutual fund product lists. They are, I imagine, rather overwhelmed. I think it's time to step away from the Starbucks analogy. It's time to ask what customization asset-management-style looks like. And there's an answer: customization, asset management style, looks like UMAs. So, I'd like to tag a line onto Lindsay's question: Who, I want to know, will be the first to make UMAs available to the average asset management customer?

Break Out the Box Cutter

by Mike Trapanese

In my life outside of distribution consulting, I play the saxophone. John Coltrane has been an inspiration for me. Generations of jazz musicians have tried to emulate his style of improv by applying music theory to his solos. As it always does in music, however, the theory eventually became a thing unto itself. I'll never forget watching a music teacher throw his finger onto the page of a transcribed Coltrane solo to point out a "wrong note." Since I've constantly got sax on my mind, I've come to realize that lumping mutual funds into style boxes is much like evaluating Coltrane based on music theory.

Morningstar style boxes have their merits. As a classification system, they are an effective way of grouping funds for reference. As a marketing tool, they present an intuitive way to describe funds to advisors. They are, however, an inductive overlay and can be limiting from a product development standpoint.

Research analysts at broker-dealers are a more savvy audience than their advisor colleagues. Increasingly, the responsibility of picking funds is being transferred to these analysts as more and more assets pass through discretionary platforms every year.

These gatekeepers are more discriminating in their selection processes. In contrast to many advisors, they understand pure alpha and actively seek it. To differentiate their products in the eyes of analysts, product developers should look to build products around successful strategies rather than style boxes.

Morningstar gives style drift a bad rap because it undermines the integrity of their peer groups. Quite often, however, "drift" drives returns as part of a manager's investment strategy. This "drift" is the wrong note in a Coltrane solo. Thus the problem is not style drift-- but it could be the style box itself. The omnipresence of these boxes has blurred the line between strategy and style box. Building products around style boxes is a reliable way to ensure beta, but at the same time it is a sure-fire way to undermine the benefits of a successful strategy.

Building a fund product from the strategy up, without consideration of the style box it will occupy, comes with consequences. Invariably, returns will deviate from their benchmark. To communicate this paradigm shift to research analysts, Athena has developed a classification platform that groups funds by common strategy elements rather than common holdings. Examples of these strategy buckets are Economic Position, Future Growth, and Profitability. We at kasina have already started to hear research analysts talking about Athena's SBI platform.

It's important to remember that style boxes are a limiting force, and trying to stick within their walls is bound to limit alpha and drag returns towards the benchmark. Similarly, John Coltrane didn't rip legendary solos by staying within the confines of music theory -- he first understood the theory, and then understood those instances in which he had to surpass it.

Just as Good, Just as Smart... but Cheaper!

by Mike Mc

The term "commoditization" gets thrown around liberally when it comes to asset management these days. And with 8,000+ domestic, open-ended funds out there, it's easy to see why. The concept gains further steam when up to 80% of actively-managed funds under-perform their benchmarks in a given year.

Of course, commoditization typically brings with it price implications. (Many products) + (similar attributes) + (low barriers to entry) = Competitive Pricing.

And yet the question nags at me... why don't active managers compete on price?

According to a study by Peter Wallison and Robert Litan, pricing differentials of up to 300% persist within the mutual fund industry in the U.S. Contrast that figure with the 50% differential seen in the UK, and you have the ingredients for a very interesting discussion.

Wallison and Litan present an analysis that is worth reading. However, I found it wanting on one point. They argue in part that fund managers have little incentive to cut costs because of the way in which fees are determined. Seems to me that, even with the surrounding regulation, managers would want to pursue lower fees for two fantastic reasons:

• It is in the best interests of the shareholder. (Isn't that what every mutual fund is supposed to be about?)
• It is, as of now, an unexploited avenue to potentially gain an advantage on the competition.

Obviously the decision to compete on price is a complex one. However, with so many firms looking for something - a message, a product, anything - to stand out from the pack, I'm hard-pressed to believe that competing on price isn't a viable alternative for certain firms.

Therefore, despite the best efforts of Wallison and Litan, my initial question stands. And I'll be restraining myself from attaching the word "commoditization" to our industry.

Understanding the Chords to the Closed-End Blues

By Mike T.

Closed-end funds have fallen out of favor after several years of strong asset growth. It's not that assets are shrinking, but more that growth rates have begun to show signs of fatigue. kasina had been keeping a close eye on this phenomenon as we work regularly with several managers of closed-end funds. For those of you who do not work directly with these vehicles, here is some high level commentary to bring you up to speed:

With closed-end bond funds subject to both the market implications of the credit crunch and investor confidence surrounding the crunch, any demand for CEFs in today's market would likely come via equity offerings.

The number of equity closed-end funds has risen sharply since 2001, but still only rings in at 221 (compared to 435 for closed-end bond funds). This rise has correlated strongly with the path of the DJIA, which is currently showing high volatility and downward movement since July. The perception that CEFs are less liquid and more volatile than open-ended vehicles may also contribute to investor hesitation. Deep discounts to NAV will most likely be interpreted by managers as a sign that investors are bearish on CEFs, if not on the entire market.

Lastly, closed-end funds typically rely on leveraging to drive returns. A direct implication of the credit crunch is that leveraging costs have risen significantly. With a leveraged portfolio, swings in interest rates can have huge consequences for performance. Today's interest rate climate is uncertain at best.

The next few months will be telling. As managers watch the markets and the Fed closely, the following question will be on their minds: Is this a hiccup in the strong growth of closed-end funds, or a longer-lasting downward adjustment in their popularity?

What comes after the GMWB?

By Steven

The GMWB has been extremely successful, and is the best selling living benefit for insurance carriers. Forward-thinking clients don't want to rely solely on GMWB's success and have begun to think about what the future holds for the industry - beyond the baby boomer generation. They are strategically exploring which riders need to be developed for those who were born after the baby boomers (born 1943-1960, now age 47-64).

kasina develops new products along with our clients by looking at the characteristics of a specific target audience. Each generation has a new set of goals, and faces fears that didn't affect previous generations. Gen X (born 1961-1981, now age 26-46), the next generation after the baby boomers, is moving quickly towards a future where they expect to face:

• Escalating health care costs in the face of increasing longevity
• Devaluation of the real estate market
• Massive inflationary pressures

This generation also:

• Gravitates toward highly customizable products
• Is committed to charity and philanthropy
• Has grown up with rewards programs

VA product innovations have to reflect these needs and preferences.

To market to GenX, annuities need to be customizable, while still addressing a diverse array of social concerns. Simple, intuitive solutions will be the most sought-after.

Variable annuities are too complex for the average investor and advisor. Generation Xers, more so than their predecessors, like to understand and be involved in their purchases.

The next generation of riders will have to:

• Address their specific interests and concerns
• Be customizable, with transparent pricing
• Offer various insurance ties
• Offer "rewards," such as a % of return given to charity, or cash back

The next generation is looming. It is now time to start thinking about their needs and retirement fears to build the rider for the future.

DC plans still do not offer SRI options

By Steven Miyao

Increasingly investors are putting their money towards socially responsible investment (SRI) funds. A survey by Mercer Investing Consulting, prepared for the Social Investment Forum (SIF), shows that less than 20% of defined contribution (DC) plans, such as 401(k)s and 403(b)s, at work, are currently offering one or more SRI funds. DC plans are starting to listen to investors and an additional 41% are planning to offer SRI options within three years.

Why would a DC plan not offer a SRI option when investors are increasingly demanding this as an investment option?

A Rolling Thunder

by Mike Mc

That drumbeat you hear far off in the distance? It's the ominous thunder from the coming storm around the fees asset managers collect on their products.

The signs are obvious and numerous:

• SEC Chairman Christopher Cox's ongoing mantra of data transparency and XBRL in the fund space.
• The ever-growing percentage of load-waived business being done in the intermediary channel.
• Proactive, blunt conversations between fund firms and their shareholders about fees, such as those seen on the Web sites for MFS and American Funds.

It's a bit of a running joke inside of kasina how fired up I get about fees. However, I get fired up because of the headstrong position of many firms within the industry. Comments like "we don't really want to have the conversation about fees with our clients" or "that is only going to make us look bad" are commonplace.

In fact, if I had a dollar for every time I heard something along those lines, I might be able to afford the loads on A shares. Of course I exaggerate for effect, but you get the idea.

The point is that our industry simply cannot afford to take a "don't ask, don't tell" approach to fees. As investors and advisors alike lend greater scrutiny to the value they are getting for their money, the only choice is greater candor and transparency.

Instead of hoping the topic goes away, firms need to tackle this head-on, especially as margin pressure continues to increase industry-wide. Wholesalers, Web sites, and marketing materials can all be used in this effort. There should be pride and justification in the fees firms are charging for their expertise, not a secret hope that nobody will notice. Firms leading the pack on this issue, such as Vanguard and American Funds, who have both publicly supported XBRL, will be able to position themselves as a champion of the shareholder and advisor and differentiate themselves from the competition.

Ultimately, this is a topic that isn't going away. Firms might as well embrace the discussion and attempt to make it a net positive. There is a 100% chance of rain; firms should start shopping for umbrellas now.

Reporting = Sales

By Anu

Recently, the kasina team researched different institutional reports from industry leaders. Asset Managers provide these reports (always quarterly, sometimes more frequent) to clients such as Endowments and Pension Funds. Each account may hold $1B; maybe more.

I was interested in one firm's discussion of their RFP reply process. That process included countless revisions of input from disparate teams across different geographies, followed by graphic design modifications. Why so much effort? Winning an RFP EQUALS revenue.

A thorough, high-quality client report also equals sales. Until recently, many firms viewed reporting as a back-office, low-importance task. That view is being replaced by the understanding that good reporting can be the deciding factor between continuing clients and those looking to exit.

Consequently, firms are beginning to investment more time and money into high-quality reports with process improvements and cutting-edge technology. As industry leaders separate from the pack, they'll continue to find that reporting equals sales.

Back to the Future: Involving Customers in Portfolio Management

by Lee Kowarski

At the ICI General Membership Meeting in Washington earlier this month, Chris Anderson (editor at Wired and author of "The Long Tail") spoke, among other things, about the increasing importance of providing customers with a voice (the "Web 2.0" movement).

In response to a question about the impact of this trend on our industry, Chris made a comment that stuck in my mind: "It clearly doesn't make sense for community management of a mutual fund."

Why not?

If Wikipedia can create an encyclopedia that is basically as accurate as Encyclopedia Britannica (and far more comprehensive and up-to-date), why can't a community make (or at least inform) investment decisions?

I think back to 2000 and the success (however short-lived) that MetaMarkets had with its OpenFund. While there was a portfolio management team ultimately making all investment decisions, the Fund disclosed all investment decisions in real-time on its Web site and encouraged open, two-way discussion via message boards. While the Fund imploded (due primarily to its focus on "New Economy" investments in 2000 and 2001), the approach is something that firms could learn from and apply to other types of investments.

Giving over full control of investment decisions to the masses is clearly a scary and challenging prospect, but firms could certainly benefit from building a closer relationship with their shareholders and advisors, and (as I'm sure Chris Anderson would agree) the masses have a wealth of information that could ultimately lead to better decisions.

Rethinking Fees: Pay for Performance

by Mike McLaughlin

Earlier this month, Fidelity announced its intention to add performance-fee adjustments to 19 more of its mutual funds. It's a simple concept: the more its fund managers trump (or lag) their benchmarks, the better (or worse) Fidelity will do.

According to Lipper, barely 200 funds (spanning 500+ share classes) use such performance-fee adjustments today. As a leader on this issue, Fidelity is effectively gambling on itself to the tune of tens of millions in profits.

Surprisingly, there is some hand-wringing over this move within the advisor community, with vague concerns about enhanced risk within the funds being the primary concern. I, on the other hand, am a huge fan.

Why? The primary reason is that such a structure directly aligns the interests of the:

• Firm
• Portfolio manager
• Financial advisors
• Fund shareholder

At the risk of simplifying things, everybody wins or everybody loses.

I also like that such an arrangement provides an avenue for differentiation for firms like Fidelity. Despite disclosure regulations, fees have long been a fuzzy part of the industry. However, competitive pressures and forces pushing for enhanced transparency, such as XBRL, are placing fees increasingly front-and-center in discussions about the industry and its products.

As a result, I see fees becoming a more important strategic weapon in the fight for assets. Outright price competition is one route, with pay-for-performance mechanisms another way for firms to take a potential liability and turn it into a strength.

Mainstream Alternatives

by Lee

Just in the past few months:

• State Street Global Advisors announced that they will will launch a small-cap long/short strategy, probably a 120/20 fund
• New York Life Investment Management's Equity Investors Group announced a 130/30 strategy
• DWS Scudder began wholesaling two new structured notes, one of which was capital protected
• A survey by Rydex AdvisorBenchmarking found that about half of RIAs believe that alternative investments will soon be as important in their portfolios as traditional investments

The list could go on for pages. Alternatives are going mainstream in the asset management industry.

As of the end of 2006, there was a total of ~$6.3 billion in net assets in long/short mutual funds (double the level at the end of 2005). With the restictions on mutual funds taking short positions lifted in the late 90's, we are beginning to see firms explore numerous opportunities, and advisors and investors are taking notice.

For those firms that still consider ETFs to be "alternative products," I encourage you to at least begin to explore the various options that are out there so that you don't get left behind.

Implications of the Pension Reform Bill

by Lee

Yesterday's Wall Street Journal included an article (subscription required) about the Pension Reform Bill that is about to be enacted by Congress. The bill includes several implications for asset managers, some of which were highlighted by the Journal:

1) The bill encourages employers to automatically enroll their employees into 401(k) plans unless the employee opts out. As kasina wrote in its Driving Enrollment and Contribution in DC Plans whitepaper, automatic enrollment is an important and under-promoted tool for firms to drive contributions. In fact, only 5% of automatically enrolled employees opt out of the plan or decrease contribution levels. However, investment selection proves especially critical in automatic enrollment implementation due to the overwhelming inertia of employees when it comes to changing the defaults. For example, one top provider sees 90% of automatically enrolled participants failing to diversify beyond the initial investment vehicle(s) in its plans. This inertia ties into the second implication of the reform bill, described below.

2) The bill makes it easier for companies to use different kinds of funds as a default option for employees who don't make an investment choice, such as life-cycle or target-date funds. These products provide participants with an investment vehicle that offers better diversification while often simultaneously generating higher management fees for providers. The changes in this legislation are likely to continue to spur the growth in the number of these structured products.

3) A third implication of the legislation is that the set of rules temporarily allowing people to contribute more money to IRAs and other plans that were set to expire after 2010 are made permanent. This change will not only allow more funds to continue flowing into the industry, but provides needed clarity for future planning (among investors, advisors, and fund companies).

4) Finally, the bill allows asset management firms to provide investment advice to their 401(k) clients. Despite a slew of possible conflicts of interest, Congress has ruled that potentially conflicted advice is better than no advice at all. At the same time, the bill shifts liability from providers to plan sponsors. It will be interesting to see, however, how many firms embrace this new paradigm and offer advice. Many providers have offered options to plan sponsors to hire non-partisan, third-party advisors to help counsel employees, but few have, especially among smaller plans. While the letter of the new law makes it extremely difficult for investors to blame providers offering advice for the poor performance of their portfolio, this doesn't mean that participants won't sue. Knowing this industry and its compliance-wary attitude, I would bet that most plan providers are likely to err on the side of caution when giving advice. I think that the firms with experience offering advice and guidance, such as traditionally-direct players T. Rowe Price and Vanguard, are well positioned to boost their DC business by taking advantage of these legislative changes.

Just Because You Can Build It, Does Not Mean Advisors Can Sell It

By Sean

In the theme song to his semi-autobiographical film, "Get Rich or Die Trying," top-selling rap artist 50 Cent brags, "I can sell anything, I'm a hustler, I know how to grind / Step on grapes, pour them in water, and tell you it's wine." His point is clear: it doesn't matter what you put in his hands, he can sell it...to somebody.

Unfortunately, 50 Cent does not work at Merrill Lynch, Smith Barney, LPL, or any of the other large distributors of mutual fund products. The advisors at these firms, unlike 50 Cent, can't sell everything. So, these firms try to stock the shelves with products that advisors can sell, or at least have a very good chance of selling.

One Mutual Fund Coordinator at a large distributor summed it up perfectly when describing how most asset managers approach product development: "They manufacture what they can manage without thinking about what advisors can sell and fit into the portfolios." The message to product development teams could not be clearer: It's not about having the most innovative products; it's about having the most innovative products that advisors can actually sell.

What most firms fail to realize is that they have a resource to vet product development ideas in the Mutual Fund Coordinators at their distribution partners. Several Mutual Fund Coordinators confirmed as much during kasina's research for its forthcoming whitepaper, "Breaking the Bottleneck: Acheiving Distribution Success by Supporting Gatekeepers' Needs." To succeed, asset managers need to begin using this resource.

How Does (Name of Competitor Here) Do It?

by Lee

Four times in the last 24 hours, a client has asked me some version of the question "How does [competitor's name here] do it? "It" has at times been related to Sales, Product, and Marketing - in each case, the client wanted to know the secret to success. The secret is that "it" is not about tactics - it is about having something unique to say. Clearly articulated differentiation helps all aspects of the business and is a necessary building block to success in all areas.

You should definitely learn from what your successful competitors do, but don't simply copy their execution - start by identifying what is unique about your organization. What makes your firm different has to be different from what makes American Funds different. We talk more about this topic in our sample Distribution Industry Analysis brief.

Creating Boomer Products - Take a Lesson from Gen XY and AmEx One

By Mike Ma

I just returned from a trip to Toronto and Montreal and have spent a lot of time talking about our Boomer study with our Canadian clients. Canadian firms are just as worried about their Boomers as we are stateside.

One of the things that we spend a lot of time talking about is creating truly differentiated products for the boomer market. In the study, we make a couple of key points about the asset management industry:

- Boomers are full of paraxoical values and they want all of it at once (e.g. wine is a great boomer product since it promotes luxury and health all at once. Are these business results a suprise?)

- There is a lack of truly differentiated products for boomers

- There is a lack of truly valuable messages that communicate how a firm can help a shareholder

To date, things have just been repackaged products that have a different moniker or a slightly different structure. For instance, we see many "Income Funds" marketed to Boomers which are really just high yield funds renamed. Different name, same stuff, (hopefully) a different market.

I think Boomers and their advisors are smarter than that and can see through it. To illustrate a truly differentiated product, experiment with not thinking of an investment vehicle as a product at all, but rather a service. A good example is American Express One, a new card that puts 1% of your purchases in a high-yield savings account. A couple notes:

- One is geared toward the Gen X and Y. AMEX is losing market share in these segments to the bank/debit card business and competing lower cost credit cards.

- Cash rebate credit cards have been around forever, but placing the money in a savings account saves the cardholder to take the money and transfer it to the right account, and then start saving ... a service. The service will let them compete with the bank value proposition.

- The product aims to statisfy the paradoxical tension between spending and saving, a trait Gen X and Y'ers are starting to share with their Boomer counterparts as they are maturing in the workforce (and paying their own bills!)

- One TV ad show a young, stylish African-American mother of twins shopping and implicitly saving for the well being of her children. Another online ad shows this:

While not a Boomer product, we can learn a couple things from this example. Create products that are services and create marketing that show how those services can make your customers' lives better.

A firm can spend money on Paul McCartney and show pictures of 50 year old surfers, but most Boomers can leave most asking, "So what?" or "Why does it matter to me?"

Furthermore, why do we stop at generating cash in income vehicles? Aren't these the same Boomers who want to travel and see Thailand, fund their grandchildren's 529 plans, put money aside for their own healthcare, care for their aging parents, while simultaneously thinking about how to transfer money to their kids in a tax efficient manner?

We have exhaustively researched the right asset allocation for the accumulation phase, but the asset manager's decumulation recommendation seems to be 100% cash. There is a need to create vehicles for sharehodlers and advisors to better create the asset deallocation portfolio. If we change our perception to answering service challenges, not product challenges, we may be on the way to developing true Boomer products.