The View

The cost of regulation in asset management industry

Asset managers need to preserve their skills in detecting investment opportunities in the face of sweeping rules and rigid corporate culture

PUBLISHED : Monday, 25 August, 2014, 3:33am
UPDATED : Monday, 25 August, 2014, 3:57am

A beleaguered asset manager told me his son showed an interest in becoming a fund manager. But the father advised him to get a law degree and work in an asset manager's compliance or legal department instead. "Because nowadays lawyers and compliance officers are guaranteed longer careers than investment managers at every financial institution."

Today, investment bankers are shocked to have compliance officers participate in business development meetings and mortified to hear them give opinions about how bankers should market to clients. Then, they must suffer the indignity of asking compliance departments to approve the background of each new client before they can meet them for the first time. These anecdotes are more than withering bureaucratic fire resulting from the financial crisis.

The risk of compliance people running financial institutions lies in their overwhelming propensity to say "no" to any new idea, product or client because that is the safest decision of least resistance. The unavoidable results are increased costs and delays for many legitimate businesses and individuals without improving protection for banks or clients.

Before the financial crisis, bankers used to say a talented trader or asset manager did not need risk control because they inherently possessed risk control as part of their thought process. Today, entire areas of perceived systemic risk such as proprietary trading have been shut down and made extinct due to the Volcker Rule. An army of compliance officers, who think eliminating risk is the same as risk control, now virtually run banks and asset management firms.

While banks are being rendered into indistinguishable service companies that buy and sell a commodity - money - the asset management industry will probably suffer the most from this new era of financial service prohibition because it makes the most difference in clients' investment outcomes.

History shows that periods of high uncertainty and risk offer opportunities for big returns. But can asset managers exploit and convert these circumstances into returns for their end clients?

Financial regulations and rigid organisational culture have turned asset management into a mass-market, undifferentiated industry on a global scale. Its managers have been industrialised and commoditised to a degree where it has lost its craft roots. Its current practices and methodologies work against capitalising on market dislocations and volatile prices.

Worst of all, new complicated rules for making investments create a dilemma where advisers are no longer close enough to clients to inspire the necessary trust and motivation to make returns beat the markets. The industry has devolved from an imaginative art into bland science, from independent craft to economic scale, from trusting judgment calls to being dependent on complex models that are far removed from business reality. For clients, the true outcomes are more risks, more complexity and higher fees.

Ill-conceived regulations threaten to dilute its individualistic, craft heritage and the skills needed to perceive unique investment opportunities. Today, these traits have become scarce. The big picture understanding of investing has become extinct especially when specialist mandates replaced balanced ones. There is an industrywide shortage of managers with bold insights into holistic drivers of risk and market shifts in volatile periods. Where will the next generation of super investors like Warren Buffett come from?

Ironically, sweeping regulation has forced the industry to merely provide products, not solutions. Since it is burdensome for relationship managers to spend the time to comprehend clients' goals, they are forced to exaggerate the virtues of their products. This rapidly entrenches a blame culture in which mitigating career and reputation risk take precedence over investment risk.

Like their clients, advisers and managers seek protection within a comfortable pack, like a bunch of high-school girls, with no creative outliers in today's investment environment. They follow the herd to manage peer risk. More often than not, they rely on client inertia and market momentum to save them from bad investment choices.

Asset managers need to protect a special mindset that is quick to detect opportunities and mobilise all corporate resources in their pursuit. Assuming that market volatility and uncertain regulatory policies will persist indefinitely, the asset management industry needs to recreate itself. Otherwise, it faces the same prospects as European economies - another "lost decade".

Peter Guy is a financial writer and former international banker