How the financial industry can succeed in our world of uncertainty

Geopolitical risk virtually disappeared from the radar of investment professionals in the early 1990s as the Berlin Wall came down and the Soviet Union disintegrated. Francis Fukuyama famously proclaimed it the “end of history.”

As it turns out, the relative calm of the 1990s and 2000s was, historically speaking, an anomaly rather than the norm. The election of anti-establishment candidate Donald Trump as U.S. president, the United Kingdom’s unexpected vote to leave the European Union, and the uncertainty surrounding this year’s French and German elections have reminded everyone that politics matter.

{mosads}As populism grows across the developed world, other geopolitical phenomena can be observed too: the growing assertiveness of China, India, and Russia, the destabilization of the Middle East; the multiplicity of terror events, and a growing migrant crisis.

After decades plying their trade on the playing fields of corporate fundamentals and efficient market theory, investment professionals find the game is changing. Investors’ growing expectations of their investment outcomes and their lack of overall trust in the industry, have made it imperative for investment managers to successfully address geopolitical risk. In a tough business climate, they simply cannot afford to disappoint investors.

Investment industry faces strong headwinds

CFA Institute data show that investment professionals are exercised about the potential impact of geopolitical uncertainty. Some 70 percent of respondents to our survey, The Impact of Political Uncertainty on the Asset Management Industry, published in February, thought that investment returns over the next three to five years would be impaired. And the political risk identified as having potentially the biggest impact on investments is President Trump.

Investors are worried about Brexit, too. A full one-fifth of respondents expect Brexit-related uncertainty to persist for a further two years, and more than one-third believe wholesale EU disintegration is likely.

Geopolitics is just one of many headwinds facing investment managers. They are operating in an industry that is ripe for disruption, as investor and regulatory demands for reduced costs and fees are growing. Meanwhile, passive investment strategies are putting pressure on traditional models, as exemplified by BlackRock’s shift in its active equity strategies in the U.S. away from human stock picking to a focus on data analysis and other quantitative methods.

The repositioning of funds will affect $30 billion of the firm’s assets under management. Together with a move by some institutions to insource investment management, investment firms’ models are under severe pressure.

And that’s before the thorny question of technology is considered. Investment firms have been late to recognize the desire of the Amazon-generation to be tech-empowered in their engagement with investment firms. Although the investment industry is catching up, incumbents are struggling to compete with technology challenger firms and the compression of margins that these new entrants are forcing.

Investment professionals are starting to recognize the potential for disruption to their industry. In another CFA Institute survey, Future State of the Investment Profession, published this month, more than half of the participants said they expect substantial or moderate contraction of profit margins in the industry. Most expect widespread consolidation of investment firms as a result.

We think the message is clear: asset management is at an inflection point and our profession needs to radically rethink its value proposition.

Actions, not words

New thinking is required to reconnect the industry with its purpose to serve society and allow capital to flow to the most productive uses. In a nutshell, it needs to move away from being an industry and towards being a profession. That is, move away from an inward-looking, self-serving entity to one that is geared towards meeting customer needs first and its profit motive second.

Moving from an industry to a profession will help rekindle investor trust. This in turn will drive greater participation in capital markets, and help create new value for asset managers and their clients. CFA Institute proposes four concrete aims which asset management firms could take on board in the quest to create trust and offset some of the risks posed in today’s geopolitical climate.

First, revise business models. We must create more value, for more clients, and perhaps on thinner margins. Second, fix our problem with young people. They don’t trust financial services. We must build business models geared to long-term investor outcomes, not our own financial targets. Third, recruit more of the right kind of people. We want investment firms to make themselves attractive to people who are motivated by more than money. Finally, adopt new technologies before they disrupt us. Embrace technology as an opportunity, not a threat.

Better outcomes are possible

A more transparent, more tech savvy, and more connected industry can respond better to all challenges, including geopolitical risk. Investors will not sit quietly while their investments rack up losses because of geopolitical events.

Whether the U.S. Department of Labor’s fiduciary rule finally makes it onto the statute book or not — the current timeframe is June 9 — investors will expect their advisors to behave like fiduciaries; that is, to put client interests above their own.

Morgan Stanley, like Bank of America Merrill Lynch before it, has signaled it will implement the standards of the Fiduciary Rule regardless of whether it is officially sanctioned, while JPMorgan announced late last year that it will stop charging its clients commissions on individual retirement accounts (IRAs). These are heartening signs that big industry players have decided to act on their own without waiting for further regulatory action.

Bjorn Forfang is managing director of relationship management at the CFA Institute. He has more than 20 years of experience, including 14 years as managing director with UBS Investment Bank.

The views expressed by contributors are their own and are not the views of The Hill.