CAPTURING “CHANGE ALPHA"

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[PIA SCHAEFER]

There's never been a time as exciting as now to be a customer of the investment management industry. I think over the last couple of years we've seen a lot of regulation. Things like value for money, pushing for transparency on fees, transparency on where performance has been generated. And that is overall been a good thing for customers of an industry that historically has not necessarily been extremely transparent, nor extremely customer-focused. I think we've not historically seen ourselves as a B2C business, for example, and I think that is changing. 

I think that differentiation between how do you interact with your customer base or your customers' customer base when you're a B2B or B2C business-- I think that is just completely merging. Everyone today expects the interaction with any service provider to be as easy as dealing with the iPhone, being on Instagram, on TikTok, or swiping left and right on apps. And I think that's a trend that we're definitely seeing as well-- a consumerization of the customer journey. A focus on the customer journey, a focus on the end customer, a focus on being able to customize at scale because you're managing to a declining top line into uncertainty-- the uncertainty that you've managed. 

And the expectations of your customer base are increasing, which in theory should drive up costs. So, you're facing nowadays as an asset manager almost a perfect storm, but also exciting possibilities, because I think this is probably the moment when our industry grows up and becomes a mature part of financial services and the global economy. 

[MARTIN HUBER]

If there's anything constant in the next 10 to 15 years, it's going to be change. On the investment management side, this means change has been accelerating over the last couple of years. But I would also argue we haven't seen nothing yet. There might be a couple of things. A, it's the whole managerial part of it which, I think, asset managers like everybody else has to deal with. But then there is a significant effect, if higher rates are persistent, I think this could have significant impact on asset managers. Because suddenly, you would see a lot of rates business going away again because people have started to internalize, which could significantly disrupt business models, especially fixed income managers or fixed income heavy managers, but also of the industry. Because if only a third of the fixed income asset is internalized, this means that we lose 15-ish percent of our asset base. 

The optimist in me would say, we still have a lot of savings that we can tap into that need to be managed. But this will create a lot of change and this will create a bit of upheaval, and I'm sure that we will see industrial changes in the asset management, but also in the investment management industry beyond pure asset management. And I believe that's a good thing.

[PIA SCHAEFER]

Talking about higher rates and the fact that that's leading to a completely different bar in terms of investment returns, and at which point it makes sense to engage with the industry, I think that is also going to be a big driver of innovation and product and a re-evaluation of the product set and how we deliver value to clients. Because if you can put your money in the bank and you just get 5% but it's guaranteed, you don't have to worry about alpha or beta or any other Greek letter, that massively raises the bar, not just on money markets or fixed income products. But I think it goes all the way through. If you have a private equity fund that has historically returned 10% but your money is locked up for 10 years, or even 15% and now you've got much higher inflation, much higher rates, I think it will really put a focus light on performance in the industry as well and change how we formulate what our investment targets are for the client base. [MARTIN HUBER]

It's also the requirement of the clients that drive that, actually, because many insurance companies, many pension funds-- they are happy to have 4.5%, 5% returns. And also, because this is their hurdle which they are required to regulatorily and their commitments to their clients, et cetera. In the past, this was a major driver of innovation, product growth, and growth for the industry as such, because given that you can't get it from fixed income, you needed to a) give up fixed income, but you also needed to come up with equity and private equity and private asset solutions to get to the investment objectives that your clients had. If they now can do it by investing in govies,by not many people are risk averse and they don't want to see the volatility that you have in equities that you have in private equity if you look a little bit deeper. So therefore, I think this is another pressure point for the industry to actually rethink their innovation strategy.

[PIA SCHAEFER]

So, I think we absolutely agree with you that change can be very, very exciting. And I think in the Aladdin business in particular, we've recently started talking about this concept of “change alpha”. I think obviously in investment management, alpha is our holy grail. I think for a while we looked at Aladdin and how our clients use Aladdin-- our technology-- to generate resilience, scale and be able to grow and lease innovation from the Aladdin ecosystem as operational alpha because you just get more out of every dollar, every pound, every yen, every euro that you invest. And also you get more out of all of your colleagues, all of your workforce, all of your workflows. 

I think in this new environment, it's really “change alpha”. It's, are you positioned? Do you have the fundamentals in place to be agile enough to take advantage of the opportunities that are provided to you and to navigate these difficult seas of change that are quite unpredictable, like you say. I think historically maybe you've had to deal with inflation and high rates, and then everything else was equal. Or there was geopolitical turmoil and everything else was equal. Today there are so many different aspects that are new, that are changing, that we can't be complacent. 

So, I think it's more important than ever to understand, who do you want to be as a participant in the industry, as an asset manager or wealth manager? Maybe you're on the index of both. And where do you create your “change alpha”? Is it from owning everything front to back in your stack and in your investment book, or do you specialize in certain areas? And where do you partner? Where do you outsource? And that creates tremendous opportunities for everyone, and I think the outcome is going to be better for customers and better for the industry. 

[MARTIN HUBER]

The original alpha is reasonably elusive. It's a difficult term to use if you use it for change. But I think I agree with you that the possibility to create alpha in change is probably higher because most don't see this as their core business, which means you have a good starting point to really help them. And I think the challenge that I see is fully embark on a partnership journey with them, because then I can see the source of alpha and I can also see the realization of alpha quite clearly. 
The problem that I anticipate is getting your partners to actually embark on the full story. Because if you only do bits and pieces, then the same thing happens as on the investment management side where you do one or two pieces of the investment process really excellently, but you never optimize front to back everything, the whole process. 

[PIA SCHAEFER]

I think that's key. 

[MARTIN HUBER]

And if you have legacy applications, if you have complexity in your operating model, and not a simple backbone where you have modularity that plays for you where you can make use of agility, where you have a lot of opportunities for change and speedy change, I think then if you get this done and if you focus on what an asset manager should really focus on-- i.e. on creating performance, both on investment but also for the client perspective and not think that they need to own everything and do everything better-- I think that's a huge opportunity. 

[PIA SCHAEFER]

I think if you're thinking returns net of cost back to the client, you can return more when your costs are lower. And I think obviously historically that has always been one way that clients leverage the platform-- is to be as efficient as possible and then look for growth and look for innovation. So, I think that is definitely one area where we see continued sources for potential “change alpha”. But I think-- 

[MARTIN HUBER]

Although the economies of scale that we should see, we don't see this as much as we actually would have anticipated let's say 10 years ago. You might remember, I invented-- or I wrote this first version of our benchmarking for the asset management industry, and we always thought it's a fixed cost business. But what we saw is that the cost relative to assets went up for nearly 25 years. We now see a flattening of the curve, and even a slight decrease, which indicates that we started to see economies of scale. But definitely not at a scale yet where we should be satisfied, where customers can be satisfied, but frankly where the industry should do more effort to actually take out all the slack and all the inefficiencies which are still in the industry. 

[PIA SCHAEFER]

It is a very interesting point you make. I think that Goldilocks scenario coming out of the last crisis hasn't really pushed anyone to make any drastic changes and re-engineer all the way through. If you were very ambitious and you wanted to be the smartest kid on the block or the best performing one, sure. But actually, you could probably do all right just not changing very much. And I think that time, that runway to make a change is shortening very, very rapidly. 

[MARTIN HUBER]

So, the future will belong to those who get prepared for this, who are edgy, fast, agile, and are not afraid to change and use whatever tools are available to be faster than competition. 

[PIA SCHAEFER]

I would agree with that. And I think that then, when you have those foundations in place and you have that agility and the resilience as well to dip into these opportunities, then I think there's so much innovation that you can take advantage of. You have GenAI and how that will probably affect many parts of the investment management, wealth management, financial services, value chain. There are so many opportunities to harness it for insight in the investment process, for productivity gains, and also massively improve the customer experience. 

But it doesn't really make sense to start your journey in AI if you don't have your data strategy in place. And if you don't have your data strategy in place, you might also not know what you're doing with the cloud. So how are you going to benefit from large language models or from creating a walled garden if fundamentally maybe your data is distributed in many legacy systems. 

[MARTIN HUBER]

You need-- you need a clear data strategy. A clear data structure. You need to be able to structure, organize, and access data sources beyond the asset management company as such. So all the financial data, all the market data you need to structure in a way that you can actually take advantage of that. Then you can derive from that your investment process, which ideally you manage, quote unquote, "scientifically," and not in an artisanal way. 

And there, AI can dramatically help you because it can point out-- you're not following the process. There's a better decision out there. Why do you do this? Why don't you do something else which you actually have promised in your process which should lead to better performance than other people? But when we look deeper, we see that the number of portfolio managers that really follow their process is actually embarrassingly low. 

[PIA SCHAEFER]

Do you see a correlation-- 

[MARTIN HUBER]

Some say half. 

[PIA SCHAEFER]

Oh, really? Do you see a correlation between following an investment process and returns? 

[MARTIN HUBER]

Yes, because that's the only way of how you can learn. Because you need to have a-- not a benchmark, but you need to have a process where you have a thesis of how do you create alpha versus the market. Once you have the thesis, what are the influencing factors that you tilt in one or the other direction? And you can only become better if you have-- 

[PIA SCHAEFER]

An ability to backtest, essentially. 

[MARTIN HUBER]

If you have the ability to a) understand, to measure, and then to back test. But then also understand, what do I need to do better? It's a little bit like being somebody in sports. You work extremely hard to get the last 1%, 2%, 3% out of yourself by using a slightly different technique. But in order to do that, you need to know whether what you are doing is efficient or not efficient. 
[00:12:30.57] SPEAKER 1: Yeah. You need to know your baseline. 

[MARTIN HUBER]

If you are a runner, you need to know whether my technique delivers the 9:59 that I would like to run, or whether my technique already limits me to a 10:20 time. And then you can start working either on changing the technique or to change my strength or work on my strength, or to change the fluidity of my movements. So, whatever it is. But you need to be able to measure and to improve. 

You're going to change food intake. You're going to change the fluid intake because you can optimize with it. And if it gets you half a percent, it helps you with a percent. But in the end, this is what really makes the difference. Because we have such a diseconomy in terms of the outcome distribution, most of the benefits goes to very few vendors in the industry. So, we have to work extremely hard. And in order to do this, we have to have a very clear understanding what we do and then improve and tinker with it all the way through to become better. 

You need to be agile to be able to also take advantage of short-term changes. I think the fast ones are going to win over the slow ones. It's not big or small. It's fast versus slow. 

[PIA SCHAEFER]

And the ones that can analyze where they make the right decisions and the wrong decisions and learn and improve their performance. To me it feels almost like so many paradigms are shifting, and silos that have traditionally seemed like set pieces of a value chain are dissolving. When you think for example about public versus private, what you do in a public market, how you finance yourself as a company on the public markets versus what you do privately-- that has changed a lot over the last couple of years.

And it's becoming almost a continuum and see portfolios or solutions where different elements are mixed and combined which then also again means that you need different kinds of technology analytics to be able to support this and processes behind it, which I think is very, very interesting. And if we roll this forward 5, 10 years starting from where we are today in terms of technology and digital assets and then think ahead to a world where tokenization is something that becomes a very big thing in our industry and makes, I think, products accessible to different customers at scale in a completely different way to the past, I find that extremely exciting. 

But at the same time, it means a lot of change is needed. 

[MARTIN HUBER]

What we're seeing is a total fragmentation of the value chain and-- 

[PIA SCHAEFER]

100%. 

[MARTIN HUBER]

--and now a reconsolidation, but in different directions. An easy example, a non-investment management example is what happened to the payment industry over the last 15 years, give or take, which was historically embedded in the banking system and you had a few credit card providers. But now you have a real payments industry which is largely independent from the banks. We are technologically in a situation where we can fragment and rebuild different business models on top of this fragmented value chain because we can suddenly pick out pieces which-- where you are spectacularly good at, and then you focus on this and then you can vertically consolidate. 

And suddenly you can be the best infrastructure provider, the best data provider, the best analytics engine, half of the asset management players in a given market, which 20 years ago was even impossible to think. It's not only that we were not able to do it. We didn't even have the language-- the understanding in place where we could think that. And now we really are in the middle of a revolution, and we now see the benefit from it, which again brings us back to the ability to change and the necessity to change. Which again then brings us back to the question of, where is my institution's “change alpha” that I can create? What's the stuff that I need to own, which I need to focus on, where I should do every effort to consolidate it? What's the stuff that I buy from the market? 
And we see the same thing, by the way, on the customer front-- so the customer ownership as we have seen historically when we talked about institutional retail and what have you. Also there that we see a convergence in buying behavior as product usage, et cetera, et cetera. So, you could say we see an institutionalization of the investment management space. 

[PIA SCHAEFER]

We've absolutely seen that convergence of asset management-- wealth management into a continuum as well. So, you see that on the client side, you see it on the product side, and technology really is the enabler of all of it. So, I think when we talk to our clients or when we talk to prospective clients and other participants in the industry, the questions they ask themselves are, where does my organization want to be in 10 years from now? Given these shifting sands, given all of these trends that are going on, do I have the right capabilities along the value chain-- along this fragmenting and reconstituting value chain? 

Where do I want to invest? Do I invest into my legacy tech debt, or can I afford to invest in innovation? And what would it take to invest in innovation, and who are the right partners that can help me navigate this where we can complement each other? And one of the elements of this environment that we're in that I find quite interesting and exciting is that also what is fragmenting, is competition, as we used to know it. Most of the time when we're facing other industry participants, what we're seeing is co-opetition or collaboration with competition. 

No one has exactly the same business model, and very often we find that we're complementary and people can or companies can learn from each other, can benefit from each other's capabilities. And I feel that with cloud becoming something that eventually the whole world will run on, where everyone is almost by definition co-located in a cloud and can collaborate in a cloud, that will accelerate these trends that we were talking about even more, because it will be even easier to reimagine value chains and reimagine customer segments and customer service. And I think that's extremely exciting. 
So, I think we're overall as a world-- as an industry, and then many of our clients and ourselves-- we're in this massive digital transformation that's only just beginning where we're re-architecting from the ground up, from individual data points up. And going forward, there's so much to look forward to and so much to really embrace. 

[MARTIN HUBER]

But it also means that nobody is safe. So, size doesn't protect you. Quote unquote, "owning the customer" doesn't protect you anymore because we have seen the-- coming back to the topic of fragmentation, we have seen all of this fragment. So, we have to do a continuous effort to be at the forefront. To be faster than your competition. 

So, partnering, learning from each other, working together, at the same time competing in other bits and pieces-- I think that's the name of the game going forward if you do not want to become the dinosaur and die out because you want to control everything. I think trying to control is now probably the beginning of the end. Those who give up control have a higher probability to survive compared to those who try to maintain and try to control everything. 

[PIA SCHAEFER]

I feel you're on to something there. It really feels like traditional modes where companies have dug their heels in and have protected certain IP, a certain process-- that is no longer going to be possible. It's going to change completely how we interact with the market, how we collaborate, and how we compete. When you look ahead, what do you think the future holds? What out of all of these trends that we've discussed is one that you're most excited about or particularly hopeful for? 

[MARTIN HUBER]

So a) I'm optimistic. I think humanity is best and most innovative under stress. And probably hadn't enough stress the last two decades. And many listeners would probably disagree, especially those who lived through some of the crises that we have been discussing. But at the end of the day, I think what you described as a Goldilocks scenario is pretty much true as the overarching time that we have lifted. 

But I think the future is going to be better because if we manage to become more agile in being prepared for the changes which still will come, I think technology, I think provision of energy will dramatically change. We're going to live in a cleaner, better, more exciting environment. For the industry, this means given that there is growth, given that the balance sheet is going to probably grow in an accelerated fashion if we get growth right-- this means that for the industry, the foundation is fantastic. 

But again, I think investment management has the luxury that you have on average better people, and I'm sure that better people and smarter people under pressure will come up with great solutions. I don't know yet what it is going to be, but I'm sure this is the only thing constant. And if I can say something very positive about the industry which I follow since 26 years, also via benchmarking, is that it was always able to innovate itself a) into sustainable business models, i.e., new products that delivered the revenue requirements in order to maintain a profit base which is attractive and sustainable in the long run. 

I think it was a little bit less successful on the front end towards its clients. I think they have seen less advancement, even though again, the last five years I saw acceleration. But in the 20 years or 25 years, I saw a lot of innovation on the product side. And that has always worked out because of the smartness of people, the looking forward, the necessity to change because there were market pressures. And I think if this is being extended to the other components of the value chain, I still think we're going to see a good future. 

[PIA SCHAEFER]

With the right amount of preparation and embracing of this change. 

[MARTIN HUBER]

I also like the idea that you put forward earlier-- this co-opetition structure to really think differently about how we operate in the industry. I think this could unlock a lot of opportunity. 

[PIA SCHAEFER]

It feels like almost having to let go of ego, of thinking, I have to own everything. I have to control everything. I have to be the best at everything. 

[MARTIN HUBER]

Very hard. 

[PIA SCHAEFER]

And then saying, OK, let's look in the mirror. These are the areas where me, where my company have a competitive advantage. How do we make the most of it, how do we brave this new world, and where do we partner with other players? It's very exciting.