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“One summer day, probably in the 1870s, friends of a major short seller got together on the shores of Newport, Rhode Island, where they admired the enormous yachts of New York’s richest brokers. After gazing long and thoughtfully at the beautiful boats, the short seller asked wryly, ‘Where are the customers’ yachts?’”

— Jason Zweig in his introduction to Fred Schwed Jr.’s 1940 classic, Where Are the Customers’ Yachts? or, A Good Hard Look at Wall Street

If investors complained about Wall Street in Schwed’s day, they’re howling now. You can see the distrust in deeply skeptical regulators, highly critical pop culture (The Big Short book and movie, and Showtime’s Billions series) and voluble protest movements ( Occupy Wall Street and Bernie Sanders’ presidential campaign). Since Schwed’s time the definition of Wall Street has broadened to include asset management, an industry that has inspired its fair share of criticism for overcharging and underdelivering. We have to admit that such strong reactions, though often based on misconceptions and exaggerated facts, are not wholly undeserved, leaving the asset management industry vulnerable to disruption.

The need for good money managers has never been greater. Total investable assets are continuously rising. High-net-worth individuals are now influential sources of capital in both established and emerging markets. Baby boomers are living longer in retirement, and as they stop working they’ll need their assets to last longer. Yet for investors too few good options exist.

Many of our colleagues don’t believe that disruption is imminent. After all, asset management is one of the world’s most profitable and exciting businesses. Why should we even worry about disrupters? The challenge, according to innovation expert Clayton Christensen, is that incumbents have a blind spot toward disruption. It is difficult to see because it goes against a set of ingrained assumptions that most likely have led to success so far. As a result, the profitable big players have a hard time seeing threats, especially when these are coming from smaller and more innovative players or outside their traditional set of competitors. Even when incumbents perceive the possibility of disruption, they discount it or cannot change their existing business model fast enough because of vested economic interests or internal bureaucracies — and by then it is too late.

We take the contrarian view. We expect that asset management is about to go through a particularly dynamic period of disruption, for three reasons: high profits, new technologies and a new set of client demands resulting from global social changes. First, the industry is extremely profitable, and excess profit pools attract competition and substitution. According to the Boston Consulting Group (BCG), total 2014 industry profits were $102 billion globally, flowing from remarkably high operating margins of 39 percent. Second, financial technology venture capital is exploding: CB Insights reports that $10.5 billion was invested in fintech start-ups in the first nine months of 2015, compared with less than $5 billion in all of 2014. And third, a number of global trends — including changing demographics, the growing power of women and emerging-markets wealth — are shifting how and when asset managers must serve their clients. Collectively, these irresistible forces are meeting a movable object: the calcified asset management industry structure.

To frame our research we created a picture of the universe of investable assets, which is made up of the global economy’s money supply minus operating capital. It is equivalent to what surplus resources can be saved or invested for future use once the economy has been funded to meet today’s needs. Collectively, the universe of investable assets totals more than $270 trillion, excluding leverage (see “Real World,” below).

We categorize the universe of investable assets into three main overlapping groups: money holders, money managers and intermediaries. The money holders are ultimately the beneficiaries most affected by how the assets perform. They also incur most of the economic risk. Money holders — including sovereign funds, individual households, retirees and corporations — range dramatically in their natures, sets of expectations and investment sophistication.

Money holders delegate to money managers, who make decisions on the holders’ behalf with respect to how investable assets can be allocated to generate optimal return at optimal risk. Some money holders may invest a portion or all of their investable assets directly into the market; they currently hold $47 trillion of bonds and equities through direct purchases. In contrast, alternative assets — including private equity, venture capital and hedge funds — are much harder for individuals to access directly. This sizable asset class, representing $8 trillion in capital, typically charges higher fees for access and is available to only a select few money holders.

Last, intermediaries such as investment consultants and funds of funds have become a critical part of the ecosystem. Intermediaries provide different services to money holders and managers. They offer access to otherwise inaccessible managers and can provide valuable investment perspectives. In today’s period of unprecedented disruption, we see intermediaries in a strategic vise: They need to add increasing value to money holders and money managers while keeping costs low and responding to relentless competitive pressures.

The value of the universe of investable assets has increased over time, fueled by both population growth (which typically expands the value of the underlying corporations and other assets) and economic growth. This type of growth is also referred to as beta return, or the above-cash-market return. To benefit from such organic returns, investors do not require much investment acumen other than smart diversification.

But to beat markets — to create real alpha (returns above the passive benchmark performance) — is much harder and, some would argue, even impossible on a sustainable basis. Delivering alpha consistently on a net-of-fees-and-costs basis has proved an elusive goal. For example, hedge funds have underperformed U.S. equities since 2000 by 1.5 percentage points annually, on average, even though their returns look attractive over longer periods: Hedge funds topped the S&P 500 index by 3 percentage points a year from 1970 through 2015. However, one can argue that hedge funds were a different dish in the 1980s and ’90s, when the industry was much smaller and more nimble.

Even if highly sought-after money managers have successfully outperformed average market returns, it is impossible to guarantee that they will continue to do so in the future. With high management fees and substantial incentive fees relative to low-cost alternatives like index funds and exchange-traded funds ( ETFs), hedge funds are under heightened scrutiny, especially in light of recent mediocre performance. As a result, many investors are asking highly skeptical questions, demanding more transparency and expecting better alignment of results and objectives.

The asset management industry is one of the few industries that collectively play a near-zero-sum game. By contrast, most other industries are positive sum: If you eat a great steak dinner, it doesn’t imply that others have to eat hot dogs. In asset management each new money manager that is able to generate alpha in liquid markets normally does so at the expense of other managers or individual investors that underperform the market benchmark. Investors happily pay high fees for top managers but resist paying them for consistent underperformance. The pursuit of hot managers combined with the mathematical difficulty of outperforming markets leads to many of the peculiarities in our industry.

Initially, we based our research on Harvard Business School professor Christensen’s classical view of “disruptive innovation.” In his framework a product or service first gains customers by doing only one or two jobs for a client, typically on the low end of an established market. Eventually, the company moves upmarket and displaces the established competitors.

For a tangible example we looked at the unprecedented growth of low-cost ETFs and index funds. As a result of the sector’s success (assets have jumped from $3 trillion to $11 trillion over the past decade), the proportion of money managed in traditional active core strategies has withered from nearly 60 percent of assets in 2003 to less than 40 percent today, a trend likely to continue (see “The Big Squeeze,” below).

Similarly, low-cost retail investment firms like Charles Schwab Corp., Fidelity Investments and Vanguard Group are not immune to pressure from the even-lower-cost, technology-enabled robo-advisers like Betterment. Change is happening so fast that disrupters are now in danger of being disrupted. In a tepid global economy, money holders worry more about minimizing costs, taxes and fees than about generating unpredictable top-line returns. Schwab is looking to take market share from traditional full-­service brokerages; Wealthfront works on snaring Bank of America Merrill Lynch clients. Meanwhile, in just a few years, China’s Alibaba Group Holding has amassed more than $100 billion in assets for its money market fund, Yu’e Bao. There are rumors of other Internet giants, such as Facebook or Google, also entering the investing business.

The beauty of the Christensen model is that it articulates why successful, well-managed incumbents often have a hard time both perceiving and reacting to newcomers from the bottom of the market. The model predicts power shifting back to consumers or clients because they get access to lower-cost, higher-value products. At the end of the day, disruptive innovation is generally good for money holders.

Consistent with the disruption concept, some experts we interviewed do not see the current generation of highly automated advisers as worrisome competitors. They believe robo-advisers lack both the investment sophistication of established managers and the human touch of investment advisers, and that may well be true today. We are not saying that any specific robo-adviser or Internet company will overtake the money management establishment. However, we think these players collectively are a meaningful threat to the status quo.

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