Every 18 months or so, those of us who do manager research at Watson Wyatt get together on a global basis to discuss new approaches and techniques that we should employ when evaluating managers, as well as discuss industry trends today and in the future. This year, our heads of research have decided to add an extra feature to our discussions—they have identified nine books of business, finance or investing relevance and assigned them among the 120+ of us attending the “research summit.” My assigned book is The World Is Flat by Thomas L. Friedman and my charge is to ascertain from what he has to say about the world that can be applied to how we research managers and to managers’ investment approaches.
For those of you who have not yet read his book, the basic premise is as the title implies—the world is flat. To him, this means that it is now possible “for more people than ever to collaborate and compete in real time with more other people on more different kinds of work from more different corners of the planet and on a more equal footing than at any previous time in the history of the world—using computers, email, fiber-optic networks, teleconferencing, and dynamic new software.”
Taken at face value, there is much that is true in this statement. I regularly “attend” research meetings with my colleagues from the U.S., U.K., Canada, and Australia. Our initial challenge was to realize that the time of the meeting would have to accommodate all schedules and our next challenge was to find a time that worked for all participants (it changes twice per year to accommodate daylight savings time in all countries and hemispheres). This is no different that an investment manager who has investment research, investment management and client service centres around the world. They too have to find ways to coordinate information sharing and research views and many have ably done this through intranets, teleconferences and increasingly webcasts. However, the biggest challenge is how to connect and collaborate among and between people and geographic regions; how to promote a unifying culture yet allow for local differences (or glocalization as Friedman terms it).
Again, many investment management firms are finding ways to do this through face-to-face offsites, having analysts and portfolio managers from different geographic regions and sectors attend meetings together. However this does not entirely deal with the culture issue. Friedman posits about glocalization, “As the world goes flat, and more and more of the tools of collaboration get distributed and commoditized, the gap between cultures that have the will, the way, and the focus to quickly adopt these new tools and apply them and those that do not will matter more. The differences between the two will become amplified.” In other words, how does an investment manager continue to evolve and maintain a competitive advantage? It is through a common philosophy and shared goals, but with a willingness to evaluate new approaches and ideas. This is very hard to measure; however, a process and a dialogue that is both internal (introspection) and external (awareness of the ways that the industry is evolving) is required.
Another key theme of Friedman’s book is the separation of value-adding activities from commoditized activities. He says: “…more and more jobs will be broken apart, with the more sophisticated tasks being done in the developed world and the less sophisticated tasks being done in the developing world—where each has its comparative advantage.” Many companies have already embarked along this path, including my own. Research is done in Uruguay and Bangalore (for North America and Asia respectively), while data processing is done in the Philippines and Mexico City.
A more interesting interpretation for the investment community, though, is the way this can be applied to investment management. Friedman is also speaking here about the separation of alpha and beta, though I am sure this was not his intent when he penned his ideas. According to Friedman, index exposure should be accessed cheaply, while active skill or alpha is value adding and can easily be separated from such a “commoditized” activity as beta management. As we all know, beta can be accessed quite cheaply through index-tracking ETFs and passive management strategies. I am not sure that alpha is easily separated from beta, but I think we would all agree that it is worth paying for when found.
However, Friedman does not stop at categorizing activities as commodity or value adding. He also comments on jobs that are untouchable including the New Middlers. Untouchable jobs are those that are special or specialized; localized and anchored; and “those new middle jobs that will be less vulnerable to the downward wage pressures of outsourcing, automation, and technological change….”.
There are some interesting implications here for the investment management industry. The localized untouchable is one whose job involves specific knowledge—this could easily be the boutique manager, one with a single asset class focus. The boutique manager is a viable and sustainable business model. Such a firm specializes in a particular asset class (for sake of argument, lets focus on Canadian equities), and has people dedicated to researching and investing in those securities. They usually have a limit on the amount of money they wish to take in; that’s in order to maintain their boutique status (and small decision-making structures) and yet allow for flexibility of investment ideas. Such a manager has many appeals, but also some drawbacks often including key man risk and financial vulnerability when their asset class is out of favour.
I often wonder why Canada has not spawned more boutique managers whereas Australia, whose equity market is equally as concentrated, has done so. One factor is the availability of back office service firms in Australia (to my knowledge these are not yet readily available in Canada). However, I think the reason is deeper rooted among Canadian plan sponsors. The majority are not willing to place money with managers who do not have a three- to four-year track record, who rely on a single, dominant individual, and who limit the amount the plan sponsor can invest. It is a shame since these managers are often creative and provide a nice complement to more core-like or index approaches (i.e., they are the alpha that Friedman spoke about).
The New Middlers is really a collection of activities including the Great Collaborators and Orchestrators, the Great Synthesizers, the Great Explainers and the Great Leveragers. I am going to focus my comments here on the Great Synthesizers since I think there is an interesting premise here. Friedman believes that the next great value breakthrough comes from putting disparate things you would not think of as going together. Clearly my reading of this book from an investment perspective is an example of this. A more concrete example is given by Jeff Wacker of EDS who predicted that a company will have a CIO, but it will not be a chief information officer but a chief integration officer. Information technology is replaced by integration of business processes once IT is so fully embedded in every aspect of the business. In the investment industry, I see the parallels of risk management evolving from the investment manager being cognizant of risk in his portfolio to a chief risk officer who not only reviews that manager’s portfolio and those of the clients, to reviewing the risks taken across all client portfolios and by the firm generally. The chief risk officer may also be looking at the risks inherent in the business—front, middle and back office.
While there is much more I could infer from Friedman’s book, one of his final statements is an appropriate place to leave this column and provide all of us with continuing food for thought: “We….will have to work harder, run faster, and become smarter to make sure that more of us are able to connect and compete, collaborate and innovate on the flat-world platform—and derive all the benefits it has to offer. But remember: the most important competition is now within yourself—making sure that you are always striving to get the most out of your own imagination, and then acting on it.”
Comments
Nicely written, thoughtful extrapolation from Friedman’s book to the investment management firm…Reading this piece was a pleasant (and useful) diversion from the usual pieces we read on investment managers and funds. Janet, thanks for sharing your perspectives!
Randy Colwell
Regional Vice President, Business Development & Strategy
Group Retirement Services
Sun Life Financial