12th April 2004

"Moving the mountain of old thinking"

By AMIN RAJAN

In this tenth and final instalment in the series on solving problems in fund management, Amin Rajan argues that new ways of thinking are more important than new ways of working. "The person who moved a mountain started by taking away the small stones"goes an ancient Chinese saying. So, to what extent have the investment firms on both sides of the Atlantic jettisoned the old model that only worked in a bull market?

In today's low nominal return environment, are they running the business like a normal business?

Few firms expected the bear market to last beyond 2001. Hence, the initial cost cutting was targeted at low hanging fruits such as marketing, advertising, travel and entertainment. The need for substantive changes only became pressing when markets tumbled again in February 2003 ahead of the Iraqi War.

Since then, some four in five houses have taken notable steps to cut costs, with one in five making radical changes to their business model, according to the estimates compiled by Create and KPMG, the professional services firm.

Encouragingly, these notable steps eschewed the time-honoured approach of emulating successful icons such as Capital International, Wellington and Fidelity, duly accepting that these firms had their own unique ownership features which bestowed special advantages. Instead, in most cases, the emphasis was on identifying their own core strengths and refocusing the business around them.

For example, Credit Suisse Asset Management, Deutsche Asset Management and Baring Asset Management are moving towards a "village of boutiques" concept in order to promote product specialism, entrepreneurialism and superior performance.

Gartmore Investment Management and UBS Asset Management are leveraging their "long only" strengths to capitalise on the huge growth in hedge funds. State Street Global Advisors and Barclays Global Investors are diversifying into absolute returns based on liability benchmarks.

Insight Investment Management, ISIS Asset Management and Morley Fund Management are forging long-term partnerships with prominent distributors in order to increase the share of third-party business in their profits. Seeing customers with new eyes has been the name of the game in all these well publicised cases and many others.

That apart, much has been done in disparate areas: for instance, the outsourcing of back office functions, linking bonuses with performance, upgrading the risk management function, branding, and creating matrix structures that leverage global strength. The list is long.

Heisenberg's famous "uncertainty principle" says that as soon as you touch or move something, it's never the same again. Much the same can be said about the global fund management industry in the light of the structural turmoil of the past 12 months.

However, as the chairman of a global firm remarked recently, "the current round of improvements are like the first-stage rocket: they've got us off the ground but they are not strong enough to propel us to where we want to go. We'll need new rockets as we progress."

This is all the more valid when it is realised that the fund management industry had premature maturity in the 1990s due to exceptional growth.

Business transformation takes time and persistence. Both in Europe and the US, for example, it took at least three recessions to transform industries as diverse as retail banking, textiles and aerospace. In each case, new ways of thinking were more important than new ways of working. The required mindset shift could not be achieved in a single step. Four basic lessons from their experiences are worth rehearsing.

First, mindset changes are usually as durable as the crisis that provokes them: to make them sustainable, business leaders constantly need to raise the performance bar and lead by example.

Second, no enlightened initiatives work in a disconnected organisation: the chasm between the top executives, research analysts, portfolio managers and functional managers needs to be tackled head on.

Third, innovation is not possible in an environment of fear or mistrust: there needs to be a culture of openness such that new ideas are honestly evaluated and thorny issues properly aired.

Finally, strategic rhetoric cannot be a substitute for tangible results: business goals have to be subjected to regular reality checks against some clear short-term targets rather than long-term pious hopes.

In critical areas, such as performance, client service, branding, risk management and compliance, actions have been taken across the fund management industry, with many more in the pipeline. They seek to improve both the processes and the cultural environment.

For now, it is worth emphasising that although the general thrust of these actions is in the right direction, the long-term buy-and-hold investors have yet to be persuaded that fund managers have given up the old habit of promising dreams but delivering nightmares.

Although new outstanding players are emerging from the current transformation, the recent mutual funds scandals in the US have prompted the cynical view that the more things change in the fund management industry, the more they remain the same. Be that as it may, it is clear that actions taken so far are in earnest: they amount to taking away a number of small stones as a precursor to moving the mountain.

Amin Rajan is the CEO of CREATE, a research consultancy specialising in new business models in financial services: amin.rajan@create-research.co.uk.