[Please note: this is currently with my editor and is in DRAFT format, feel free to read but expect typos - final version should be available shortly]

Been reading up on Sun Tzu’s “The Art of War”?  If not, you had better move the book to the top of the weekend reading list- the next ten years of your career might depend on it.

It is (for those who have not read it) one of the world’s oldest and most respected texts on military strategy. First translated into French in 1772, it is on the reading list of many who seek competitive advantage (including the U.S. Marines and the CIA). Beyond direct warfare, it’s lessons have been applied across a broad range of disciplines including sports and business.

In my reading, The Art of War is a guide to winning by doing other than your opponent does or expects you to do. Sometimes that means not treating them as an opponent at all.

Particularly interesting is the subtlety of the strategic approach Sun Tzu outlines. He emphasizes the need to exploit nuances at critical moments on the field of battle. We are in such a moment in the asset/wealth management*.

My bet is that the winners in the asset management industry over the next decade will be marked by their understanding and ability to strategically capitalise on subtle nuances**.

By focusing on the nuances, I am not suggesting that the ‘big things’ don’t matter – they definitely do. In fact, probably more so than ever. But in some ways, the big things are obvious and accounted for – strategically, they belong to the past.

At points of influx, during shifts in paradigm (as we are now without doubt experiencing), the nuances are the fulcrum points from which the future will be driven.

Given the rate of change in our industry,  if you have not done so already, there is limited time to get ‘the big things’ right simply to be on a foundation for growth. This is because your competition is on the move. Frankly, much of this should have been figured out shortly after Lehman’s lights went out (if not before).

Today’s nascent nuances are the big things of tomorrow.

How to Make Their Clients Ours -or- Let’s Deal with Middleman First?

As I have been discussing extensively in recent years, the question of client control and dis-intermediation is one of the great undercurrents of our industry. The points of influence over asset owners and their investment decisions are in flux and will increasingly contested amongst market participants.  The full outcome remains uncertain but this much  is clear:

To the extent that an asset manager and intermediary distributor/adviser are offering the same service to an end-client, they are not partners but competitors.  To the extent that they can take aspects of business from a competitor without jeopardizing the all important relationship with the end client (the one with the money), they should (ugh em, will).

In these days of shifting relationship and roles between asset management ‘manufacturers’ and ‘distributors’, let me point out a pertinent, and oh so subtle emerging nuance. So nuanced in fact, it revolves around the positioning of just one little series of words, but oh what  powerful words they are!  These words may prove to be key artillery in the art of client acquisition.

Though the tactic is attributable to Sun Tzu, it is perhaps children who are the earliest masters of the approach. For those readers with children, you know the tactic well – it goes like this.  Have you lost a flashlight, a pen, or perhaps an automobile to the subtlety of the shift in possessive case? I take what is yours by simply calling it mine. No need for a war (in the conventional sense), no need for hostility. A smooth and unchallenged conquest.  And so it goes: your car, the car, my car… as easy as that.

This shift in possession takes place  with a special twist only possible with children (and as I would argue) investment professionals. There is an asymmetrical risk/return profile. As long as the newly possessed object continues to work as it should and no maintenance is required, everything is fine but when it breaks down and needs service, then you (as the rightful owner) get it back. Car runs out of gas, my car no more.

You, dear parent (and asset management professional), are already living  in the shadow of  Sun Tzu and his Art of War.

Across the Divide

You have likely seen the campaign for BlackRock’s “Investing for the New World” that ran the last couple of months. Full page ads in the WSJ, FT and elsewhere. Direct to investor advertising. Going retail. Iconic video shoots with lots of emotion. Connecting BlackRock to the client (that is, the one with the money).

I recently watched most of an hour long  ‘interview’ between Larry Fink and another senior BlackRock colleague of his. Peppered in the conversation about the changing financial world and Larry’s insights, a wee little indication of another New World emerged.

On several occasions during the hour interview, Larry and his colleague referred to the Financial Advisers (FAs) (employed by the financial intermediaries that distribute BlackRock’s products) as “our FAs”.

As quickly as you have lost your pen to your child, has Larry (attempted) to take the sales force of an intermediary who distributes BlackRock’s products simply by calling them his own and by so doing created a tremendous point of leverage to the end clients under the FA’s guidance? Increase a sales force and loyalty by adoption? If you are an asset manager and want to maximize the powerful distribution capabilities of a large distributor while not giving up control of the end client, this could be one such tactic.

But it is not just on the main stage that these nuances are growing into something big. On a scale far below that of the global asset management behemoths, we are seeing parallel developments. Boutique asset managers are providing Registered Investment Advisers (RIA) in the U.S. (similar in approach to IFAs in many other parts of the world) with ‘investment solutions’ branded as the RIA’s own. Combining asset allocation and security selection, they are the ‘outsourced CIO’ of the high net worth investor world.

The relationship with the client is that of the RIA but for how long will it be before the asset manager begins to call the adviser its own?

An Excerpt

From the Art of War, Chapter 3: “Offensive Strategy”

Generally, in war the best policy is to take a state intact; to ruin it is inferior to this. To capture the enemy’s entire army is better than to destroy it; to take intact a regiment, a company, or a squad is better than to destroy them. For to win one hundred victories in one hundred battles is not the acme of skill. To subdue the enemy without fighting is the supreme excellence.

Thus, what is of supreme importance in war is to attack the enemy’s strategy. Next best is to disrupt his alliances by diplomacy. Thus, those skilled in war subdue the enemy’s army without battle.

(Italics mine).

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* Though of course the stakes are inconsequential relative to war – lets’ not take ourselves too seriously here.

** The convergence of alternative and traditional and the eventual mainstreaming of alternative investments was but a nuanced spark when some of us fringe thinkers began discussing (nearly ten years ago) that its eventuality was inevitable. So it goes with ETFs and the bulk of asset management products today.

Larry Fink is advising investors in general and his clients in particular to own 100% equities. Clearly the man who was instrumental in building a 3.3 trillion dollar asset manager on the foundation of bonds has become a stock guy.  Whether or not this radical asset shift is sensible is certainly debatable. But an equally interesting question  for many of us thinking through the quickly evolving nature of asset management and distribution is:

“who, exactly, are Larry’s clients?”

and, what does he know about asset allocation? Is Jan Investor, ABC Pension Fund and XYZ Foundation BlackRock’s client or that of the investment intermediary who, so graciously, made the allocation to BlackRock’s investment strategy?

Certainly the intermediaries through whom  BlackRock and every other asset manager around the globe have gathered assets (investment consultants, private banks, broker-dealers and the like) see the situation differently. They are not in a position to take Larry’s advice and move their clients into 100% equities. In fact, they are not interested in BlackRock’s  (or any other manager for that matter) opinions on asset allocation at all. In fact, they are the ones giving asset allocation advice and getting paid for it. Without the advice, what are they good for? Are they simply an introduction service for fee-hungry asset managers with 40% (+/-) margins?  How are they going to earn their fees and maintain themselves in the relationship? Ah, there’s the rub.

These intermediaries, at least in how they are used to operating, do not want Larry’s advice and asset allocation acumen – they want him to ensure that the fixed income products outperform their peers and benchmarks, that the hedge funds produce absolute returns, that the style of the equity products don’t drift…get my drift? Stay in the box Larry, we’ll let you know when we need you.

The dynamics between asset managers and the intermediaries who have been standing between them and the end-clients (read: the ‘client’ with the money) are not what they were twenty years ago. The intermediary is (was) in the driver’s seat, making asset allocation decisions, hiring and firing managers whose responsibility was narrowly defined – stick to the asset class/style for which you were hired and leave the asset allocation to us.

We have been watching this unfold for years but it has now reached the momentum point ™ (sorry Malcolm). In recent weeks, I have had repeated conversations with asset managers who tell stories about seeing the institutional consultants who once included them in searches showing up at finals presentations as competitors offering ‘implemented’ multi-asset solutions themselves. Well, well.

Ok, if no one else will say it, I will. You guys aren’t friends, really never have been. Stop pretending and just put the gloves on.  The disintermediation battle is on.

Though the frictions have clearly been developing (albeit relatively slowly), few in the industry, on either side of the trade, were terribly concerned about the evolution in the relationship between ‘manufacturing’ and ‘distribution’. Everyone was making money, markets were headed up, the asset allocation models, if not working as hoped, were at least not so apparently broken.

For many of the traditional asset managers, there were other things to worry about – being crushed by the ETFs charging from the left or picked off by the hedgies hiding in the shadows to the right. Insofar as distribution relationships go, rising tides…

But now the tides have receded. Margins are compressed. Regulation is overbearing. Clients are dissatisfied and are not as sympathetic to the manager/consultant agency problem as they once were.  Everyone is seeking a closer relationship with ‘the’ client and migrating to where the fees are. Each is seeking to control the relationship (and stay in the game). If I am being held as fiduciary, I want to get paid! It turns out (right after client-first) we all want the same thing.

Of course, this is not an entirely new situation.  Arguably it is a return to the state of the industry before there was a distinction between asset allocation and stock selection. To be an asset manager was (is) to not only buy stocks and bonds but to decide when to own one as opposed to the other. That was in the days when bank trust departments were at their peak of power…alas.

And who threw the first punch? Was it asset managers encroaching on the world of the adviser/consultant through developing products incorporating asset allocation and ’solutions’ or vice versa with ‘implemented’ consulting? Doesn’t really matter – blood has been spilled.

While this topic manifests itself in multiple ways around the world throughout client segments and geographies, perhaps the most visible implications are the growth  in ‘multi-asset/multi-manager’ on the part of what have been traditional asset managers and ‘implemented consulting’ and ’solutions’ on the part of those who, in large part, have simply been the buyer of individual asset management products. Outsourced CIO anyone?

This is a game changer – it will turn the industry on its head.  One must hope that the arrangement best suited to meet the needs of the end-clients will ultimately win out. What that model(s) looks like is being defined today.

There has been plenty of double counting  in our industry but for how much longer? At some point we will need to answer the question:  “Whose client is it anyway?”

It seems that American Funds, the formidable asset manager based in Los Angeles, is having a bit of an odd Oscars moment. They are winning all of the accolades but not seeing the box office sales.

In recent industry surveys and analytical pieces conducted for year end 2010 in the U.S., American Funds comes out on top of the list. They are being touted as #1 (in U.S. markets) in the areas of “consistent, dedicated to advisors, ethical and trustworthy” as ranked by advisors in a recent poll conducted by kasina (http://kasina.com/favision_new.asp). Their placement at the top of the pile is not new; they have been the show to beat for nearly two decades. They have long been the ‘go to’ suite of products for many financial advisors.

In connection with the release of the report, Lee Kowarski, a principal at kasina, stated, “It is critical for asset managers to establish a strong brand, especially in this environment where advisors are concentrating 64.8% of their assets under management with their top three providers…[w]e have observed that a firm’s score on the FA Vision Brand Index is positively correlated with customer advocacy (the likelihood that a customer will recommend the firm), which is a key predictor of flows.”

According to kasina’s poll, American Funds has an industry crushing “FA Vision Brand Index” score of 25.06, – three times higher than Vanguard (8.58), the next highest in the ranking of advisors’ opinions. Simple math (and the correlations that kasina suggest) tell us that American Funds would be flush with inflows; people would be lining up at the red carpet to see them and casting votes with their wallets thrown open.

Nope. Beyond all the well wishes and back patting, things don’t look so good. American Funds are seeing record outflows. They are in fact hemorrhaging and have been since 2008. According to data compiled from Morningstar Direct, they have lost $52,603,000,000 (that is billions) over the twelve months ended January 31 2011 in their U.S. domiciled funds. In 2010, they lost basically what Vanguard took in. Want to guess what business looks like across Europe and in Asia?

Credible arguments for the losses have come to American Funds’ defenses. Some industry pundits argue that the flows are, on a percentage basis, not so significant given the firm’s total AuM. Others have pointed out that the outflows are reportedly concentrated in a couple of distribution channels and therefore not indicative of broader trends. Others suggest that they are not particularly strong in bonds and therefore were victim to their predominantly equity driven business during the flight to quality. Others point out that performance has struggled short term and led to redemptions. Each of these points are more or less spot on but I am not buying the broader argument that this is a momentary lapse for the company. It is the indication of a longer running problem.

For certain, they are a huge company (and in fact part of the larger Capital Group) and not going to disappear overnight by any means. Yet, it is tough to see their growth drivers in the current environment. They have, in recent months, introduced a few new products – something that has not happened in years. But perhaps the indication of a change too late? They have recently been beaten by faster, leaner and/or more innovative shops. As the purveyors of the ‘core’, they have been standing in the middle of the road too long and have failed to keep up with key distribution and product trends. When you stand in the middle of the road too long, you get run over.

I think they better figure out what is really going on instead of listening to people talking about just how lovely their garments are.*

* The “Last Emperor” won 9 Oscars in 1988 and grossed $43,984,230. The emperor with the new clothes in the famous children story was misinformed and took some bad advice.

I will be leading a panel discussion with three senior manager research analysts at the Fund Forum in Boston on November 1st.  We will be discussing ‘post crisis’ evolution of fund/manager selection and what analysts are looking for from asset managers now.  A taste of the topics to be covered follows:

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Through the market turmoil and rapid evolution in the asset management industry over the last several years, one thing remains crystal clear. Decisions about the buying and selling of investment product are increasingly concentrated in the hands of manager research analysts.

Collectively, the global group of analysts who work within broker/ dealers, banks, RIAs, institutional consulting firms and other financial intermediaries are arguably the key client group for asset managers. Their opinions drive a sizable (and growing) percentage of the overall worldwide flows into and out of funds.

Given changes in regulatory environments, a fiercely competition landscape and the increased complexity of the investment environment, professional buyers using a highly sophisticated institutional selection process will eventually be the norm worldwide. Successful asset managers are structuring their organizations to prepare and capitalize on this development.

The strengthening role of the analyst is driving asset managers to reevaluate their approach to selling and supporting their products. Asset managers are using robust strategies for liaising with analysts and ensuring their needs are met.

Well-equipped and ultimately successful asset management firms understand the selection process and the mindset of the analysts who are responsible for driving a major portion of worldwide flows. They understand that developing strong relationships with analyst teams is a tremendous leverage point for their business.

These managers provide information and support that goes well beyond a factsheet and market commentary. They anticipate the need to support the analyst during shifting market phases and through changes in the investment product. They recognize that presenting to an analyst is not a sales pitch but a dialogue with a knowledgeable counterpart who a tremendous level of information at his or her fingertips.

Such managers recognize the particular challenges of the analysts’ job and seek to alleviate some of the pressure points through timely flows of information, with honesty and transparency.

Analysts tend to be a highly skeptical buyer group who work within an environment that is performance-driven, risk adverse and highly regulated – a complicated combination. Analysts don’t take kindly to being given the ‘hard sell’. They follow a structured decision making process and, in order to do so, need to have access to clear and concise sources of information about the investment product in view.

There are, as most recognize, already far more investment products available then are needed. Nonetheless, worldwide product proliferation is at an all time high. Further, the growing complexity of a new generation of products requires analysts perform sophisticated and careful analysis to get comfortable enough to render an opinion.

The converging of aspects of what once were called ‘alternative’ and ‘traditional’ are leading to an evolved playing field for managers and analysts alike. Complicating manners further, the commonly used approach to asset allocation and the theoretically tenets upon which it is based are being eroded at a rapid rate.

At the same time, the strength of ETFs, structured products, and a variety of other wrappers has pushed the competitive landscape for asset managers to new levels.

‘Post-crisis’, fund analysts are demanding even more from asset managers. The products they are interested in buying display attributes distinguishing them from successful products of the past. Innovative managers who can prove that they have the sustainable skills to develop and manage these products and service the sophisticated needs of analysts stand to gain; others will be left behind.

More information on the event and the panelists can be found at:

(http://www.icbi-events.com/fundsusa)