A race to the bottom: Technologies are disrupting investment industry
“Computational power isn’t just changing the old literacies of reading and writing. It’s creating new ones.” – Clive Thompson, Smarter Than You Think
There is no hiding from technological disruption these days which has spread quickly into every sector from health care, oil and gas, consumer discretionary, real estate, banking, insurance, legal, accounting — even to the investment industry.
The level of connectivity in devices is the reason why this period of technological disruption is different from prior periods such as the 1990s tech bubble. In particular, the subsequent build out of the internet of things has resulted in the acceleration and rapid adoption of new technologies that are using data to effectively drive down prices of products and services for consumers.
In the investment world, this level of connectivity has suddenly allowed equal and full access of information to the many chartered financial analysts out there willing to do the research. As a result, the level of efficiency in the markets has increased to the point where it is becoming nearly impossible to consistently outperform passive benchmarks — especially one in which there is little to no volatility. Looking ahead, imagine what will happen when more of these CFAs start using cognitive computing and artificial intelligence to start analysing all of this data.
It isn’t surprising to see exchange traded funds (ETFs) do very well in this environment. They themselves have been a very powerful disruptive force to the high-fee mutual fund industry. Suddenly, the average investor can own the market at a substantial discount to an actively managed fund that is struggling to deliver alpha due to higher fees and greater broader market efficiencies.
While the fund industry is trying its best to adapt by lowering fees themselves, it is becoming a race to the bottom having to compete with ETFs that charge as little as 10 basis points. More so, it is competing against the banks and even insurance companies who have both the size and scale to be a low-cost and profitable manufacturer of ETFs.
Interestingly, ETFs have a lot in common with the network effect being used in other industries. This is where a product or service is nearly given away at cost in order to build out an internal distribution system which additional higher margin products or services are then layered on top of. This makes it very difficult for a single-service provider such as a mutual fund company to compete against a multi-service financial institution.
Then there are the investment advisers who have finally begun using ETFs themselves in order to protect their margins in an environment where regulatory and administration costs are rising and investment fees are falling. From a value-add perspective, their role is still important in regards to asset allocation and ETF selection.
ETFs have a lot in common with the network effect being used in other industries.