Innovation seen as key for investment management

PALM DESERT, Calif. — Investment management companies can help investors cope with the shift from defined benefit plans and the derailment of Social Security reform by coming up with new and innovative products, said one industry expert.
The industry just needs to make sure public-policy-makers give it the “flexibility” it needs to come up with those solutions, said Paul David Schaeffer, a San Francisco-based managing director with SEI Investments Co. of Oaks, Pa.
But getting policy-makers onboard won’t be easy, said Mr. Schaeffer, who delivered his comments last week here at the Mutual Funds and Investment Management Conference, which was sponsored by the Investment Company Institute in Washington.
That’s because regulation and legislation tend to be reactive, rather than proactive, he said. Indeed, many of today’s pending rules address “yesterday’s problems,” Mr. Schaeffer added.
It’s one reason why the industry needs to take a more activist role in crafting public policy, he said.
Of course, the Investment Company Act of 1940 allows for innovation through an exemptive process, noted Thomas P. Lemke, general counsel for Legg Mason Inc. of Baltimore.
Innovation by exemption
Although the Securities and Exchange Commission is taking steps to hasten the exemptive process, that process can be slow, he said. Plus, the fact that the industry’s ability to innovate requires an exemption sends a bad message to innovators and encourages the development of products that are not governed by the act, Mr. Lemke added.
Not all of the challenges faced by the investment management industry stem from regulation, however. “The industry is under spending on technology and innovation,” said Mr. Schaeffer, whose firm is a developer of investment management technologies. With the right technology in place, investment managers can better communicate with clients and construct better investment solutions, he said.
Another challenge involves getting investment managers to change their mind-set from thinking of the industry in terms of “silos,” Mr. Schaeffer said. Products such as mutual funds, separately managed accounts and exchange traded funds should be viewed as belonging to the same industry, he noted. They all are “building blocks” that can be used together, Mr. Schaeffer said.
Investment managers seem to be getting that message.
Such mutual fund companies as The Vanguard Group Inc. of Malvern, Pa., and Rydex Investments of Rockville, Md., now offer exchange traded funds, noted Darlene DeRemer, a partner with Grail Partners LLC, a Boston-based industry consulting firm.
ETFs on the rise
“ETFs are not necessarily a foe but a friend of the industry,” she said.
The ETF market, which is much smaller than the mutual fund market, will continue to see “outsized growth relative to mutual funds,” Ms. DeRemer said. ETF assets are expected to surpass $1 trillion by 2010, from $430 billion today, she added.
Mutual funds, meanwhile, account for more than $10 trillion in assets.
Of course, ETFs face many of the same challenges that mutual funds do — particularly in regard to regulation, said Joanne Medero, global head of government relations at Barclays Global Investors of San Francisco, the largest ETF manager in the United States.
Despite such challenges, the investment management business still is very profitable, Ms. DeRemer said. Winning strategies from the past will continue to be the mantra going forward, she said. Investment managers who deliver strong, consistent performance will attract and retain the best talent, Ms. DeRemer added.
But tactics will evolve.
For example, the role of intermediaries is growing, and the investment management industry needs to continue to adjust to that reality, Ms. DeRemer said.
With regard to product, expect investment managers to focus on things retiring baby boomers will find attractive, she said.
Asset allocation funds already are gaining ground as investors favor prepackaged solutions in preparing for retirement, Ms. DeRemer said.
Income-oriented solutions also are on the rise, she added.
Because insurance companies specialize in providing income-
oriented solutions, expect them to be major providers of product, Ms. DeRemer said.
To ensure that it develops truly innovative products, however, the investment management industry needs to raise its voice and make sure policy-makers don’t restrict its ability to innovate, Mr. Lemke said.
“The long-term health of the industry is tied to providing investors with innovative products and services on a continuous basis,” he said.

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