By Jason Hazell, Head of Investment Communications NAB Asset Management
“What you really should have done in 1905 or so, when you saw what was going to happen with the auto industry, is you should have gone short horses. There were 20 million horses in 1900 and there’s about four million horses now.” Warren Buffett made this comment in a speech to University of Georgia students in 2001. He went on to point out that there were 2,000 auto stocks in 1900 and only three survived to the 1920s and none of them are making cars today.
Disruptive innovation was a phrase coined by Harvard professor Clayton Christensen in 1997. He describes a situation whereby incumbent market leading companies, whose success has been driven by their ability to continually innovate their products and services to retain their biggest and most profitable clients, find themselves in a position where a new competitor is taking away their smallest and least profitable clients. The company therefore faces the prospect of having to defend its lowest margin business. This is a challenging decision for any company to make.
While this continual innovation from the incumbent market players creates products or services that are well suited to their large profitable clients, it is not necessarily well suited to their smaller clients who may not value the complexity or sophistication of the offering. This creates an opportunity for disruptive innovation by new market entrants with new technology that allows them to lure these smaller clients away from the market leaders while still making good margins due to their lower cost bases. As we turn our attention towards the wealth management industry for insights into disruption and potential game changers for 2016 and beyond, I have spoken with two industry veterans who are very well known to our business to provide a perspective on the past and to offer their insight into the future of our industry.
Dick is very well known to many of us through his long career with the MLC business. In 1989, Dick joined MLC; in 1993, he became CEO of the Retail Funds Management business of MLC and in 1996 he was appointed CEO of the Corporate and Institutional Funds business of MLC. He is currently the Chair of the MLC Advice Board.
“Disruption has always existed in our industry” he says, summing up his involvement with the Australian wealth management industry for over 40 years. His first experience was in 1986 when MLC introduced the MLC Equity Credit product, which enabled households to re-draw from their home loans over the phone. This disrupted banks’ net interest margins at the time, causing a significant decline in margins, which meant that the end customer remained a winner.
However, the most profound disruption that Dick has witnessed was the introduction of the fee for service model for the advice industry. “Things have changed radically since the introduction of fee for service; this was a great disruption.” MLC took a strong leadership position in the market on fee for service, which has significantly changed the industry since and brought the cost of advice to light.
The move to fee for service across the industry also had broader ramifications. This was due to commissions strongly supporting the link between financial advisers and managed funds. This has evened the playing field and has since enabled the rise of other forms of product structures (such as LICs, ETFs, SMAs and mFunds) in the Australian market, where historically managed funds dominated the industry. Add to this the significant move of self-directed investors towards self-managed super funds (SMSFs) over the same period and we see a clear disruption in industry dynamics as the fee for service model is adopted across the industry.
When looking forward into 2016, the conversation moved to the disruptive impact of big oil price moves. Dick made the point that when oil prices rose from US$15-20 per barrel in 1998 to over US$130 market commentators saw disaster looming for the global economy. Now, with oil prices plummeting to around US$30, again market commentators are fretting about the potentially significant geopolitical impact of such a fall. While there is no doubt that significant moves in prices of key commodities will have an impact on the global economy, like the classic Australian poem by bush poet John O’Brien about farmers lamenting disaster at every turn, Dick cautions against interpreting all moves as negative. “We’ll all be rooned”, said Hanrahan, “Before the year is out”.
Jeremy is well known to many of us as the former CEO of Vanguard Investments Australia. He has over 35 years of experience in our industry in both Australia and the US. He is currently the Chair of NAB Asset Management and the co- founder of SuperEd, which is focused on helping super fund members plan for their retirement through the provision of affordable online advice solutions.
A discussion with Jeremy Duffield about his career path is an interesting case study in itself regarding disruptive innovation, particularly from his time in the US. The surfer’s guide to business management, his personal business philosophy, centres around positioning your business to either catch a strong growth wave, riding a wave better than others or most relevant for this discussion on disruption, creating a new wave altogether. His earliest example was from the introduction of discount brokerage in 1975 in the US.
“Jack Bogle’s introduction of the first index fund into the US market in 1976 was the start of a significant disruption to the investment management industry.” This example from Jeremy’s time at Vanguard has all the hallmarks of a classic disruptor; slow to take off but over time developing a foothold with a new segment of clients who were looking for lower cost access to investment markets. The addition of ETFs and the ability to directly distribute made possible by the internet during the 1990s, has massively accelerated the growth in passive investment, which has grown to over US$5 trillion or an estimated 20% of investment markets over 30 years.
When looking forward into 2016, Jeremy identifies fintech start-ups, particularly in the advice space, that could drive major change over the coming years. “Digital advice is exhibiting signs of being a classic disruptive innovation within the wealth advice space.”
Just as the ‘democratisation’ of technology transformed computing from mainframe computers accessible to only a select few to smart phones available to almost everyone in around 30 years, are we witnessing the start of something similar with digital advice? Jeremy thinks so and with only 15% of Australians getting advice, digital advice could ultimately lead to better tools and support for financial advisers to drive a greater take up of Australians seeking advice.
There is no question that our industry is at an intriguing inflection point with the move to self-directed investing and nascent digital advice offerings. Disruptive innovation, while the latest buzzword, is an important part of a normal functioning market place and perhaps the only surprise is really how quickly innovation is accelerating due to digital enablement.
Of critical importance though, is that generally disruption in wealth management is difficult and often doesn’t persist due to the significant trust barrier involved when customers make decisions about money, particularly their life savings. We hope that if history is a guide, disruptive innovation will ultimately guide the market to a result that provides a better outcome for our clients.
The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail Clayton Christensen 1997 claytonchristensen.com
Said Hanrahan John O’Brien 1921 en.wikipedia.org/wiki/Said_Hanrahan
Disruptive Technologies, Catching the Wave Joseph Bower & Clayton Christensen 1995 hbr.org
Speech to University of Georgia Students Warren Buffett 2001 nasdaq.com/article/warren-buffett-speechto-university-ofgeorgia-students-part-1-cm238914