For four decades, John Casey has shaped how trillions of financial assets are managed more so than any other strategist. Casey, Quirk & Associates, the successor to Barra Strategic Consulting Group that John established with his partners in 2002, is the trusted advisor to some of the most prestigious, innovative and ultimately successful investment managers and financial institutions. Casey Quirk has advised a majority of the world’s 50 largest investment management organizations since the beginning of 2009 including the London Stock Exchange and Barclays Global Investors. I was more than a little curious before my lunch with John in the Casey Quirk office in Darien, Connecticut. Refreshingly, the man whom Pensions & Investments famously coined “the king maker” was completely devoid of hubris. While reflecting on how he identifies winners in the investment management industry, John shared that “investment acumen” is not enough. He also looks for “good commercial instinct and good business sense.” John warned that “many people in this business say ‘I am so smart and I do not need anybody. However, the best money managers know that they need a team to succeed.” During our meeting, I observed that he practices what he preaches. The Casey Quirk team is incredibly important to him and John engages and brings in various team members and seeks alternative points of view to complement his own perspective. Our conversation included John Casey and partner Jeff Stakel.
Katina Stefanova: Looking back on the asset management industry, do you think that the industry has become more demanding and complicated overtime.
John Casey: Yes, certainly. During the early 70s, all investors were looking for was investment acumen or perceived investment acumen. Let us not forget that in 1972, the entire pension fund industry was $200 billion and the whole mutual fund industry was only $50 billion and that includes money market funds. The 1973 – 74 equity debacle encouraged investors to look for alternatives to the big banks. So many new firms came to life. In the late 70s and through the mid-80s, thousands of firms became SEC-registered advisors. It took little capital and infrastructure to start a money management business. Planning, good management and technology were not as essential in those earlier days. The barriers to entry are much higher today both because the industry is saturated and because investors are more educated. Several generations of professionals have grown up inside pension funds, public and private global investors have learned a lot during both periods of volatility and growth over the past three decades. Thus today, an asset manager needs to be a well-run business that can pass extensive due diligence. Passion isn’t enough.
Stefanova: An educated investor is a good thing overall. There has been a general backlash against underperformance by hedge funds. CALPERs is withdrawing from direct hedge fund investing. Warren Buffett made a prediction that index funds would win over a decade over hedge funds and is so far winning. Do you think such a reaction is justified?
Casey: The smart investor today is looking at what do you get once all the costs are paid. Casey Quirk has published several whitepapers over the years that focus on what we believe investment managers need to do to successfully meet investor needs. What is the return after all costs are factored in is going to be a real challenge for investment managers. Thus we have had the increase in passive vehicles which have grown into a multi-trillion industry. If the hedge funds want to be important, they need to deliver net returns that are valuable and consistent. However, the last six years are not representative as the equity markets have gone mostly straight up. If we were to have a downturn, hedge funds may become popular once again assuming that they offer good risk management. Hedge funds have become more popular as a risk management tool in a global asset management portfolio.
Stefanova: Do you think it is easy to assess who are the asset managers that can deliver positive risk adjusted return going forward? Surely, just looking at past returns is not enough. I wrote an article about the risk blindspots of portfolio management. How does Casey Quirk advise investors to differentiate amongst asset managers and find quality?
Jeff Stakel: We would think about what we call “investment quality” as certainly broader than the investment return that is delivered to investors at the end of the month, the quarter, and the year. Going back to John’s point, we look at the total quality of the client experience, which includes the investment strategy, the risk management, the consistency and quality of the portfolio, the caliber of the team overseeing the investments on a daily basis. One of the big things that we see as a trend in the industry is the alignment of interest: What are investors demanding and are the managers addressing these specific needs in the appropriate manner.
Stefanova: Do you go beyond the portfolio strategy to understand the risks embedded in an asset management company and assess the technology infrastructure, the processes and controls, and more broadly the operational risk in the firm? As you know the majority of financial services failures happen because of operational risk issues and lack of controls?
Stakel: Katina, your point is spot on. John shared the importance of business management beyond investing and distribution. It applies to a broader operational infrastructure and risk management. For sophisticated buyers today, holistic risk management is almost table stakes, which is why as discussed, the barriers to entry in the investment management industry today are much higher than they were previously.
Casey: However, firms and clients brush over some of these issues and they are taken for granted. There is not enough deep understanding of the characteristics of the non-investment aspects of a business. Possibly, this could be because there are not enough people who understand the various non-investment aspects of an asset management firm at the level of depth required.
Stefanova: I have also noticed the same problem. Most institutions and family offices do not do adequate due diligence beyond the track record of the investment firm which is not representative because organizations change and performance changes. This is something I want to educate investors about over time.
Casey: We develop checklists to cover everything but I do not think it is widely practiced in our industry. There are boxes that go unchecked and confidence that is inherited more easily than it should be.
Stefanova: Definitely. The US government is trying to manage systemic risk through tighter regulations and to drive greater transparency given the last economic crisis. Do you think the level of regulation that has been added to the asset management space is effective or not and why. What should the government do differently?
Casey: I have more confidence in firms living with the right amount of fear of not doing things correctly than I do about frauds. Madoff sucked people in because they did not do their homework. I look at some of the regulatory efforts and cannot help but think that some new regulations make work for people who live in fear every day of doing something wrong and are fairly tightly regulated internally. Fear is a great friend in our business and the fear of goofing things up is the world’s greatest fear if you are managing money.
Stefanova: I agree with you that the government is not well positioned to regulate the asset management industry and drive transparency for all kinds of reasons and that is a long discussion. However, I do think that adequate transparency is beneficial for investors and the question is how do we drive that…
Casey: Well how do you define it?
Stefanova: Yes, how do you define it. And how do we better align incentives between the asset manager and the investor. These incentives are asymmetrical at the moment on many levels. For example, in my article on taxes and transaction costs, I explain how asset managers are incentivized to trade a lot while investors maybe better off holding longer and pay attention to taxes. Another asymmetry is that while both benefit on the upside, the losses for the investment professional are limited while the investor can lose a lot on the downside. There is generally no sharing in the business models of losses. Additionally, there is the perverse incentive to hold assets and get paid just for holding assets and not generating alpha. Recently, investors have caught up and are moving to passive low costs investment vehicles. Do you think the fundamental structure is going to change and investor and manager interests will better align?
Casey: We always have been believers that in the end the market adjusts and performance matters. I think investors overtime would price the industry where it should be priced. Right now it has been a world where fees have not been scrutinized carefully. Historically, the assets under management were not that big but the industry has exploded in recent years. Just look at the pension fund industry which grew from $200 billion in the early 1970s to where it is today in the trillions of dollars. As a results, management fees matter a lot of more and have earned money managers billions. For passive funds fees have dramatically decreased already. But managing even a passive management firm can be immensely profitable because you need fewer people to do so. You take an industry that has grown that much but the fees have not changed and you begin to wonder when would the fees be arbitraged away. In my view, the clients have to make the first moves, but it will take a long time.
Stakel: The question speaks to a bigger trend in the industry. There is innovation in many aspects of the industry, but in particular in the area of aggregating passive management and targeted alpha strategies for both institutional and retail investors which puts pressure on traditional mutual funds.
Casey: Another problem we see is that the investment management industry is typically not good at teaching, at helping investors understand. Thus the business gets out of balance. Some money managers have the mentality that clients are lucky to be with them. We use the term “application management” or how to apply investment management skillsets to a client’s structure. It is probably very common in the technology industry but our industry has not caught up.
Stefanova: Looking at the asset management industry over the next 10 years and the trends that are developing what advice would you give to asset management entrepreneurs? Where do you think the opportunities are?
Stakel: Looking at the landscape of asset management over the next five to ten years, there are a few big trends that would influence how we would advise building an asset manager today. The first big trend is that organic growth in the industry is going to slow and net new flows will decrease as a percentage of managed assets. What that means is that it will be ever more important for asset managers to compete for turnover assets or manager replacement assets. To do that, managers will have to have the outcomes that clients are going to want. For individuals, desired outcomes could be anything from wealth transfer, wealth accumulation, decumulation in some cases. Institutional outcomes could fall into liability management, liquidity, absolute return. Building products with an outcome oriented mind frame is a big key to success for the next few years. Furthermore, managers would have to create the right portfolio of outcomes to deliver to targeted clients. The tricky part will be creating the right client engagement model and understanding what investors are demanding in terms of risk management and portfolio exposure. It would be critical for asset managers to educate the clients and have a technically proficient client service team.
Stefanova: Would you add technology innovation as a driver of change in the asset management industry in particular in the retail space?
Stakel: As wealth transitions across generations, there will be a requirement to deliver investment and content through new technological medium. Starting to incorporate these platforms will be incredibly important for asset managers. If you look at the youngest generations, they grew up watching their parents’ wealth decrease in two big violent market swings: the 2001 dotcom crash and more recently the 2008 financial crisis. There may be a generational hesitation to go all in with a traditional financial advisor so some of these technology platforms, are a good stepping stone for the millennials. The big question is as the millennials mature and their needs become more complex, what would the role of the traditional investment advisor be and that still remains to be seen.
Stefanova: Thank you John and Jeff for your valuable comments.