Effect on financial services
Breaking with the past
When we first wrote about Uberization five years ago, we asked whether asset managers could gain a competitive advantage by shifting more pieces of their value chain to others. Based on the strong growth of sub-advisory arrangements and operational outsourcing, it seemed logical that there would be similar opportunities in distribution, research, IT hosting, product development, data management, human resources, and other functions. Facing new competitors and cost pressure, asset managers might find that networked business models could lay the foundation for more consistent and sustainable growth. As we noted then, “With today’s computing platforms, companies can easily connect with talent and resources far beyond organizational bounds.”10
Those organizational bounds came crashing down in early 2020 as COVID forced everyone to work from home. With employees untethered from physical offices, the stage was seemingly set for a wave of Uberization, with independent contractors taking the place of full-time employees. Companies are understandably reluctant to part with their most cherished assets, so this transition has not yet materialized in any wholesale way within the established asset management industry. We may, however, see less emphasis on full-time employees as hiring resumes, with more firms choosing to engage with independent contractors who enable them to get the same work done with more flexibility.
Meanwhile, we are seeing the growth of a parallel investment industry unfettered by the traditions and rules found at existing firms. This new world reflects the essential characteristics of Uberization more precisely than a rejiggered version of an old industry ever could. Much like Uber, it represents a reimagining of an industry built around platforms and peer-to-peer transactions that reduce friction and costs.
Any mention of P2P is likely to remind readers of Napster and other file-sharing sites from the 1990s. Despite successfully disrupting the music industry, they eventually gave way to new digital platforms that actually generated revenue for asset owners. Services such as transportation and portfolio management may reflect significant intellectual property, but they are not protected by copyright. As a result, they are more susceptible to disruption by interlopers who are not shy about taking on legacy business they view as bloated and inefficient.
Innovation at the speed of thought
How do you protect the value of ideas? A strong brand helps, but that has become notoriously difficult for asset managers whose relationships are often intermediated by advisors and consultants. Many turn to content marketing in an effort to highlight their core competencies. The difficulty with thought leadership is how to showcase original thinking in an extremely crowded market in a consistent manner over time. Competitive pricing is always attractive but erodes the top line. Strong distribution is a sound strategy that may ultimately come under serious attack if younger and increasingly affluent consumers migrate to completely new online platforms.
Rather than amplifying existing ideas, well-funded startups are using technological innovation to stake a claim in the emerging fintech ecosystem. Technology is already permitting the creation of banks unencumbered by physical infrastructure, direct lending platforms generating superior yields, and customized planning and advice at affordable rates. Robinhood has a famously compelling interface. SoFi has proven adept at bridging silos and creating a holistic experience. Many fintech unicorns got their start in payments, lending, or banking, but investment management is squarely in their sights, and the real-time feedback loops and market platform afforded by social media mean they could theoretically ramp up their visibility and competitiveness in record time.
The GameStop saga of early 2021 further illustrates the disruptive power of technology; this time by coordinating the actions of many otherwise unrelated individuals to create an outsized impact on the markets. Dismissed by some as a simple pump-and-dump scheme, this incident nevertheless underscores the power of decentralized action in the service of an idea. Is there a business model there? Perhaps. We cover several in our report on Twitterization. This particular episode, however, illustrates the power of atomization and hints at potential competition for professional money managers. Few are interested in mobs replacing analysts, but there is something to be said for the wisdom of crowds, especially those empowered with instantaneous information, sophisticated technology, and the age-old desire to eliminate the middle man. Notwithstanding the trust factor, advanced performance analytics may ultimately lower the barrier between professionals and amateurs, highlighting superior investment skill wherever it is found.
The business model revolution is about more than simply blowing up hierarchical organizations or transitioning from employees to contractors. It is also about reducing friction and transaction costs. Michael Munger, the author of Tomorrow 3.0: Transaction Costs and the Sharing Economy, notes “The middleman sells reductions in transactions costs, at a price much less than the transactions costs being replaced. This in turn makes possible transactions that otherwise would never happen.” Like Uber and Airbnb, companies such as MarketAxess sell reductions in transaction costs, leading to greater transaction volume. Though well established now, the electrification of trading was initially revelatory in the notoriously fractured and non-standardized world of bonds.11 The success of platforms like Liquidnet and Tradeweb also illustrates the ability of new networks to reshape markets. The banks that dominated fixed-income trading for so long are increasingly being sidelined by investors choosing to buy and sell among themselves.12
Revolutionaries and survivors
One route to long-term success may involve the embrace of decentralized finance, or DeFi as it is commonly known. DeFi is aimed squarely at disrupting existing financial transactions and intermediaries through the use of blockchain technology. The ability to embed smart contracts in Ethereum (the second-largest cryptocurrency after Bitcoin) makes DeFi an intriguing enough value proposition that its locked-in value rose from less than $1 billion to more than $13 billion in 2020. DeFi protocols are proliferating quickly and now include asset management tools, lending, derivatives, insurance, prediction markets, and myriad other applications. Some even offer backbones for communities built around shared ideals and resources, effectively promising an alternative to traditional corporate structures. Of particular interest to traditional asset managers will be tokenization, where non-custodial transactions could theoretically involve the buying and selling of virtually any asset by anyone with a cryptocurrency wallet. Ownership stakes in idiosyncratic and illiquid assets would suddenly become not only tradable but also divisible.
As of early 2021, DeFi is still a niche, but the growing interest in cryptocurrencies by mainstream financial firms suggests there could be more widespread integration around the corner. Barriers including a steep learning curve and arcane jargon are being overcome as the two worlds come together. Large, highly regulated markets might prove more resistant, but DeFi promises a quantum leap forward for developing markets, much like mobile telephony did for countries with little existing telecommunications infrastructure.
Despite the onslaught of new competitors, it would not be surprising to find that well-capitalized incumbent financial firms are up to the challenge. After all, the industry is already responsible for some of history’s most enduring and effective networks, with Exhibit A being the stock market. Such incumbents endorse the power of ideas, free markets, and meritocracies. With significant capital on hand, they can also always choose to invest in disruptive competitors if their own efforts fall short or if they are looking for a catalyst.
Already primed to look for the next big thing, at least some asset managers will look past their institutional blinders and carefully observe their environment and weigh alternative ways of doing business. Central to their analysis will be a careful examination of where economic value is accruing as business models evolve. Understanding that it is increasingly impractical to be all things to all people, there will also be greater emphasis on segmentation, specialization, and integration. It may no longer be possible to control all the parts, but every effort must be made to control outcomes and experiences.Read Next Section
10 SEI, The Upside of Disruption, 2016.
1 1 Marc Rubenstein, “Anatomy of a Successful Fintech,” Net Interest, November 13, 2020.
12 Matthew Leising, “Wall Street Is Getting Cut Out of Bond Market It Long Dominated,” Bloomberg, April 1, 2019.
The Investment Manager Services division is an internal business unit of SEI Investments Company. This information is provided for education purposes only and is not intended to provide legal or investment advice. SEI does not claim responsibility for the accuracy or reliability of the data provided. Information provided by SEI Global Services, Inc.