Tasked with steering
In a conversation with Money Management Executive, Arnott discusses the strategic decisions the firm made as it reengineered itself following its 2004 acquisition by Canadian insurer Manulife Financial. He also considers the challenges facing asset managers in answering alternative investment demand and even potential competition from technological innovation and new, non-traditional players entering the asset management space.
John Hancock has moved up recently in Morningstar rankings of long term mutual fund managers. What would you attribute this success to?
I would start with shortly after the merger. It was at that point that Manulife made the decision that they wanted asset management to become a bigger part of the overall pie, and the senior executives decided they wanted to invest in the business. So two seeds were planted - one was a fairly significant expansion in our distribution capability. The second seed that was planted, which was my responsibility, was to build out the product line. Manulife was selling a lot of packaged products, so variable annuities, retirement plans, where full open architecture made a lot of sense. The John Hancock funds platform only had two small subadvisory relationships then. So the decision was let's take the same subadvisory model and apply it to the John Hancock Funds platform, which is now John Hancock Investments.
The obvious difference in application is that there really isn't any value proposition if we work with Franklin Templeton to create a bond fund. So we started executing on what we call a managed architecture product line, taking our expertise in asset allocation, finding individual exposures for investors in those asset classes, and recognizing that the world is our oyster in where we go to find managers.
If you look at our top 15 selling funds, we're not overly concentrated in any one fund. But if you go 15 funds deep in terms of our distribution, which would represent 80% of our sales, out of those 15 funds, 11 of them didn't exist on the platform prior to 2005. If you look at what's driving our net flows, its decisions that were made since 2005 in terms of what products we would add to the platform and how we would meet investor demand.
Help us understand the process you and your team followed to arrive at this strategy.
One of the things that I was involved in right after the acquisition was strategic planning around what we wanted to do in asset management. Because quite frankly, when Manulife was acquiring John Hancock, there were plenty of firms saying, 'Hey, we'd like to take that mutual fund family off of your hands.' After a fairly significant amount of deliberating, the decision was made that yes, this was a gem that just needed some polishing. Where I am today is a continuation of executing on that general idea that started in 2005, which is to take this thing, which had a good footprint, decent penetration in the financial advisory community, but not tremendous; let's add more distribution to it in terms of more wholesalers, but most importantly, it really comes down to the product. If you don't have the product, you're dead in the water, no matter how many salespeople you have.
How did the argument against spinning off the mutual funds hold up? What was the conversation?
It was the recognition that from a diversification point of view, it would be a better scenario for Manulife stockholders to maintain and grow its base of wealth and asset management businesses around the world. If you look at Manulife's business, it has shifted. It isn't in the variable annuity business anymore. We certainly have a block of assets that are quite large where we are servicing existing contract holders, but we are not doing new variable annuities. The long-term care business isn't as big as it once was. Even insurance isn't as big as it once was. So today because asset management has grown so tremendously, it has taken up the piece of the piece that was shrinking because traditional insurance businesses were changing. So it has played out as a very smart strategic decision.
Now you're in the asset management space, which is seeing its own shifts too.
We think with focus comes a higher ability to generate alpha. So as an example, firms that are average in where their asset bases are, firms that are average in those big boxes are going to have trouble, because it is difficult to gain market share relative to ETFs and indexes if you're average. But if you're able to offer investors a manager that has shown the ability to produce alpha over an index, over the long term, you have the ability to gain market share. So, in fact, our number one and number two best-selling funds are a large cap value fund and a mid-cap value fund. Asset classes that most firms would say they won't want to be too worried about. But it's because of that model we think we have a higher probability of bringing managers that can produce alpha, because we are dealing with managers that are singularly focused in those particular strategies.
That brings me to a second evolution. There was a day where you could have a bunch of wholesalers, and if they were really good at playing golf, and really good at buying steaks, you might've been able to sell a decent amount of an average product. Those days are gone. I would venture to guess that about 80 cents on every dollar is touched by some level of fiduciary professional, such as a gatekeeper. There is no incentive for a gatekeeper to choose anything other than the best in class, for a set asset class. We're well positioned relative to that trend because we think the same way as those gatekeepers.
Given their importance, how do you structure manager recruitment?
We're looking for managers that are specialized and have a nice cultural fit with our beliefs. We fundamentally believe that you have to put the needs of the shareholder first in any decision you make. Hedge fund managers really don't have that perspective that it's not their money. It's the investor's money. It's a doctor, a lawyer, a teacher that's investing their assets.
We obviously want to see that there's proven performance, but we take a lot of time making sure that it isn't luck that's gotten them there, that there was a process. The worst thing you can do in this business is disappoint people. And disappointment comes in the form of downside capture more than one might expect. We also make sure that the managers have real ownership in the business. We like them to invest alongside in some meaningful way in our funds, but we also want to make sure they are connected to their business in the form of partnership or equity.
So we want to make sure the right cultural aspects are there, the right structures are there to attract and retain talent, and the right compensation structure is there. We want that compensation structure to be long term. Quite often you'll have a manager that's put up a good track record institutionally, but they might be sitting on an $8 billion asset base. Our goal is to have something that's scalable. There have been plenty of managers with great records whom we've walked away from because it became clear to us they would've had a lot of difficulty managing in a different flow environment, or in an environment where they will have to grow rapidly.
Do you think this industry would be pursuing alternative investments in the same way if 2008 didn't happen?
No. But we were using alternatives back in 1997. Firms that are truly asset allocators probably would've had that exposure. Asset allocation is the one thing that permeates our business and has shown value. But would there be as much demand for them if 2008 didn't happen? Probably not. Back in 1997, alternatives meant something else - it meant international small cap and TIPS. So the definition of alternatives changed. But it has always been the same idea, finding uncorrelated streams of returns that protect the downside.
Where then do you find yourself in the traditional versus alternative debate?
I think alternatives have a real place. We're not one or the other. Our answer to core or alternative is yes. They both have important places in asset allocation. Where we are today, if you look at the market, we are at a very unique inflection point. There are moderately high valuations in equity markets and fixed-income yields are very low, with the threat of rising interest rates. Where can you go, in a very broad, macro way? So that in itself has generated a lot of interest in alternatives. You want to either synthetically produce an equity-like return or a fixed-income type return, but not have the same valuation or trade risk. The challenge is that there aren't a lot of firms that are good at doing that.
ETFs continue to gain market share. There are almost daily product launches.
For the average manager, ETFs are a compelling substitute, so I think ETFs will continue to gain scale. But I think the beta game is done. What's effectively happened in that space is that the race to zero has effectively occurred. Managers in beta ETFs make money, but it is not a huge revenue driver. What beta has become, for anyone who is entering it new, is a client acquisition strategy. If you think about what is going on at Fidelity and Schwab, they've come into the ETF game a little late, but it's more about attracting more customers, because their grander strategy is accessing a broad share of wallet. You think about the stuff they put at the front of the supermarket, they may not make a lot of money on it but it brings the customers in, and you hope you get them deep into the aisles. That's that basic strategy. So the beta game is well played out, and any new entrants are doing it from a client acquisition perspective. I think there's real opportunity in smart beta, or strategic beta. We'll see what the next evolution of that term will be. But that's a rules-based approach, it obviously has to be well thought out, and it has to be easy to understand. We've got a lot of strategic beta product out there, and people don't quite see the value proposition yet. But it will evolve.
Your peers have been debating the possibility of Google entering asset management and causing disarray.
Maybe one or two of these robo advisor startups builds a scaled direct business. You will see partnerships. I do think there's a real potential that Apple or Google will come into this space. The seismic shift will be when large broker dealers who shun customers with less than a million dollars use technology to come down market.
I think though in the end, it will be a net gain for investors.
