Diving into blue ocean

The market is also overcrowded with portfolio choice and new group of companies that offer portfolio-construction expertise. In the top-end of the market, where 20% of the intermediaries are gathering 80% of the investable money, no company seems able to stand out. Total charges passed on to customers and the below benchmark performances of many actively managed funds are under constant scrutiny.

Based on all the noise in the system, it seems clear that current business models are unsustainable, and yet, while change is happening gradually, it is only because regulatory and media scrutiny is increasingly exposing unfair customer treatment.

Few companies are providing the transparency and simplicity that the intermediaries and customers deserve. Complex fee structures, rebates, misleading quotations, and questionable performance fees still prevail.

A new language has emerged to explain the slow transition taking place. Terms such as clean-pricing, explicit-fees and real-alpha, imply a past of dirty-pricing, hidden charges and extra fees levied for beta.

Whilst many are trimming prices incrementally to remain competitive, some are just shrewdly capturing the margin at a different link on the value chain, hence the term smoke and mirrors often attributed to the industry.

As a participant in retail distribution for the past 20 years, I would say that the industry has made commendable progress towards doing the right thing. Unfortunately, this view was not shared by one of the keynote speakers at the 2013 FPI Conference who referred to some of the practices taking place as scandalous and smacking of greedy capitalism. If this is the case, then radical change is on the horizon.

The concept of blue and red oceans was introduced by W Chan Kim and Renee Mauborgne¹ in 2004 to describe how industries and companies shape their strategies according to their level of differentiation, their ability to create new demand for their products and the way in which they deal with their rivals.

Companies operating in red ocean are servicing the same demand. They are caught up in intense competition and they are unable to create more value for customers without increasing their costs. Companies thriving in blue ocean look different than their competitors. They create new demand for their products and they provide more value off a lower cost base. Ultimately they position themselves as uncontested market leaders.

Good South African examples are kulula.com and Discovery. Future examples may be Old Mutual with their front-running strategy of fee-based billing and 10X with their low-fee passive funds.

In an event, many asset managers, product providers and intermediaries are prospering through the co-existence of a red and blue strategy. Some product providers even have a unique offering for select intermediaries which enables them to dominate niche markets.

The high total cost to the retail customer is the sum of the investment fees (TER), the administration charge and the advice fee. This issue is where a lot of the pressure is building up. Even the intermediary’s remuneration is under fire, but due to the leverage they have and the value they add, it is probably the safest of all the layers for now.

A retail customer buys the same product as an institutional customer but pays more than double the price due to a long value chain of high earning participants. The conundrum of how to reduce the retail price requires a radical change in strategy.

The question of whether there is a better way forward is a complex one that leads to more questions. Who will create a blue ocean if the incumbents cannot? Will it be an offshore provider that has no legacy? Will it be a local provider that changes the rules of the game?