Platforms are evolving with technology playing a big role. Find out what that means for funds.
Read the transcript and Q&A below:
Today we're here to talk about trends and platform distribution, which is something we're seeing a lot of drivers in those trends affecting how our members can access the platform distribution model. Now specifically there are trends in regulation, technology, rationalization, what I'm calling data value and operational ease. Why am I addressing this topic? Going out and talking about it. Well, as a director, my actual focus is on both operations and distribution, which having grown up in the asset management industry is an interesting place to end up, because when I joined the industry you either did operations or distribution that you've never met.
But in the past ten years they've started to have to work together, begrudgingly some days, but they are definitely intertwining. So that interconnectedness of the operations, both of the fund and of the platform and the distribution strategy, whether that's sales and marketing or other factors, is all coming together and is affecting each other in ways it never has before. And for a little context, before I joined the institute, I managed two different large trading platforms for the bank side of the business. I'm very familiar with what's going on here and hopefully my experience will be beneficial.
Because it being in my job description, why talk about this? Well, it is the number one topic that asset managers who are members ask about, especially for boutique or smaller fund families, that's the thing they want to know. And they ask questions like, how do we get on a platform? Why is it so hard to get on a platform? What's driving this rationalization that keeps happening? Why can't they just let us on the platform? And then pandemic aside there are actual drivers and trends that are affecting why platforms are behaving the way they are, why the gatekeepers are behaving the way they are and why it's becoming more difficult to get on a platform and why it's even in some cases more difficult to maintain their position on a platform.
These questions I think make more sense when you put them in context of the trends we're going to discuss. Now it doesn't mean you're going to like all the answers I have. I don't have a magic button to put you on a platform. If I did I could probably go into consulting. But I think this will put it in context, and while it may not give you direct answers it will allow you to inform a better strategy as you determine how to do this. And then I had a recent experience which highlighted context for me that I'd like to share. Especially in this COVID era, I was participating in a virtual roundtable discussion with members and one of my members who is on the call who I would describe as an exceptionally buttoned-down, conservatively dressed professional in the 20 years that I've known her, was asked a question, what was the most unexpected thing that's happened to her during this entire transition to work from home.
And she said she was doing laundry earlier in the week and she realized that she was sorting her t-shirts into work t-shirts and non-work t-shirts. Now this is a woman that I don't think I've ever seen without a blazer, a blouse and a skirt, never mind a t-shirt ever. And she said, her work life had changed. The context of how she did work, what she wore to work had all changed suddenly. I think that's an interesting thing from the standpoint of platforms are accelerating their change for a number of factors that we're going to talk about. But keeping those in context, it's going to change really fast and you're probably not going to realize that it's changing and affecting you.
As Marilyn mentioned, you can ask questions via the Q&A button at the bottom and I will attempt to answer them at the end of our time together. I always think the more questions you have, the better the session is for everybody. To dive right in, why is it so important to be on a platform? It may seem like a silly question because [inaudible comment] once you do it. And I think a fund should ask itself, why do I want to be on a platform, and two things we'll talk about in a minute, what is a platform and which platform are you going to try to get on? But from a statistical perspective, the 2020 edition of the ICI Fact Book made the observation that in our household survey, which is an extensive survey that we do every year, 77 percent of investors' households owned mutual funds outside of their employer response for plan. This isn't just the people who went through their 401K plan. That's excluding those people. But follows three-quarters of the marketplace basic households are using an investment professional of some sort and generally accessing the funds from an intermediary market.
If 77 percent of the investing public is accessing it that way, it's an important part of your overall strategy. Now today we're going to talk about five trends or drivers that are affecting what's going on. My hope is, like I said, that you'll take away some information that will help you put things in context and figure out what the best platform opportunities are for your organization and its unique distribution strategy. As I said before, I don't have an easy button. There's no easy way, there's no short checklist to get on a platform. The process of getting on a platform is really about entering into a relatively long-term relationship that can be pretty frustrating and can take a long time. Planning in context are the biggest keys to developing good partnerships.
And I think the best way for members, especially smaller members and boutique firms to think about this is you need to find a platform that complements you as a fund, and that may or may not be the first couple that spring to mind, and where your funds are a complement to the platform. Moving into regulation, regulation has been a major trend in the industry, has impact every year, we always talk about it. But platform distribution has been particularly impacted over the last I'd say three years. With more distribution happening, you have the collapse on the wire house broker dealer side of the equation and the bank and retirement side of the equation also began going to omnibus, going to platform distribution. The FCC has noticed that. They made a prominent note of it in some investment management guidance that they gave in 2016 and I'll quote, "The use of omnibus accounts by broker dealers and other financial intermediaries has increased significantly in recent years because a single omnibus account held by a mutual funds transfer agent represents the share balance of many beneficial investors being serviced by an intermediary."
It's pretty obvious for those of us who have been in the business for a while, but it is noteworthy – the regulators are paying attention to this. They're understanding the transition from some of the shareholders servicing pieces from the traditional TA environment inside the fund to the third party. And one of the things that happens when that happens is you're delegating sub TA responsibilities or sub transfer agency responsibilities to the blackboard. And you as a fund become responsible for oversight of said blackboard and that is a time consuming process. As one of the regulatory outcomes or drivers here, you have to factor in what that's going to mean. You may have to work really hard to get on that platform, but then you need to police that platform.
The takeaways are factor into the equation being on a platform will require resources and just charging this oversight responsibility, and including – you really need to understand how the platform's structured, who's accessing your funds, how you're accessing it and then all the defined sub agent responsibilities are being accomplished. And this is a two-way street. Funds have this responsibility to their regulators, platforms have it to their regulators as well. And staff time and resources are required.
The other thing that's driving this is the recent activity around the DOL and the FCC for the fiduciary rules – generically all the fiduciary rules, whether you're talking about the best interest standards or any of the other rules. Most importantly the now vacated DOL rule. We literally saw a re-examination by the platforms of how they were going to structure themselves and what products they were going to provide to their clientele. Now those platforms, especially the big ones that come to mind – the large wire houses, the name brands that you think of, they tend to be large, integrated organizations. They have a clearing service. They have their own brokers, they may service registered investment advisors, they may call investment counselors, independent advisors, plan consultant. All these people's needs and some of the things that have grown up over time no longer fit into the model that was emerging, whether it was load funds, no-load funds, wrap funds, etc. They couldn't be all things to all people and manage the regulatory risk, so they started to pair down the offerings. The structure of the fund made a difference.
Moving out of the regulatory framework and moving more into technology, I don't think anybody would be surprised to hear that technology is a major driver and that there are a lot of trends here to consider. The structure of platform distribution has evolved a lot over the last 30 years. Back in the last century the major push was you wanted to be a manager of one of the major wire house platforms. That made sense, they were easily defined, they generally had a captured advisory community that you could market to, could direct flow, this is great. It was an easy to understand proposition. And at the same time, it was pre-2000, you had the rise of the DIY investor. There were platforms that just did execution and they wanted to have as much product as people wanted to have, so getting on those platforms was ostensibly easier than it was in other times as they move forward.
The other thing was at that time it was pretty expensive, risky and difficult from a technological standpoint to build these platforms to offer all these funds. The barrier to entry was limited to a very small number of players who had the wherewithal, the technology, the standing and the size to pull this off. And a lot of the technologies that we take for granted now didn't even exist in that sort of pre-2000 world, and certainly have accelerated. The concentration of distribution that was of course more direct fund, less intermediary and then we started to shift after 2000.
Now today we're in a very different place. The bulk of distribution as we discussed is happening on platforms. And interestingly despite all the mergers and consolidation that you see in the industry, there are more platforms than there's ever been, which is counterintuitive but true. But interestingly, the three largest that come to mind, they aren't one platform. You may have a single channel to get into their environment, but they may be many things to many people. A large wire house may have its own captured in-house advisors as one sales channel. They may have a clearing business. They may have a retirement offering that they can be part of. And it goes on and on – bank, wealth management, self-directed investor, platforms.
There are a lot of different types of platforms, and even once you get into one label you still have a choice to make about which type of investor you're trying to interact with, and as a smaller and often I like to say more sophisticated boutique fund offering different, more advanced technology or rather more advanced styles of investment than some of the larger fund companies, you have to think about where do you fit in, and these all have different scale. Now what's happened though is the evolution in technology has made the segmentation possible, lowered the technological barriers, so you have a lot more people in the space. You have the rise of robo. How is that going to work? But more impactful than that, and something you should keep in mind as you're trying to move down this journey of getting on a platform, is the general application of rules-based processing and robotics, and how that's impacted back-office processing. Again, we're talking about the context you need to be thinking about.
Mutual funds, particularly open-ended mutual funds, are not an easy fit into a rules-based processing environment, especially from a back office or compliance standpoint. There are a lot of rules. There's a lot of qualifications. They vary widely between funds, sometimes even between CUSIPs in a single-fund family. Keep in mind that a platform is looking at a large – they're one entity processing, depending on how you want to slide the numbers, 6,000 different CUSIPs, 12,000 different CUSIPs, 18,000 CUSIPs, 25,000 CUSIPs. In order to scale their platform up, they may want to reduce or restrict the offerings to a particular set that fits within their operating parameters. And the important takeaway here for you as a smaller fund is, is figuring out how do you fit into the construct. That could be a really important consideration.
If they are moving to a primarily, as an example, transaction-based environment they're not going to be as amenable to things which have load waves or 12B1 fees because it creates additional complication. And I really can't overstate this trend. In the platform world, they're trying to automate, create straight-through processing and reduced risk just like you are. Their regulators are pressuring the same way that your regulators are pressuring you and their executive management is pressuring them to accomplish the same things that you're often being asked to accomplish. The morals the platform needs to maintain for a single CUSIP the less likely it is that you will get onto a platform. Just as simple as that.
That leads us to rationalization. And we hear that term a lot now. People are talking about we're rationalizing the platform. That's why we can't let you on, that's why we're kicking you off. Why is that? It's pretty much in the name. They have to rationalize their resources because things have changed. And like we discussed, the technology and the trends and the structure 20 years ago was very different. Even when I joined the industry, the cost associated with the brokerage settlement operation, the risk associated with settlement, etcetera was sort of accepted as a cost center. It didn't need to justify its existence. That's no longer the case. Now the operations side of the business, the clearing platform, the one serving the advisors, they all have to justify their existence on a revenue basis. The more expensive read less automated, less you plug in you are the less likely the platform is to embrace you.
I'll give you an example. When I was running an open architecture platform, which we were not specifically restricting it because we served other banks and people that wanted lots of different things, we actually went through an exercise at one point, we got past 10,000 CUSIPs on our platform and we said, should we just paper the entire open-ended universe? Because our clients are asking us most often for what we at that time called micro funds, boutique funds, unique strategies and those were often very hard to chase down, limited resources to respond to our request, they took a lot of time to set up, our clients weren't happy with that. Would it make sense for us to just CUSIP the 18,000 to 20,000 CUSIPs that were most likely to be used and deal with it?
Well what we found out was I worked for a guy who was a math major so he wanted me to work through everything and tell him it was justifiable. We sat down and we said here's what it's going to take to map out all the rules for all these CUSIPs. Even more challenging than that would be to ensure that all those rules could be operationalized in several different systems, communicated to our underlying clients that we were a regulated entity for banking entity, so we had to make sure we were going to pass our audit and not fail on anything. And then we would be on a certain amount of staff to review all the selling agreements, when those things expired, when they needed to be amended, when things were launched, when things were retired, perspectives updates and meet with 600 or 700 fund families to talk about sales, distribution and oversight. That ended up being a really big number.
And I know several of the large label houses went through a similar exercise at the same time and said it really doesn't make sense to pay for everybody. I'm sharing that to illustrate that it costs real money to service a fund platform. And top managers are being asked to justify their expenses and quantify risks. And their easiest and first step to do that is to restrict the offering and create a box that they want people to be in. Platforms only produce revenue if the CUSIP is held or traded. Expending resources on assets which are never carried or low levels or low volume ends up being a losing proposition and strained resources.
The next trend that I want to talk about is data has value, or data value. This is probably one of the more controversial ones. As distribution has moved to the intermediary construct, it's also largely been converting to omnibus, also many times in one single trading account, netted or not, had the funds. And this hits all the bells and whistles for the platform, it's more efficient, it mitigates dollars settled, touches on things like posting dividends, transferring assets potentially happen more efficiently. But it does make oversight more complicated and it generally divorces the trade data from the origin of the trade, which as a fund is very boring to you. You want to know who the advisor is. You want to know who the influencer was. You want to know who you need to interact with as things come through that platform and not being able to tie out your sales to influencers and activities is not a place you want to be.
Well, because of the way that we have structured the industry currently, the platforms have realized that they have some of that data. They might like to say they have all of that data, but they don't. And they realized that that data has value. And what does somebody do when they have something which they think has value? They attempt to monetize it. The takeaway here is the data has value, the platforms may have it, the data they have may or may not be of value to you, but in entering into a relationship if you get on a platform you need to find out what they can provide. Now as a practical example, data that they can provide on trade origin could be rich data stream. They might know exactly who the influencer is, the advisor that can help him, the program that's running this, there's a rebalance on a single trade, whatever. But they may not. They may just only be able to provide you with the institution that's clearing through them that's passing the trade and they don't have any of that downstream rich data that you're looking for. You need to find that out so you are not spending more than you should on data that you need. Not all data is worth what somebody's willing to charge you for it.
And then the last piece, which I touched on before, was operational ease. Again, the big trend just generally, and this is true in your transfer agent and it's true in the platforms processing, the ability to automate and do things in a rules-based system that people don't have to touch, people don't have to get an email and enter it into the system, people don't God forbid have to get a fax to enter it into the system. This is important and is another barrier. And there is a movement out there among many of the platforms to require that you use one of the centralized utilities, whether that's PPCC or something else, or if you're going to do certain things with them, they're going to require you to program through their formats and send the data when they expect it to be sent. That could be things like NAV's, daily mail rings, estimates on dividends and capital gains, finals – a lot of things to consider there. But when you think about it in the context of they might be managing the rules on 6,000 or 8,000 CUSIPs, makes sense as they streamline, they'll want that data in machine-readable format as fast and as robustly as possible.
In conclusion, we covered regulation as a trend, technology as a trend, rationalization, data having value and operational ease. We have some questions I see. I'm going to review a few things to consider and then we'll get to the questions. Rationalization, it's here to stay. It's not going away. Engaging with a platform is the only way that you will be able to figure out if you fit into what they're looking for, and more importantly if they are what you're looking for. Just 'cause they're a platform doesn't mean they're going to be the best distribution strategy for you. What are their most important characteristics? What are yours? And that goes into fit. I can't really emphasize this too much is it's a relationship. What's beneficial for you? What's beneficial for them? Is there a place where those two things overlap and that's where you find a platform that could work for you?
Decide what data you need from an arrangement to drive your process. Now that data is a commodity and is vended in the marketplace, somebody's going to be willing to sell you data no matter how much it's actually worth to you. Figure out is it necessary for you to get it that way? Is it optimal for you to get it that way? Can you harvest that into your bigger strategy that you're doing with SunStar and others in your marketing aspects? Does it work? Is it worth it? What's your ROI?
And then the very last thing I'll say is, the big thing I hope you take away from this is entering into a platform relationship is no longer just getting to the club and getting behind the velvet rope. This is about a relationship and it needs to be a two-way street. What’s unique about you that would fit well with how that platform is operating and what is it about that platform that's unique or specific that will best serve and plug into the people you are trying to target, which would be very different if you're going after retail clients and the mass market versus institutional assets.
Do you think in time it will be easier or harder to get on platforms?
If you keep going in blind I would say it'll get harder and harder and harder if you really take the time to realize what's going on and spend some time getting to know the platforms. I think it can get easier. And I would tell you, not just because I'm from the ICI, with any of your trade associations – ICI, SIFMA, MICSA, anybody like that, leverage those contacts to begin that dialogue. But I think regulation will continue to be a major driver and that will make things harder because people are getting more uncomfortable with some of the risks.
If getting a platform is a conversation, how do I find the person to start – well, as I said before, leverage your contacts. Certainly as an example, maybe ICI, myself and a colleague, Jeff Nailer, we manage some advisory committees outside of the ones that are mentioned in my bio that engage with the distribution community, whether it's bank, trust, retirement, broker dealer or advisor. We are a resource if you want to use us, and there are other trade associations. SIFMA comes to mind, which is another excellent resource.
How big is the threat of robo advisors?
I think it's overblown. Model portfolios have been around for a really long time. Robo is just model executed in a different way facing the client. It's about getting to the advisor who's building the model, which is really challenging. It's really challenging today and it will be really challenging tomorrow. But I don't think the fact that robo's out there is going to make it any more difficult.
What resources does ICI have?
Me. Call me.
What is the minimum AUM?
I've had this conversation in the last week with a number of large platforms, and they said there are some guidelines. It's more about what do you offer. There's certainly some minimums and any of the platforms will have a serious discussion with you about what those may or may not be, but the way that people have had success, despite not having the perhaps minimum amount of required assets, is by demonstrating that their investment strategy provides a unique and complementary strategy to what those advisors and/or investors might want. I think that we answered all the questions, so thank you again for allowing me the time today and I hope everybody has a good day.