A half-century ago, CFA Institute led the movement to forge together a loosely defined collection of activities in the investment business, creating the profession of investment management and research. The body of knowledge and standards of practice that subsequently evolved are the foundation of our profession today. But this process of evolution has not brought us to an optimal state, as evidenced by events such as the 2008 financial crisis, the ever-growing displacement of long-term investment by short-term, speculative trading, and an equity investment management industry that, in aggregate, consistently underperforms its benchmarks.

In this context, one might argue that it’s existentially necessary for investment professionals to consider proactively what action they should take to ensure our profession remains relevant and adds value for its clients. The following offers perspectives on six of the most important challenges we face, and some thoughts on what we can do about them.

Unbundling charges for investment research

Institutional as well as individual investors like to receive sell-side analysts’ reports and advice on securities. History shows, however, that there’s strong resistance to paying directly for such research and advice. This may be because investment advice is a softer, less reliable form of advice than its counterparts in the legal, accounting, and medical fields, and because investors have a tendency to believe they are the parties adding value, not their advisors. The unbundling of charges for investment research from trading commissions—which is being considered by securities regulators in North America and mandated by regulators in Europe (MiFID II)—threatens to render research a product/service that is separately disclosed and directly paid for. In all likelihood, that will be purchased in smaller, more targeted amounts, and the initial consequences for investment analysts’ remuneration and employment are likely to be negative. This can best be addressed by greater and more specific efforts to market the important contribution of research to investors and to ensure higher value added by analysts in their advice and recommendations.

Competition from the electronic media

Although the electronic media take pains to emphasize that they don’t provide investment advice (partly to avoid greater regulation of their activities), they do, in effect, communicate (at little or no cost) a great deal of implicit investment advice through their interviews with managers, advisors, and other experts, and their own news comments and agendas. Half an hour watching CNBC or Bloomberg News is, in many respects, an experience similar in kind, if not in depth, to a meeting with a fund manager or analyst, and many guests and regular commentators on the media’s programs are full-time investment advisors. Add in Internet search engines, corporate websites (replete with data, management presentations, and comments), and the multiplicity of free advisors and bloggers, and it’s not surprising many investors feel, however misguidedly, that they already have all the information and advice they need. Until the ascendancy of the financial media in the 1990s, fund managers and analysts had the field of investment advice wholly to themselves and could require and receive generous remuneration indirectly through fees and commissions for their services—many of which were of a basic nature by today’s standards. The challenge to investment professionals in an increasingly direct-pay environment is to prove their worth in the face of abundant information flows and free advice from a great many quarters.

Dominance of short-term thinking and trading

In the 1930s, John Maynard Keynes said, “Markets can stay irrational longer than you can stay solvent.” Capital markets have always been short-term oriented and easily distracted by current events, a fact that has both frustrated long-term investors and, at times, provided attractive entry and exit points. However, capital markets today are arguably more dominated by short-term considerations than ever (achieving guidance/consensus quarterly financial results, capital flows, and other technical and behavioural factors), partly because such short-term issues are easier to discuss in an entertaining way on the all-pervading electronic media. Under these conditions, the ability for long-term fundamental values (which are still the focus of most investment analysts) to be accurately reflected with any consistency in securities prices is greatly diminished. This means that most analysts—who estimate long-term value and base their forecasts of share price performance upon those values surfacing in share prices—run the risk of continuing to be increasingly wrong in the short term. Some corporate issuers and others, frustrated by the extreme short-term focus of the stock markets, have recently suggested abolishing the regulatory requirement for quarterly financial reporting and returning to six-monthly reporting. These suggestions, which have been recurrent over the years, would constitute a backward step, however, and would be contrary to the goals of maintaining full disclosure and efficient markets. To address this issue, analysts and portfolio managers have little choice but to amend their valuation models and price targets to better reflect the new technical and behavioural aspects of share pricing and volatility, and to adjust their advice/actions accordingly.

New risks

In the capital markets of a generation ago, the risks were smaller in number and easier to identify than today. There was business risk, interest rate risk, and economic risk. Today, in addition to these traditional risks, international capital flows play a much greater role in influencing securities prices, commodity prices are more volatile, exchange-traded funds (ETFs) and computerized trading present new systemic risks, financial leverage at government and consumer levels are greater, and levels of geopolitical tension and regional conflict are the highest they have been in many decades. In certain regions (notably Europe and China), the banking industry’s bad loans and high leverage pose serious systemic risk in the event of a recession, and the complexity of businesses, accounting, regulation, and financial structures add further to the levels of risk. Changes in index levels and share prices move on a daily basis by amounts that once would have been viewed as unusual in a week or a month. Behavioural forces—high premiums on technology and growth, intolerance of any deviation from quarterly guidance/consensuses—create large gyrations in market prices. Simple models of stock price behaviour that assume share prices will revert to underlying fundamental valuation norms on a predictable basis are more inadequate now than they’ve ever been. The challenge to investment managers and analysts is to identify and incorporate the new risks—which are all-too-seldom addressed comprehensively in current ratings and advice—into their price forecasts, risk-reward analyses, and recommendations.

Most active fund managers fail to outperform benchmarks

Studies in North America and Europe have consistently shown that most mutual fund managers underperform their benchmarks (more than 90 percent of them over a 15-year period in the U.S., according to the SPIVA US Year-End 2017 Scorecard) and that most investment consultants fail to pick market-beating fund managers. Widespread failure to deliver targeted results is an existential threat to any industry. The fund management sector has been able to partially address this issue by emphasizing that it provides desirable diversification and risk management, particularly for small investors, and that the liquidity constraints of large funds make outperformance difficult to achieve. However, these reasons are hard to see as fully justifying the payment of high management fees for relatively mediocre returns, especially in an environment of low returns overall. The alternative to high-fee, actively managed funds is low-fee index funds and other specialized ETFs designed to match the returns on particular asset classes. However, the requirements for portfolio managers and analysts in firms that manage these funds are small, compared with the needs in firms that actively manage funds.

To establish their worth and preserve their careers, active fund managers must hone their skills and/or shift their focus to areas where their acumen can lead to superior returns. Otherwise, they face the consequence of losing more and more of their clientele over time. The challenge is writ large, and the solution—admittedly, much more easily stated than implemented—must lie in improving performance.

Looming competition from AI

As a tool under the control of portfolio managers and analysts, AI offers the potential to expand the role of computers in investment analysis even further than it has over the past 40 years. However, as early experiences with program trading and the misplaced faith in “portfolio insurance,” which contributed to the 1987 market crash, have shown, there is the potential for misuse of AI and for misunderstandings arising from overreliance or blind belief in its capabilities.

As AI makes the transition from buzzword to buzz saw in reshaping the investment management field, investment professionals will need to be vigilant in ensuring that the uses to which AI is put are well understood and well controlled. AI has the potential to become a powerful new tool, a strong competitor, or a risk-increasing market disrupter. In all likelihood, it will be all of those, but for investment professionals in the future, the challenge will be to ensure they’re at the leading edge in benefiting from the opportunities, but not in bearing the downside risks.

The age of disruption

It’s hardly ground-breaking advice to suggest that investment professionals need to hone their skills, do a better job, and keep on top of new developments. But our message is that investment professionals need to fully appreciate the greater extent of the threat to their jobs and remuneration that exists today than existed in the past, and that they must accelerate their efforts to address the important challenges they face before they’re overcome by them. It’s all too easy to be complacent in the assumption that good times in the capital markets will return and restore buoyant demand and remuneration for traditional professional services in the investment field. Communications, commerce, and society are currently undergoing an “age of disruption,” and in all these rapidly reshaping fields, the wisest approach to change is to try to capitalize on the benefits that come from the new while maintaining the advantages of the traditional. In the investment profession today, that perspective could not be more apt.