The Future of Finance

Ten Reasons Finance Will Keep Changing
Constant flux is the norm. Get used to it.
Bloomberg, June 22, 2018

One of the great variables of appearing at investment conferences is the question-and-answer session after your presentation. No matter how well-prepared you may be, it’s hard to anticipate every query.

Such was the case earlier this week, when I was speaking to employees at a scrappy startup in Pennsylvania (OK, it was Vanguard Group). It was the last question, and it was a gem: “What do you think the financial-services industry will look like in five or 10 years?”

After acknowledging the advantages of being free of the burden of having made any forecasts, I offered up a short and woefully incomplete answer. Today, I want to fill in some holes.

The old expression “The days are long but the decades are short” barely hints at just how fast the world is changing. Facebook Inc. was moving beyond its dorm-room startup phase back in 2008, and was about to go cash-flow positive. Apple Inc.’s iPhone was almost a year old, having been introduced to mostly lukewarm reviews, and Uber Technologies Inc. was a full year away from being founded. Indeed, the list of items that didn’t exist 10 years ago would also have to include Bitcoin, the iPad, Slack, Instagram, Venmo, Snapchat, Candy Crush, Square and so much more.

Rather than simply make unfounded guesses, we can borrow from the approach advanced by Philip Tetlock, professor at the University of Pennsylvania and author of “Superforecasting: The Art and Science of Prediction.” In a nutshell, the method outlined in this invaluable book is: What do we already know, and what can we extrapolate from that knowledge?

My top 10 list would have to include the following:

1. Declining fees: The Vanguard effect is well known, and the reduction of costs has become a central feature of the money-management industry. This applies to mutual funds, exchange-traded funds, brokerage firms and hedge funds. I have yet to see any signs that this is approaching a bottom anytime soon.
2. Indexing: The flows don’t lie: money has continued to move from actively managed funds to passive, and from costly to cheap, especially since the financial crisis.
3. ETFs: These have been growing steadily, and their gains in many ways parallel those of index funds. Inflows are robust, as is new product development. Don’t expect the rise of the ETFs to slow anytime soon.
4. The death of alpha: Perhaps nothing has driven so much money to both indexing and ETFs as the inability of the active asset-management community to consistently deliver on the promise of market outperformance. There have been the slightest signs of improvement lately, and demands to wait until the next crash to see the merits of active. However, these claims are up against an accumulating body of academic research showing most investors should be using low-cost index funds.
5. Fin tech: The advent of new technology specifically geared to make owning, trading and managing money more effective and efficient has led to substantial shifts in the industry. This has affected not only how business is conducted, it has raised the required skills needed for back-office operations.¹
6. Behavioral finance: The work begun by the many academics in the world of behavioral economics shows no sign of slowing down: It is being adopted by more practitioners as we learn the impact of our own human foibles on our decision-making, especially when money is involved.
7. Communications, storytelling: How the industry informs investors and other stakeholders such as employees continues to rapidly change. The rise of blogs and social media, the broad adoption of podcasts, the increased use of screen-sharing technology with conference calls all suggest that the ways the industry communicates internally and externally is in the midst of a metamorphosis. Narrative storytelling is an increasingly large part of that.
8. Fiduciary rule: The Trump administration may have formally killed the Department of Labor’s fiduciary rule, requiring retirement-plan investment advisers to put the interests of clients first, but it might be too late. The rule has been adopted by the advisory side of the business, and the big brokers have also warmed up to it. As I have discussed before (see this, this, this and this), it is probably too late to put this toothpaste back in the tube.
9. Consolidation: This seems like a sure thing, and I see nothing to stop the so-called roll-up strategies that have led to consolidation among registered investment advisers. As long as the return on investment remains attractive, it will continue.
10. Head count: It was no surprise during the financial crisis that employment in the industry fell. Perhaps what is surprising is that despite the robust market recovery, job reductions continued in 2015, 2016, 2017 and this year.

I am certain there are other factors that will affect how finance looks in a decade, but this is a good start. The only constant in the industry seems to be change: As long as the potential for doing things faster, cheaper and better is out there, modern finance will be in a constant state of flux. We’re just going to have to live with it.