“Change is the law of life. And those who look only to the past or present are certain to miss the future.” — John F. Kennedy
Investment management teaches us to be wary of saying, “This time is different.” While history doesn’t replicate itself, it does follow similar patterns: The challenges we face today may be new in scale, but not in nature. Inflation, supply chain issues, asset bubbles, prolonged bull markets, shifting global dynamics, and political risks are all familiar obstacles investors must navigate.
However, there are rare moments when we identify significant changes that will have long-lasting effects on individuals, society, the economy, and the planet. As investors, it is crucial to distinguish between temporary market turbulence and truly transformative developments that will shape our lives permanently.
A New Paradigm
We have identified three such phenomena that truly represent a paradigm shift in the asset management industry. They are:
- Environmental, social, and governance (ESG) influences and investing with a stakeholder mindset
- Diversity, equity, and inclusion (DEI) as a driver of alpha
- Advancements in data and technology
Why now? The COVID-19 pandemic was a tipping point, exposing the vulnerabilities of the global marketplace and our interconnected world. It forced rapid change and adaptation on an unprecedented scale, revealing the limitless pace of evolution when driven by necessity.
However, the driving force behind these paradigm shifts goes beyond the pandemic. Unprecedented demographic changes are amplifying these new perspectives and behaviors. The younger generations, specifically millennials and Generation Xers, rely heavily on data and technology and hold progressive views on DEI, ESG, and stakeholder capitalism. As they inherit the largest transfer of wealth in history, estimated to be $68 trillion in the United States alone, their influence will reshape the financial services industry.
While the current generation of investors has initiated these changes, the next generation is accelerating their momentum.
Now, let’s examine how these shifts will impact the asset management industry and alpha generation individually.
1. ESG and the Rise of Stakeholder Capitalism
Not long ago, mainstream investors rarely talked about ESG influences. ESG criteria were primarily used in exclusion-based strategies, but now they are more robustly applied to manage risk and seek additional performance. The idea that ESG information is economically relevant is widely accepted today. This represents a significant shift for equity market investors.
Central to this paradigm shift is the growing emphasis on stakeholder capitalism. Investors now understand that companies have responsibilities beyond their shareholders; they must consider the interests of employees, suppliers, customers, the environment, and society at large.
A company does not exist in isolation. Its economic success depends on ethical and honest practices. Asset owners have realized that companies not aligned with broader stakeholder interests may face economic challenges. This evolving definition of fiduciary duty has implications for investment practitioners.
Adopting stakeholder capitalism requires a new approach to ESG investing. Asset managers must not only consider company-level characteristics but also examine how companies interact with their ecosystems and the resulting implications.
2. Diversity, Equity, and Inclusion
While DEI is encompassed within stakeholder capitalism, it warrants separate attention due to its impact on society and company performance.
The COVID-19 pandemic and the social justice movements have unveiled the inequalities in our society and fueled the demand for diversity and inclusion. Research consistently links diversity to better profitability, higher employee retention, and reduced investment risk.
Unfortunately, the financial services industry has been slow to embrace diversity in decision-making roles, despite recognizing its positive effects.
Diversity and inclusion extend beyond business considerations; they build resilience in our economy and lead to better outcomes for people, society, and the planet. Asset management firms must embrace diversity as technology disruptors and innovators, creating an inclusive environment that welcomes historically underrepresented groups.
3. Technology and Data
Technological innovation has revolutionized the economy, making technology a fundamental aspect of most sectors. The rise of social media and our online identities have transformed our lives. Access to technology and digital literacy are key factors for economic success at an individual, company, and national level.
Data is also undergoing a transformation. We now have access to vast amounts of data, and its circulation speed is truly transformative. This, coupled with the decentralized nature of data creation, highlights the importance of data accuracy and information validity.
These changes are reshaping investing. The asset management industry provides a case study: New tools like natural language processing and artificial intelligence (AI) can sift through the vast amount of unstructured data generated daily. News travels at lightning speed, and social media exposes companies like never before. With lower barriers to entry, new data sources emerge regularly, giving investors access to valuable information.
While these tools have potential drawbacks, investors who embrace cutting-edge technology and alternative data gain a competitive advantage. In a world where every basis point matters, access to data and the ability to derive actionable insights are essential.
These three changes truly mark a new era. They are relatively new, fast-moving, and their trajectory is less certain than the challenges traditionally faced in equity market investing. Those who expect a return to the pre-ESG, pre-DEI, and pre-AI status quo will not be prepared for what lies ahead. Likewise, those burdened by bureaucracy may have the desire to embrace change but lack the ability to adapt practically.
The New Stakeholder Paradigm
What these three changes and the demographic shifts behind them have in common is their novelty. However, the silver lining is that significant and disruptive changes force us to innovate, find new solutions, and explore new opportunities. Investment firms that succeed during this paradigm shift, which we refer to as the new Stakeholder Paradigm, will understand the expectations and requirements of new constituents and be agile enough to shape their own destinies. Those who fail to grasp these changes or cannot address them will struggle to survive.
Instead of playing catch-up, we must embrace and lead these fundamental shifts. Merely adapting to them will result in inferior outcomes for investors. To thrive in this new era, we need a different approach and a different type of investment firm that acknowledges the challenges of equity market investing while embracing stakeholder orientation, inclusivity, and the fast-paced world of decentralized data and technology.
We are optimistic about the future of investing, but only firms with a truly differentiated approach will succeed.
If you enjoyed this article, make sure to subscribe to the Enterprising Investor.
All opinions expressed in this article are the author’s own and should not be considered investment advice. The views expressed may not necessarily reflect those of CFA Institute or the author’s employer.
Image credit: ©Getty Images/Thomas Jackson
Professional Learning for CFA Institute Members
CFA Institute members have the ability to self-determine and report professional learning (PL) credits earned, including content from Enterprising Investor. Members can easily track credits using the online PL tracker.
