The late Harvard Business School professor Clayton Christensen found that in many sectors, low-end disruptors typically take hold at the bottom of the market and then work up to satisfy more demanding market segments. That very phenomenon is happening in the investment management industry. The industry is now showing the traditional earmarks of a sector ripe for disruption — most obviously, unhappy customers and very profitable incumbents.
In order to understand the next wave of disrupters, we use professor Christensen’s formal Disruptive Innovation framework. He popularized the idea of analyzing a company by looking at the “jobs to be done” its clients needed. Most money managers think their main job is generating alpha, but they are wrong. According to Amanda Tepper, CEO of Chestnut Advisory Group, investment performance alone does not drive asset flows.
We summarize below all of the jobs to be done by an investment manager in each category, across technical, functional, and emotional benefits. For example, Vanguard Group delivers not only the technical and functional benefits of low-cost investing, but ladders that into the emotional benefit of trust, of putting clients first and not making an excessive profit.
The hierarchy of jobs to be done by investment managers
Technical: What the product/experience does/is — “the offer”
- Investment strategy: Generate alpha; don’t lose (too much) money; match liabilities and obligations; minimize expenses, and taxes; exposure to targeted sectors; legacy/achieve political or social goals; and protection from tail risks.
- Execute investments: Source/generate investment ideas; research/due diligence; make investment decisions; manage portfolio and exit.
- Administer investments: Administration; build optionality; compliance with the law and religion; and transfer wealth to heirs.
Functional: What the product/experience provides to the client — “the execution”
- Easy and convenient user interface; customer service; access to networks; education; self-discipline.
Emotional: How the product/experience makes the client feel — “the tone”
- Peace of mind; social validation; exclusivity; control; excitement.
Technical jobs to be done
A money manager must do all of the technical jobs at an acceptable level just to get in the game. We’ve listed below the major technical jobs, in roughly descending level of importance. We break these into three subcategories: (a) investment strategy; (b) execute investments; (c) administer investments.
Investment strategy
Generate alpha
Some investors look to optimize for the highest returns above all other goals. They can typically tolerate extended volatility.
Investors focused on returns may want to invest in the most nascent of asset classes, which historically have generated astronomical returns for early investors. Historical examples include art, carbon credits, collectibles, cryptocurrencies, frequent flyer miles, internet domain names, lifetime individual income, litigation finance, mineral rights, patents, receivables, SaaS company recurring revenue, non-fungible tokens (NFTs), social media accounts, FBA third-party sellers on Amazon and other virtual currencies such as video game currencies.
These asset classes usually lack liquidity, legal protection, credibility among professional investors and indices, and they’re extremely high risk. However, as they develop, these asset classes accrete more of the infrastructure of the larger, established asset classes.
Read More
Similarly, angel investing is the highest-returning asset class we’re aware of, with median returns of 18% to 54% across 12 academic studies. However, angel investing has a long duration, extreme dispersion, high time requirements and poor visibility.
Don’t lose (too much) money
People hate to lose money more than they care about making money. The clearest example of serving this need are specialists in structured products, e.g., Axio Financial. Halo is a two-sided marketplace connecting investors to structured products offered by leading global financial institutions, easing access to these instruments.
Match liabilities and obligations
Pension funds are the best example of investors who do not prioritize getting the highest return possible but want assurance that they can meet their financial obligations on time. Even a family office that may not have a legal obligation to pay pensions does need to plan ahead for when they’ll get cash from the other side of their illiquid investments.
The universal liability is inflation. Inflation-linked bonds are an innovative tool to address this liability, alongside traditional inflation hedges such as real estate and commodities. In some markets used to high inflation, such as China and India, money molders choose to invest a significant portion of their wealth into gold.
Individually, the main liability that people are concerned about is their lifestyle: mortgage, food, etc. People want to know they have enough cash to cover many months (preferably years) of their ongoing living expenses, even if their liquid investments tank and their illiquid investments are locked up.
The average high-net-worth household keeps 25.2% of its assets in cash, much of which may be mostly outside of their investment portfolio. Such large cash holdings may represent a drag on overall returns, but if that level of liquidity enables investors to psychologically withstand market volatility and therefore not sell when the market dips, then the cash plays an important psychological role.
Minimize expenses
Vanguard is the role model of the low expense money manager industry, both because of its focus on indices that require minimal research and its highly unusual status as a money manager that is owned by its own funds. While hedge and private equity funds typically report management fees and performance fees, there is little transparency around other fees charged to funds such as legal, compliance, entertainment, custodian and even middle office, which can easily add up to 100 basis points.
Companies such as Addepar, Novus and Vitrio help aggregate and expose the costs embedded in a fund as part of holistic portfolio governance. Novarca helps institutional asset owners to identify unnecessary expenses and cut costs to enhance returns.
Minimize taxes
Poorly managed taxes and transaction costs can kill returns. As one form of protection, robo-advisers provide automatic tax-loss harvesting to help investors minimize taxes. Donor-advised funds, popularized by startups like Daffy, allow investors to both directly support select nonprofit causes and take advantage of the tax benefits usually enjoyed by foundations and endowments.
Betterment faces the interesting challenge of balancing giving the customer unlimited decision-making power, while at the same time helping minimize tax losses. Part of their solution is to make graphically clear the tax implications of any trade you make on their system. They have found that explicitly publicizing the immediate cash cost of selling a losing position helps deter users from executing, and therefore concretizing, a tax loss.
Another example of an extremely tax-preferred asset class is early-stage venture capital. The best-case tax scenario for most U.S. asset classes is long-term capital gains of 15%-20%, plus 3.8% Medicare tax, and the gains count toward Alternative Minimum Tax (AMT). In contrast, early-stage venture capital gains, if optimized for Qualifying Small Business Stock (QSBS) gains, are tax-free federally and in 45 states. They are also excluded from 3.8% Medicare tax and from AMT adjustment. Most losses are expected to be deductible against income.
Exposure to targeted sectors
Money holders often seek to invest in certain targeted sectors for strategic and risk-hedging reasons. This drives the development of highly targeted funds with tightly defined target sector exposure. A common example is exposure to markets that are hard to trade, such as frontier markets. Republic expedites access to late-stage private companies and funds that are typically hard to access.
A number of platforms have emerged to make the assortative mating dance between limited partners and general partners more efficient. This helps money holders identify specialty funds that can address their specific needs, no matter how niche. Allocate and iCapital Network help retail LPs identify the right alternative managers. CEPRES, Palico and Trusted Insight provide similar services for institutional LPs.
Legacy/achieve political or social goals
Investors increasingly seek to put their money where their heart is — whether it is based on social consciousness, religious views or a hobby. Millennials and women are more likely than their past generations, and men in general, to value doing good in addition to doing well.
Social impact, or “green”, bonds offer a creative way for investors to invest in companies offering returns linked to achieving certain defined social impacts. Ethic is a “tech-driven asset manager that powers the creation of sustainable investment portfolios.”
Protection from tail risks
A non-trivial percentage of investors want to protect themselves in the event of major economic dislocation. They might invest in a backup luxury second home, ideally in a stable country like Canada or New Zealand. Portable wealth (gold, jewelry, diamonds) allows you to cross borders easily. Certain local businesses (e.g., a restaurant or farm) can provide income even in the midst of turmoil.
Catastrophe insurance (e.g., flood insurance) provides protection against narrowly defined protections. However, in a tail risk scenario, traditional financial services providers will probably not be reliable. An example of a company addressing this need is Praedicat, which improves the underwriting and management of liability catastrophe risk. PreData offers predictive analytics for geopolitical risk.
Technical job to be done: Execute investments
The essence of investing is to make wise investment decisions. We break this down into five jobs:
- Source/generate investment ideas.
- Research/due diligence.
- Make investment decisions, including a financial model with sensitivity analysis.
- Manage portfolio.
- Exit.
Source/generate investment ideas
Some investors monitor social media to identify new investment themes, e.g., with ExplodingTopics. Public market investors can participate in any of the numerous online communities (SumZero, Seeking Alpha or The Motley Fool) to identify new ideas. Axial and Intralinks Deal Nexus make the process of sourcing in the private midmarkets more transparent. For both origination and competitive due diligence, a host of data companies aspire to be the “Bloomberg of private companies.”
Research/due diligence
Typically, investment teams assemble research in notes, file folders and CRM systems and send hundreds of internal and external emails as they dig into a situation. Wonder provides outsourced research quickly, tapping a network of 6,000 analysts. ParagonIntel specializes in tracking the activities of the management teams of the “world’s most important companies” to obtain early insight into problems, transitions and other inflection points. Drop Technologies (Cardify) and Earnest Research tap alternative data sources for KPI tracking, position-sizing, prioritization and idea generation. Toggle offers retail investors basic quantitative AI-powered tools and services that have traditionally been the domain of large institutional incumbents.
Make the investment decision
The decision is typically made in an investment committee meeting. Once the team has gathered the data, the team quantifies a few cases in a spreadsheet and writes a memo that captures the story and highlights opportunities, risks and issues. This process works well if the research is solid, the team is disciplined and decision-makers are strong.
Bullet Point Network (BPN) has developed a patented software platform and process to help investors combine research management and scenario modeling to drive better decisions. BPN can build up to 100 scenarios for a company’s actual cash flows and assign appropriate probabilities to each key driver based on an investor’s logic and insight.
Manage portfolio
Stratifi offers a low-cost, intuitive and scalable portfolio hedging SaaS platform for investors. Accordion Partners offers Maestro, a technology platform designed to institutionalize a private equity firm’s unique approach to accelerating portfolio company value.
Exit
A range of companies are working to make the M&A process more transparent and less serendipity-driven for later-stage companies, including Axial, BankerBay, Intralinks Deal Nexus, and Interexo. EquityZen, SharesPost and ZenPrivEx have specific initiatives to help employees and investors liquidate their positions in late-stage companies.
Technical job to be done: Administration
The last set of technical jobs to be done are administrative.
Administration
Addepar was founded to address this need, particularly for family offices that often have wildly heterogeneous portfolios with inconsistent reporting protocols. Carta helps companies and investors to manage their cap tables, valuations, investments and equity plans.
Some money managers are beginning to provide greater transparency. ARK Invest offers several ETFs with near-real-time exposure of their individual trades.
One of the current problems that institutional investors face is the lack of adequate transparency and control of all costs charged by the manager. The opacity of these arrangements creates an opportunity for companies such as Vitrio and Novus, which provide technology platforms to institutional investors for systematic oversight of fund managers.
Build optionality
Many of the world’s greatest investors have earned disproportionate returns by being able to invest when the markets are panicking. Gary Zimmerman, CEO of MaxMyInterest, notes that Warren Buffett keeps an especially large cash holding so that he can “be greedy while others are fearful.”
This job is often called “liquidity,” but optionality is not identical to the traditional “liquidity” solution of maintaining a large percentage of your portfolio in cash. Many sophisticated investors run a barbell strategy: Lots of long-dated illiquid assets balanced by lots of cash. The cash gives them liquidity and thus the ability to withstand long periods of illiquidity in the other half of their portfolio, which enables them to capture excess returns associated with time arbitrage.
Another method of providing optionality is to have a highly reliable line of credit from a very low-risk source, secured by assets that are not vulnerable to market dislocation. Zimmerman said that some of his hedge fund manager clients maintain zero cash. They tell him that if they ever need cash, they just borrow against their stocks. This is a rational way to keep optionality without the opportunity cost of leaving money in cash. But such a strategy isn’t immune to the risk inherent in highly volatile markets and may not provide the full cushion that liquid cash can.
MaxMyInterest helps people manage their liquidity efficiently by automatically allocating and managing cash across multiple banks to earn the highest possible interest rates, even as rates change while keeping this cash fully FDIC-insured. This enables investors to maximize the return on the portion of their assets that they choose to hold in cash without sacrificing safety or liquidity.
Compliance with the law
Firms like Behavox, AQMetrics and ComplySci bring technology to the extremely complex process of complying with relevant regulations in all the domiciles in which an investment manager may operate. These technologies can also allow regulatory arbitrage, e.g., allowing investors to conduct activities in one geography that might be illegal in another geography.
Compliance with religion
Religious institutions, religiously observant individuals and some family offices look for investments that are compliant with their religious views.
Transfer wealth to heirs
It’s relatively simple to address the tax and legal considerations associated with moving assets to your children. It’s far harder to prepare children and sometimes newly added family members (in-laws) for the challenges of “affluenza.” Early career coaching firms help the next generation get or stay professionally on track, e.g., Early Stage Careers, Evisors, Graduway or TheMuse.
Functional jobs to be done
Easy and convenient user interface
Consumers are accustomed to mobile-native, intuitive interfaces when they shop online or use social media. Investment management firms need to offer a similar-quality user interface. One of the secrets of Robinhood’s explosive growth is its intuitive, game-like user interface.
Customer service
If customers cannot accomplish their goal via the convenient user interface, they expect great customer service to address their issue. Joseph Reilly Jr., a family office consultant in Greenwich, Connecticut, says that advising people about money is being “part financial expert, part shrink, and part friend and confidant.”
Access to inaccessible networks
Some investors buy Berkshire Hathaway stock just to get an invitation to their annual meeting. Some VCs choose to invest in a company in part to build a stronger relationship with existing prominent investors. Companies that have raised money from celebrities sometimes attract investors eager to put money in just to have a shot at rubbing shoulders with the glitterati.
International venture capital firm HOF Capital is backed by over 70 families and institutions that own over 445 enterprises and brands, and manage over $350 billion collectively. One of the reasons both limited partners and companies work with HOF is to get access to that powerful network.
One of the reasons why so many people are excited about investing in NFTs and DAOs is that these crypto-native investment opportunities come with built-in community, typically on Discord. Much of the web3 community uses Twitter as the backbone of discussion about investments.
Education
There is no ongoing education requirement for many professional investors. Investors may have little understanding of the arms race around esoteric asset packaging rampant on Wall Street, or how high-frequency trading actually affects the market. It falls to money managers to educate investors on how new strategies work, although potential conflicts of interest abound.
Some venture capitalists will acknowledge that they will invest in a space primarily for education without having a clear vision of how the company’s vision will play out. The fastest-growing sector in investment research for the last two decades are expert networks, e.g., GLG or disruptor Xperiti. These networks displace what some managers historically considered their investment edge — a proprietary group of expert relationships built up over years in the business. The expert networks offer direct access to experts on any possible category for on-the-fly education.
Self-discipline
Just as with losing weight, there is no shortcut to success in investing. Money holders need to start by putting money aside, which requires discipline. There are business models that encourage such discipline, including certain retirement pools, e.g., 401(k)s, which charge penalties for early withdrawal.
Numerous companies have started to help people with their 401(k)s. FeeX helps people reduce the fees involved with 401(k)s. ForUsAll provides 401(k)s for small businesses. Captain401 offers the “easiest and most affordable 401(k) retirement plan.” Guideline is an automatically managed 401(k) plan.
Digit helps retail users save more money, track their spending, pay off credit card debts and minimize fees such as overdrafts. Acorns rounds up your purchases to make saving money as painless as possible.
Particularly creative is StickK, which enables you to sign a “commitment contract,” which could be something like “save $25,000 for my honeymoon.” This is a binding agreement you sign between “present you” and “future you.” StickK helps users define their goal, acknowledge what it’ll take to accomplish it and get it done. StickK helps you achieve that goal through a combination of accountability and the risk that you’ll lose the money you may put up as a stake.
Emotional jobs to be done
Jobs at the emotional level create a deep connection with investors.
Peace of mind
“No one ever got fired for investing in Goldman Sachs.” This fact is why large institutional investors invest in beautiful offices, highly visible philanthropy and tailored suits (or in the social distancing era, beautiful Zoom rooms). There is less career risk investing in the same funds their peers select; career risk is one of the biggest enemies of alpha.
This goal directly contradicts the goal of generating alpha. Sanjay Gupta, an experienced institutional LP, said, “Smaller, hungrier emerging managers tend to outperform larger, more established groups.”
One of the historic objections to venture capital is its long time to liquidity, as LPs like the peace of mind of seeing capital come back periodically.
In India, gold is an extremely popular savings vehicle. It has aesthetic use, doesn’t require reliance on government or financial institutions, is portable and discreet. Rupeek is an Indian startup that believes that it can add 2% to the Indian domestic GDP growth rate by helping Indians borrow against the approximately 25,000 tons of gold (approximately $1 trillion worth) they are collectively holding.
Social validation
“I want to know that other smart people are investing alongside me.” One of the great ironies of investment management is you get the best returns by being contrarian, but most investors value the comfort of knowing that other investors think about a situation similar to the way they do.
An easy way to achieve this is to invest in a syndicate (if you’re an institutional investor) or through an angel investor group (if you’re an individual).
Exclusivity
Certain goods are inherently exclusive. An NFT or a given piece of art or real estate is not normally interchangeable with any other piece of art or real estate. To help improve access to this asset class, Masterworks is building a community for retail investors in blue-chip art, e.g., masterpieces by artists like Warhol and Monet.
Certain investors prefer to allocate in “selective” hedge funds, as opposed to boring mutual funds, precisely because hedge funds are not broadly marketed to the hoi polloi.
Control
“Limited” partners are called that for a reason: They have minimal power over what a general partner chooses to invest in. One of the major reasons why more investors are choosing to go direct is they are excited about having control over where their money goes and significant influence over what the companies in which they invest do.
Over the past decade, family offices have increased their direct investments nearly 4x (to $100 billionn+), and 50% of family offices plan to increase or maintain direct private equity (and venture) activity in coming years. Mike Ryan, CEO of Bullet Point Network, argues that this is mostly driven by the desire to increase control over the timing, purpose and destination of family office’s capital allocations, although the desire to reduce fees is part of the story too.
Excitement
Some investors put money into art, wine, jewelry, antiques, stamps or even sports teams more as passion investments than as a financial investment. Other investors put money into equity crowdfunding sites and product crowdfunding sites in part because of the excitement and ego gratification of investing in a small, unknown, exciting startup company.
A few companies have emerged that use the excitement of gambling as a motivator to persuade users to save and invest. Long Game, PoolTogether.com, PrizePool and Yotta Savings are “auction-based savings” companies that offer clients the chance to win lottery prizes by saving money on their platforms. This is a proven model in Brazil and certain other countries and only recently has become legal in the U.S.
Disclosures:
David Teten is an investor in numerous investment tech companies, including Addepar, Asaak, Clarity (sold to Goldman Sachs), Drop Technologies (Cardify), Earnest Research, Indiegogo, Republic, Stratifi, Wonder, and Xperiti. He is an Advisor to Bullet Point Network.
Katina Stefanova is an investor in AcordIQ and Long Game and is a former Bridgewater Senior Executive.
Contributors:
The first version of this paper was co-written with Brent Beardsley, formerly a Partner with Boston Consulting Group. This study would not have been possible without the collaboration and support from Brent and from the Boston Consulting Group. We also want to thank the research, technology, and editorial team who supported us during this study: Greg Durst, Jen McPhillips, Jenny Wong, Charles McLaughlin, Michael Rose, and James Ebert, plus more recently Ariel Cohen, Caleb Nuttle, Spencer Haik, and Cormac Ryan of Bullet Point Network.
These disclosures were added to this article after it was published.