Investors must collaborate to innovate

Institutional investors are sheltered by competition, which in some instances can be beneficial, but it also means they are shielded from competitive forces that drive innovation. A new paper by Gordon Clark and Ashby Monk, looks at why the current model of either insourcing or outsourcing investment management doesn’t allow for innovation, and the models of cooperation and collaboration that can change that.

There has been a surprising lack of institutional innovation among asset owners, suggest co-authors Professors Gordon Clark and Ashby Monk, due in part to the fact the current organisation and management of these institutions has been stagnant since their establishment – in many cases 50 to 70 years ago.

This is an important observation in the context of the rapid rate of transformation in the investment management industry, and the rate of product innovation in global financial markets.

It’s a problem because the lack of innovation has transcended the behaviour of investors.

“The stasis of the sector has been such that these types of financial institutions have, on the margin, taken higher levels of risk in the hope of realising returns that could compensate or the low rates of institutional adaptation and development. At the limit, the crisis facing US public funds is illustrative of the costs and consequences of institutional stasis,” the authors say.

A new paper by Clark and Monk, “Transcending home bias – institutional innovation through cooperation and collaboration in the context of financial instability“, suggests that industry wide norms favour continuity and that investors must look to new organisational forms for innovation.

The paper argues there is now a premium on institutional innovation, whether internal or external, whereas in the past there was less emphasis on make or buy, as it was less important than issues of strategic asset allocation and investment management.

Cooperation or collaboration between institutions, they suggest, allows a space for senior managers to experiment and learn which can then be applied to their own organisations or external providers.

Clark, who is a professor at the Smith School of Enterprise and the Environment at Oxford University, says that whether managing assets in house or through an external provider, institutional investors, are not faced with an opportunity to learn a new way of doing things.

“The contractual basis for outsourcing is very sterile, the terms and conditions are so well known and are always the same, it doesn’t give you much of a relationship with providers,” he says.

Clark and Monk, who is the executive director at the Global Projects Center, Stanford University, argue the problem facing institutional investors is more than that of responding to financial instability, the aftermath of the GFC and on-going euro crisis. And that recurrent financial crises have masked a significant shift in the underlying properties of financial markets.

Responding to these circumstances requires flexibility in institutional form and function, and they argue that the current norms of in-sourcing or out-sourcing investment management don’t provide senior managers enough flexibility to respond to changing market conditions.

Cooperation, at a minimum, and collaboration, at a maximum, can be seen as opening up an “action space” for innovation otherwise denied by the norms and conventions of the sector.

While there are some barriers and costs to collaboration, as outlined in the paper, the benefits are many including giving senior managers opportunities to create, extend or modify the resource base of their organisation.

“It allows a space for in house managers a place to learn and experiment outside their own organisation,” Clark says.

The key to successful collaboration is an issue explored in another paper published last year in the Rotman International Journal of Pension Management.

In “Effective investor collaboration – enlarging the shadow of the future” author Danyelle Guyatt, tested an eight-step framework based on collaboration theory, and looked at how it worked in 12 real-world investor collaborations.

Guyatt found a number of factors underpinned effective collaboration: a high level of trust among members, a similar mindset, sharing common interests and an open atmosphere.

The groups that ranked highest in terms of effectiveness were typically smaller groups which suggests a correlation between the size and action of a group.

The effective collaborations also all shared a high level of active involvement from their members in small-group meetings, working groups, research groups and events.

On the flip side, those collaborations that didn’t work as well shared a lack of clarity about their goals, a fragmented target group, lack of trust, bureaucracy among implementation and not enough focus on outcomes.