How Magellan’s Brett Cairns approaches innovation
For Magellan’s Brett Cairns, understanding innovation came from a most unusual source: a story about McDonald’s and milkshakes written by Harvard professor Clay Christensen. In his book, Christensen explains consumers don’t necessarily buy milkshakes for their taste – they ‘hire’ them to do a job.
He observed over 50% of all milkshakes in the U.S. were hired before 8:30 am. Why? Because, unlike muffins, milkshakes can be consumed while driving, don’t leave crumbs on seats, and are filling. In other words, they serve a particular function in Americans’ morning routines.
“The big message here is that opportunities to innovate are around where people are making compromises in life, and they often don't realise they're compromising.” – Cairns
It's that leaf from Christensen’s book that Cairns has taken and applied at Magellan and the way it approaches innovation.
One recent dilemma Cairns has spent years trying to tackle is creating a solution investors want to hire for a steady income at retirement, while also factoring in the need for growth and downside protection.
In this wire, Cairns further expands on the topic of innovation and the role global equities can play for investors seeking to strike the delicate balance between risk and return in today’s market environment.
Image: Brett Cairns, Chief Executive Officer, Magellan Financial Group (Supplied)
How do you individually and as a firm approach identifying opportunities for innovation?
We haven't set out as a firm to necessarily be a disruptor or try to come up with innovative products to sell. It's really about trying to solve a problem for clients.
The active ETF, which we listed back in 2015, was really a reflection of us asking the question: ‘Why are investors who only want to trade on an exchange precluded from accessing actively managed funds? Was there a rule, or a law, or something? What was actually going on there?’
As we explored the answer to that question, we started figuring out the constraints and set about solving the issue.
And as we went through that process, we observed there was really no distinction between listed and unlisted funds. They're just the same funds. People invest in units of a fund, and how you actually enter it – whether through a form or on an exchange - really shouldn't define what the fund is.
So, it took a little bit of time for me to convince a few people and work with the regulators and indeed some registries, but eventually, we fused the two together. We've essentially now got a single open-ended fund, which you can invest via the traditional method of filling out a form or through a platform and exit or enter via an exchange.
To us, it was an extension of a logical progression of firstly, trying to get the friction out of the system, and second, our focus on clients.
Do you seek inspiration from other companies and how they approach addressing market needs?
There are actually books by two authors I would point people to.
The first is the Nature of Technology by Brian Arthur, a book no one has probably ever heard of. Brian Arthur was one of the founders of a place called the Santa Fe Institute, which I had the pleasure of going to years ago and it deals with a lot of complexity theory and how that works.
In his book, what he was really pointing to is that most technology, most innovation around isn't generated when you're walking through a field and come up with a magic idea that no one’s ever come up with before. It doesn’t work that way.
You add on, or you ‘pinch from’ - as he calls it - another domain and use it to solve problems. And to me, that's a really important insight. And you can see we’ve done that to some degree with the active ETF.
The other series of books that have influenced me quite a lot is the work by Harvard Professor Clayton Christensen who some people may know. He’s written two books that I think are very interesting.
The first one around 2000 was called the Innovator's Dilemma, which really discussed the idea that a lot of firms who are subject to competitors innovating across their industry tend not to innovate.
They get stuck in what they've been doing and for them to go and do something else and disrupt themselves before someone else does becomes quite difficult. And so, you've got this innovator's dilemma on how to actually keep moving and innovating.
But in his second book, which to me was equally as interesting, he was asking beyond why people don't innovate to how to think about the innovation process and the book's called Competing Against Luck.
And it gets to what I was saying, what's the problem you're solving? What's the job that you're doing? And the one that sticks in my mind at the beginning of that book- he's basically asking the question ‘what's the job of a McDonald's milkshake?’ That's a very interesting question.
He came up with the theory that people ‘hire’ products to do jobs.
As an example, he sat outside McDonald's in the US and watched people. And in the mornings, of course, people were pulling up, buying these milkshakes, and going to work. More than 50% of milkshake sales would happen in the morning work rush.
And so, he asked a few of these people ‘why are you buying milkshakes?’ And the answer was ‘I need to be able to consume something while driving and have it fill me by the time I get to work. When I eat a muffin, it drops everywhere.’
The point of the story is that McDonald’s milkshakes had a particular function in people’s morning routine. They were ‘hired’ to do a job.
And yet, when he got there in the afternoon, he noticed people were consuming milkshakes in a different way. It was usually families, often mothers, taking their children there, having a break, and having a good time drinking their milkshakes.
The big message here is that opportunities to innovate are around where people are making compromises in life, and they often don't realise they're compromising.
If you can help people solve that compromise; if your organisation can direct its energy towards solving a problem you’ve identified, then you’ve got a much better chance of coming up with a solution that works.
That’s a good segue to shift from theory to practical application. What’s the market need you’re trying to solve with FuturePay and why do global equities provide the solution?
The savings system in Australia, across superannuation, has been obviously spectacularly successful in many respects.
At the same time, Australia has been a very early adopter of defined contribution and has moved away from the defined benefit model. What that has done is deliberately push the problem of financing retirement back to the individual rather than driving reliance on employers or the government to provide a pension at the end of your working life.
When you were on the old defined benefit arrangement you’d work for a company or the government, and they would provide you a percentage of your salary until you die and there was really nothing else to think about.
Under the defined contribution model, you have to think about funding yourself for retirement and it’s a real problem that’s been clearly underserviced. From our perspective, we’re asking ourselves ‘what is the issue here? What could we do as a fund manager that has some use for people?’
It's a very tricky problem because you're solving for a bunch of issues: getting as much money as possible for the end of your working life, managing risk and return, diversification, stability of income, and sequencing risk.
You need some growth in there because you’re not 100% sure how long you’re going to live given rising life expectancies. At the same time, you also need access to your money.
All those challenges make people anxious because they need to think about so many variables and how they're measured. For example: what's a sensible strategy? How do you know one's better than another?
On the way up during accumulation, you can think about returns, risk, and Sharpe ratios, and all the things that Modern Portfolio Theory entails.
But what about on the way down, in decumulation? What do you do?
We spent a lot of time trying to think about it and we developed a utility function to take into account that people, in order perhaps, prefer their income and the stability of their income over necessarily getting growth in their capital, although they want some of that as well, and they value access to that capital.
So, we had to come up with a utility function to be able to properly measure that. And then that led us to the FuturePay structure.
What made you focus on this issue in particular?
When we started to develop this, we were really looking at what financial advisers are doing for their clients at the moment.
The adviser community, through a lot of trial and error and a lot of hard work, has really homed in on a strategy (commonly known as ‘bucketing’) that does actually add a lot of utility and value to their clients.
But we felt we could come in and really help them and their clients address some of those challenges around sequencing risk and the anxiety of having a stable income to cover living expenses.
For us, it was really about thinking through those problems and creating a solution in a product sense.
Clearly, underneath the hood on this, you need a proper portfolio, you need a sensible portfolio that drives returns. And we do that for a living with our expertise in global equities, Aussie shares, and infrastructure.
But we have also introduced a structural element around reserving and these other things, which we believe brings great utility to it, and is really an extension of strategies that are well employed at the adviser level (‘bucketing’). And again, it gets back to what I said with Brian Arthur's book: it's not a blinding insight.
It's really taking that existing technology, and then trying to push that forward and make that more efficient and more effective. And trying to bring that in a way that's perhaps more useful.
Can you give us the elevator pitch on FuturePay?
If we think about the challenges I’ve been outlining, the crux of it really is that during decumulation, people desire a fixed and known payment from their investments.
The reason we called it FuturePay is to get people to think about the product as a salary replacement solution.
When you're working, you get a known salary that comes in every month, and you can budget around expenses and these sorts of things. You also want that same certainty during retirement, but as I mentioned you need those investments to grow to some degree whilst having access to your capital.
The problem is that they all conflict with each other.
You need growth to address longevity risk. But in doing that you're also clashing with sequencing risk.
And what I mean by sequencing risk is that if you keep taking money out when markets have gone down, you’ve got less money invested and less capital to draw on when markets recover because you’ve been selling at lower prices to fund expenses.
How is FuturePay solving this?
What FuturePay has done is really taken a pooled investment into a portfolio of growth assets, which in this case is our global equities strategy and our global infrastructure strategy, which we believe has got some great underlying characteristics of lower volatility and downside protection, concepts that perhaps people are familiar with.
And from that, we then pay out a fixed dollar amount of income, essentially, which is indexed to inflation. And we pay that every month and it goes up with inflation each quarter.
What we’ve introduced in FuturePay is a reserving function; a pool of capital known as the Support Trust that sits alongside the portfolio of assets. That reserve pool is there to help the core fund pay its income when markets have been beaten down.
Importantly the reserves are there for the benefit of the investors in FuturePay but are not owned by them, they are effectively mutualised which adds significant efficiency. Again, we pinched an age-old concept to help advance the overall usefulness.
So, when markets go down, rather than dipping into the underlying pool of assets and selling them and experiencing sequencing risk, the Support Trust will put some money into the core fund to supplement distributions and support the maintenance and stability of the income.
And what that does is mitigates sequencing risk. So now you've still got money invested in the underlying growth strategies as they continue to grow over time.
Conversely, when those growth strategies generate sufficiently high returns above inflation, we’ll take a small portion of that outperformance and top up the Support Trust.
Currently, the Support Trust in FuturePay at the moment has got about 32 months of distribution sitting in it. In other words, if share prices didn’t move for a long time, FuturePay could pay distributions for 32 months without dipping into the underlying portfolio.
And therein lies the insight that planners have been using for some time - this bucketing approach to help mitigate and manage sequencing risk. Hopefully FuturePay will help take this along further as it adds enhanced efficiency through mutualisation and effectiveness with its in built reserving process, while doing it in a fund structure with daily liquidity.
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