RBC Capital Markets analysts Kenneth Lee and Mark Dwelle look at the beat up world of asset management and like some of what they see. The list of problems facing traditional asset management firms is deep and well-known. In a world where the Department of Labor reached above the US Securities and Exchange Commission to develop a fiduciary rule for recommending investments that limit a firm’s profitability, computer-based “robo-advisers” threaten to make human asset advisers obsolete at a time when Eugene Fama categorized portfolio management as a part-time job. Yet in such a hostile environment, hidden value inside the asset management industry can be found. Just look for the artificial intelligence, niche investment strategies and firms engaging in a consolidation strategy.

Asset management firms – Passive investing is not the big trend, the “age of specialization” is upon us

The advent of passive investing has been viewed in some quarters as threatening to active management. Low fee ETFs that generally don’t attempt to pick stocks to “beat the market,” on the surface, point to a game-changing revenue adjustment model for asset managers. But it is looking below the surface where Lee and Dwelle see opportunity.

While passive might indeed continue to prevail, a more significant trend is forming, that being the “Age of Specialization.”

“The most attractive investment strategy niches include alternatives,” the report said, pointing to strategies such as long/short equity, global macro, absolute return and specialized fixed income.

What is attractive about niches outside the mainstream is that sophisticated investors pay for unique knowledge or the ability to achieve an important strategic goal, such as noncorrelation.

“Active specialty equity, which includes international/global equity, natural resources equity, real estate equity” – all with different performance drivers – enjoyed high fee rates relative to the more vanilla strategies.From the RBC perspective, the best strategies combine passive with a “smart beta” approach. True passive – an easy to replicate S&P 500 index, for instance – can lead asset management firms to starve in a fee abyss. But those strategies outside the mainstream that deliver on their promise of true “alternative” performance drivers, even if it is undiscovered “beta,” command appropriate fee value.