An abridged version of this Insight piece was also published as a guest article in Investment Week. Click here to view.
Between the global financial crisis in 2008 and the outbreak of the Covid-19 pandemic, the global asset management industry had grown every year – barring a 3% drop of c.$2 trillion in 2018, from which the industry bounced back in style the following year, recording a rise in AUM of over 15%.
But in that same period revenues had been steadily falling as a percentage of AUM, partly due to the continued decline of active core products and the shift to passive funds. Costs remained at a stable proportion of AUM, with established asset managers hampered by legacy technology and process inefficiencies in areas with a headcount-to-volume dependency, such as allocations matching. Consequently, asset managers’ profit margins have been gradually narrowing and profitability decreased still further in 2019.
This incremental impact of a reduction in fees and persistent cost pressures was being more keenly felt even before Covid and the resulting volatility in stock markets subdued AUM growth in 2020, with some funds reporting huge outflows of capital. Latest estimates for AUM growth in 2020 fall in the region of 3% for US and Europe.
It is no surprise then that asset managers are turning to technology with increasing urgency to address the cost, regulatory, and revenue challenges they are facing.
Cutting costs via tech solutions
It is no surprise then that asset managers are turning to technology with increasing urgency to address the cost, regulatory, and revenue challenges they are facing.
On the cost side of the equation, there are two key issues driving technology change. The first of these is the need to reduce the costs of legacy platforms by replacing them with modern architectures. Legacy systems are not just costly to run and maintain; they also present an operational risk, as staff with the knowledge to maintain systems based on legacy technology are becoming scarcer.
The second is the push to drive down costs through a globally consistent end-to-end workflow that streamlines processes and removes inefficiencies where headcount-to-volume dependencies exist. M&A is also being used to create economies of scale, as evidenced by Charles Schwab’s acquisition of Ameritrade. The increase in retail segment investments, which in 2019 grew to account for 42% of the market, means that there is a larger volume of smaller deal sizes, so it is even more important that related costs are kept to a minimum.
Regulatory hurdles
Another driver of technology change is the need to comply with regulations and accounting standards. Major regulatory issues currently facing asset managers include best execution, uncleared margin rules, the potential impact of the US DOL ruling on fiduciary duty, and Libor transition.
Transaction costs still place high up on asset managers’ agenda and, in certain jurisdictions where best execution is mandated, it is essential to collect evidence of having adhered to it.
The final phase of the Basel Committee and IOSCO’s uncleared margin rules (UMR) will now take effect on 2 September 2022, at which point thousands of buy-side firms with derivatives of a notional value exceeding €8 billion will have to comply with the rules. Firms with derivatives of a notional value exceeding €50 billion will be subject to the requirements from 1 September 2021. These new requirements around uncleared margin, especially initial margin, will necessitate technology solutions.
The June 2020 Department of Labour ruling on fiduciary obligation, if ratified, will also impact some firms, which will need the capability to disclose fees to individual clients.
Finally, rates portfolios will need to be bulk-amended to reflect Libor transition. Interest rate swaps and other products will need the ability to use one reference rate up to a certain date and then switch to another reference rate.
Covid-driven lockdowns have demonstrated the need for systems to seamlessly support remote working without disrupting clients’ access to relevant data or hampering their investment activities, with communication tools embedded into the application.
Tech investment driving revenue growth
While asset managers should invest in technology solutions for cost reduction and compliance purposes, that alone is unlikely to ensure success. There are significant opportunities in leveraging technology to not only drive efficiency but also enhance capabilities and increase revenue. Prime examples include improved execution, supporting a wider range of asset classes and investment strategies, using historical data to better anticipate client needs, and superior digital offerings.
In the area of trade execution, technology enables asset managers to select the appropriate low-touch or zero-touch options for the large volume of smaller deal sizes. At the other end of the scale, asset managers can leverage data to seek appropriate sources of liquidity for large transactions.
Legacy systems tend to be siloed, making multi-asset strategies harder to manage. Asset managers need the capability to seamlessly execute across asset classes and manage multi-asset portfolios. The underlying data model needs to be capable of handling the disparate asset classes and their nuances but should also be capable of normalising across the portfolio to compare performance.
It is increasingly important for the asset classes that firms support to include alternative investments, with higher-fee products such as private equity, private debt, real estate and infrastructure accounting for 46% of global asset management revenues in 2019.
Meanwhile recent research by Gartner and Fidelity showed that a fifth of institutional investors already hold digital assets and almost a half are considering them, lured particularly by the low correlation of returns to other assets. The buy-side would be well placed to consider a digital asset capability, bearing in mind the lack of custody services and regulatory clarity.
Sustainable investing has also become increasingly prominent, especially in Europe. This trend is likely to continue into America and Asia also. Until there is a globally recognised accreditation and assessment of companies’ ESG performance, asset managers will need a technology capability to assist with their own assessments, analysis, and performance reporting.
Covid-driven lockdowns have demonstrated the need for systems to seamlessly support remote working without disrupting clients’ access to relevant data or hampering their investment activities, with communication tools embedded into the application. Modern cloud-based architectures are much better suited to this. A guided user experience to make process execution as efficient and low-cost as possible minimises costly operational errors. By contrast, legacy platforms that require months of training to understand can cost asset managers not just revenue, but also associate staff unwilling to work with dated systems.
Where systems are exposed to clients, it is even more critical to provide a differentiated user experience. A 2020 study of asset management found that to be competitive, managers need to be able to do more for less, such as providing enhanced capabilities and a differentiated client experience at a lower cost base. For companies with legacy systems this can only be achieved by a step change in the technology being used, not by incremental fixes. The drive to mobile and digital is expected to continue across all asset classes and Covid has served to accelerate this.
Investing in technology change – acquisitively and organically
Some firms may buy these revenue-generating capabilities, such as digital capability for traditional voice-based companies and access to alternative investments capabilities, through M&A activity. Morgan Stanley Wealth’s acquisition of eTrade is an example of purchasing a self-directed digital capability. There is an expectation of further M&A activity across the buy-side and these will require significant merger integration efforts to ensure that there is a coherent client experience and to harvest the potential cost and capability enhancements.
Asset managers are thus investing in technology change to address cost, regulatory, and revenue issues. Whilst it is not clear what the long-term impact of Covid disruption will be on investor confidence, it is clear that asset managers that address their cost base issues and enhance capabilities for alternative investments and ESG factors are the ones who will be well placed to survive any flight to safe haven assets.