The seven factors influencing the Asset Management industry.

Introduction

I was performing some research on the Asset Management industry which identified seven factors that are influencing the industry. I thought I would share in case people found it interesting.

1. Regulation

Arguably the most prominent factor at the moment is Regulation or, more specifically, the “tsunami” of new regulations which is inundating the Asset Management industry following the credit crisis of 2008. This wave of new and updated regulation is set to continue for the foreseeable future. This complex set of existing and new global regulations is and will continue to provide a number of challenges to the Asset Management industry. For example increased costs to comply which is squeezing profit margins, an adverse impact on innovation increase complexity

These challenges are in turn forcing the Asset Management industry to change the way they work.   Firms need to review cultures, capital requirements, product develop processes, investment strategies, marketing approaches, distribution , their operating model and associated infrastructures as well developing the ability to complete regulatory returns.

Firms also needed to develop new capabilities to comply with data protection regulation covering the ability to collect, retain and process data and manage information; this area has recently been strengthened by the recent implement of the General Data Protection Regulation (GDPR) on 25th May 2018.

The industry needs to be aware of any unintended consequences caused by the new regulation especially to Investors. For example, new regulation to monitor the risk profile of a portfolio could result in firms putting pension funds in lower risk investments which could harm their long-term investment returns. Also, some of the new regulations are costly to comply with (such as central clearing of Over-The-Counter derivatives) which means firms could not use them which, again, could ultimately impact the Investors investment returns.

Finally firms also need to cope with the changing (and still unclear at the time of writing) landscape caused by BREXIT.

2. Changing nature of Investors

The second characteristic is the changing nature of the Investors. As mentioned earlier, the Asset Management industry has a wide range of different types of Investors which range from very large multi-billion pound pension funds down to individual retail investors who invest several pounds a month. However the dynamics of this group are changing.

Firstly, since the credit crisis in 2008, Investors are becoming “savvier and more knowledgeable” and they are focusing their attention on a wider range of activities as well as investment returns. For example performing detailed and regular due diligence on Manager Governance processes, their fees, their risk management processes as well as the processes followed for decision making. They are also looking for Managers to take a more ethical attitude with their investments (hence the increase in demand for ESG compliant products).

Secondly, the dynamics or the ‘make-up’ of the Investor group is changing. At a global level, life expectancy has risen by 50%, the world population has risen and there has been a sharp rise in the ratio of global wealth to income. This means there are more savers, younger savers, older savers and richer savers. This global change directly impacts the profile of the Investor group. At the lower Retail end of the business, the impact is more obvious because more savers will mean more Retail clients. However there will be impacts to the higher end because more savers will mean bigger Pension Funds and increased tax revenue which will boost the size of Sovereign Wealth Funds.

Thirdly, Investors are taking on more responsibilities for managing their own assets and presumably liabilities. A prime example of this is the move from Defined Benefit pension funds in the UK to Defined Contribution funds where the emphasis is on the Investor to proactively manage investment decisions. Second there has been an increase in High Net-Worth Individuals and Sovereign Wealth Funds with more diverse agendas and investment goals.

Finally, a number of new competitors are entering the industry. Some of these are not that obvious. For example some larger Pension Funds (i.e. an Investor) are building capabilities for them to directly manage their own assets and to reduce their reliance on external Managers. Therefore Managers are being replaced by Investors.

Consequently, the industry needs to understand that the client’s perspective of value is getting tough and it will need to get much smarter at understanding what clients value.

3. Evolution of Products

There is an also ongoing sea-change in the types of Products within the industry. There are a large number of products with the Asset Management industry which are currently being rationalised into a fewer products but with a greater concentration. This change has been driven by the following factors.

Firstly, the increased burden of regulation has resulted in many products being too costly and complex to run. Historically firms have never really understood the costs behind their products mainly because the margins were large enough that costs always appeared immaterial. However since the introduction of more regulation the costs and complexity to comply have increased which has resulted in many products being unsustainable.

Secondly client demands have evolved which means a number of products do not meet their investors’ needs. Products ranges are moving away from pure alpha equity managed returns to products focused on advice and outcomes balanced against cost and investor liquidity needs. For example a pension funds nowadays are more interested in having dedicated cash flows to meet pensioner payments (i.e. outcomes) as opposed to having their investments outperform the FTSE-100 by 1% each year (i.e. alpha returns).

Thirdly, the composition (i.e. the assets the investor’s money is invested in by the manager) is also changing. The increase in investor education is resulting in a two way separation of the assets invested in by managers. At the top end of the range there are the investments which are seeking higher returns but often cost more and have less liquidity such as Hedge Funds, Private Equity Funds. Property, Infrastructure and Commodities. At the bottom end there are passive investments which track indices (such as Exchange Traded Funds and Trackers) and bonds which do not provide as great investment returns but are far more cheaper to operate and far more liquid. Therefore, the traditional alpha strategies are being squeezed in the middle because they do not offer sufficient investments taking into account their cost and liquidity.

Furthermore, the change in asset composition has been driven by the increased burden of regulation.  New regulation such as UK Pension Act 1995 which introduced Minimum Funding Requirement (or ratio of assets to liabilities of 90%) linked discount rates to UK Gilts. This meant that Pension Funds tended to purchase low volatile UK Gilts, to avoid large swings in their surpluses, and consequently avoided more volatile assets such as equities.

Finally, managers tended to be ‘distant’ from their Investors and did not offer any significant personal or customer service.  However firms need to ensure the Product offers are expanded to provide much better customer service elements going forward.

4. Lack of trust in the industry

The fourth characteristic within the industry is the lack of trust that Investors (and the general public) have in the Asset Management industry. This lack of Trust is across the entire Financial Services industry and stems back to the Credit Crunch of 2008 and has been kept going by a constant stream of damaging media stories covering areas such as general incompetence, poor customer service and undeserved bonuses. While Asset Management firms could argue that they were not the part of the cause of the credit crunch, because it was caused by Investment Bankers and their actions, they are deemed ‘guilty’ in the public’s eye. Therefore it is essential that Asset Management firms have sufficient governance and risk capabilities to try and increase trust.

This characteristic can be split into two areas; namely tangible capabilities and intangible capabilities. 

The tangible capabilities are primarily driven by the new regulation currently being implemented. This regulation is forcing firms to implement greater oversight responsibilities, new governance models and new processes to support decision, risk management and transparency. The challenges of implementing this have been discussed in more detail above. However the other grouping is intangible capabilities which items such as cultural change, behaviour change and ensuring there are no silos exist to stop the flow of data. This area is far more challenging because changing deep-rooted behaviours is a complex tasks. Firstly individuals themselves will need to change and then their interactions with other individuals will then need to change. This is an area that the regulators are particularly focusing on

5. The need for timely and accurate data

The fifth characteristic of the industry is the need for timely and accurate. This is essential to the Asset Management industry and it could be argued that this is the ‘blood’ of the industry. Data are required for: managing the investor’s assets; managing distribution channels; completing regulatory returns; cost/profit management; governance processes; and product management.   Unfortunately many firms struggle producing timely and accurate data due to major efficiencies in their operating and technology platforms. This is discussed further below

6. Poor Operating and Technology Models

The sixth characteristic of the industry is the constant challenge that operating and technology models have to keep pace with the changing nature of the industry.

Historically, these operating models have been costly to operate, rarely ‘fit for purpose’ and hard to manage. They consist of a complex patchwork quilt of duplicate, ineffective and poorly implemented technology, a variety of in-house manual processes and various 3rd party outsourced arrangements for covering various and duplicate functions. However the demands of extra regulation, more demanding investors, new product ranges, and the need for accurate and timely data as well as superior governance processes will place more pressure on these already struggling platforms. 

These extra demands will stretch the already struggling capabilities of these operating models because they will be expected to cope with more demands. The end results is that various processes and technologies are ‘bolted’ onto the side of the operating model which only increases their ‘patchwork quilt’ nature. Some firms have looked at various change initiatives to make a step change to improve their operating model. These can range in size from small system upgrades to massive business transformation activities. However the Asset Management industry has a poor record in implementing change and therefore many of these change initiatives do not provide the benefits hoped and could, in fact, make the situation worse or more ‘patchwork quilt’.

7. Cost Pressures

The final characteristic is profitability (with associated revenue and cost) management. This area has been mentioned above several times but, because of its important to firms, it has been mentioned as a separate characteristic. All Asset Management firms are economic firms as in they need to make a return of some sort (normally a profit) to its shareholders. However, the constant demands mentioned above are increasing costs as well as reducing revenue which means profitability is being squeezed.

I hope that you find this useful? But please feel free to comment especially if you have differing experiences and/or views?

? Paul Taylor 2021