It is undeniable that in the wake of the global financial crisis, the Asset Management industry has witnessed an unprecedented recent period of product engineering. Tectonic shifts in investor sentiment and attendant investment philosophy, combined with new IT capabilities have opened the door not only for new products (see my previous post, AM Product Engineering: Is there an Active ETF Tsunami Looming?), but also for new ways of doing business for asset managers, be it across portfolio management, risk management, client service or elements of administration such as reporting and data management.
The issue, however, is less about the availability of such products, but rather how an asset manager can more efficiently deliver them (along with any / all other enhanced business models requirements) in a more consolidated manner given the persistent, bottom-line pressure from continued industry fee compression. While investors may “want it all,” there is a strong, countervailing need for asset managers (and asset servicers) to develop enhanced operating models that deliver these capabilities with efficiency, minimal running costs and the presumption of scale. And this need is further exacerbated by the requirement to comply with multiple regulatory regimes across the globe requiring asset managers to have agile and transparent reporting.
For many asset managers, the first step on this journey to the efficient operating model has been the recognition of a “convergence” trend. This trend recognizes portfolio management as being increasingly multi-asset class as well as multi-strategy. This trend is in stark contradistinction to the many process and / or technology infrastructure silos that are observed in industry. Typically, these silos have boundaries along product and asset class lines such as alternative investments, derivatives, ETFs and externally managed portfolios.
The resulting challenge for asset managers is determining precisely where they should expend their scarce capital and management and execution capacity in support of the “convergence” trend. This requires a point-of-view as to: a) what level of cross-asset and cross-strategy integration of their operating model is actually achievable, and b) what savings can be harvested from such operating model changes as platform consolidation and attendant process reengineering. Discussions of target operating models typically span people, process and technology dimensions so let’s evaluate each of these relative to the desire to achieve a more integrated operating model:
People
The creation of new investment products such as smart beta strategies, active ETFs and liquid alternatives has been met with enthusiastic demand for this expanded product offering by many investors including retail investors. For instance, liquid alternatives, which provide mass-market access to hedge fund and private equity strategies – are expected to grow by more than 25% over the next five years[1]. However, as the list of investment products offered by asset managers proliferates so too does the breadth of skills required across various groups within asset management companies. Unconstrained multi-asset strategies, for example, require traders and portfolio managers to have deep expertise across multiple asset classes (e.g. equities, fixed income, commodities, etc.) and instruments (cash, derivatives, etc.). As many firms are still organized in asset class silos they may benefit from breaking down those divisions and promoting cross-training to develop the required expertise.
Similarly, the people challenges posed by an expanded product offering are not limited to trading and portfolio management but also extend to the area of client service. Approximately half of all inbound institutional client service inquiries are ultimately related to understanding portfolio composition, risk and application of the investment process (versus operational or other processing errors). This requires a human capital function with significant analytical training and skills as well as operational understanding[2]. Such a human capital function may require greater expense but may be indispensable nonetheless.
Further underscoring the human capital challenges, in the realm of private equity the existing service levels provided to Limited Partners have often been described as basic as and of significantly less quality than that provided to comparable institutional investors in other traditional asset classes (e.g. fixed income, equity). Some industry participants have cited that this may be because this function has historically often been handled by investor relations; a group not traditionally trained or otherwise equipped to deal with the complex portfolio inquiries and data requirements associated with client service.
As new products continue to emerge and as investor portfolios increasingly span across asset classes, firms’ ability to manage and answer investor queries in a more comprehensive and standardized manner is expected to be an important differentiator. Consequently, sourcing the human capital for such a function may be challenging due to the breadth of skills required and competition in the market.
Process & Technology
Incorporating new products and strategies into a more consolidated operating model poses a number of practical challenges on process flows and systems particularly since many of these are asset class and/or strategy-specific. This applies across the value chain, where trade-booking, risk, collateral, valuation and accounting platforms used often vary across products.
For example, in the hedge fund space, there has always been a quest for a real-time stock record and process to support such activities as hedging and intra-day risk management. As traditional strategies become less constrained, requirements such as these may begin to span across asset classes. Therefore, firms should carefully evaluate and identify opportunities to consolidate platforms to minimize the increased complexity and costs associated with maintaining such a hybrid infrastructure.
To be sure, while the lines separating asset classes may be blurring, they may persist for some time. There will continue to be idiosyncrasies among certain asset classes which will limit the degree of consolidation which is achievable. For instance, accounting peculiarities for real estate and private equity assets may render platform consolidation across traditional asset classes challenging.
Similarly, the data models associated with many financial products may not be sufficiently similar to support consolidated processing and reporting. As a result, firms may still need to compensate for multiple-source systems through the use of special purpose infrastructure for data management consolidation and reporting. One example of a consolidated data management requirement is document management. Investment management agreements, service level agreements, pricing agreements and other documents are typically costly to maintain in distributed physical form. Consequently, system solutions in this space typically have a high return on investment.
Lastly, more integrated operating models carry benefits which transcend cost-saving. Consolidation of transactional information may make it easier to “mine” customer data and identify valuable client opportunities (e.g. cross-selling).
In summary, there are numerous market forces at work that are driving changes in product mix, service expectations and explicit IT and platform capabilities. Asset managers (and asset servicers) that first evaluate and then remake their operating models to deliver greater efficiency – across asset class and strategy – may have an advantage in protecting their future margins.
