Asset Management: Actively Failing
"As investors pour into index funds, asset managers are seeking new strategies to keep them on side"
Active Managers Face Dire Multi-Asset Passive Onslaught
"Multi-asset and passive products will soon account for 93% of total net inflows"
Hedge Funds' Tech Metamorphosis Seen in Citadel's Microsoft Hire
"Silicon Valley watch out. The finance industry is coming after your top managers"
Hedge Fund Robot Outsmarts Human Master as AI Passes Brexit Test
"By luck or design, Nomura’s Simplex Equity Futures Strategy Fund ended the [Brexit referendum] day with a 3.4 percent gain, one of its best results in three months of trading."
Paul Tudor Jones Calls on Quants to Revamp Firm Hurt By Losses
"Jones, suffering losses and about $700 million in investor withdrawals in the second quarter, has accelerated a high-tech revamp at Tudor Investment Corp"
Regulator Calls For Greater Asset MGMT Ops Oversight
"The Financial Stability Board (FSB), a global regulatory body, has proposed a set of policy guidelines including recommendations targeting firms based on size""
The Asset and Wealth Management Business Model— Under Siege
The asset management industry is under siege. A near-perfect storm of poor investment performance, mutual fund outflows, investor preferences for passive, low-fee strategies, and an onerous regulatory environment have led to a fundamental shift in the asset management business model. From the largest traditional asset managers to the smallest alternative and wealth management firms, assets under management have been contracting and/or moving into lower-margin products, forcing these firms to reassess their revenue, growth and profit potential going forward. As recently reported by the Financial Times, “Profits for asset management companies are set to fall by a third over the next three years, with analysts highlighting the rise of passive investing and volatile markets as the biggest threats to active managers. Between 30-35% of the profits earned by investment managers globally could be ‘wiped out’ by 2018, unless more radical steps are taken to cut costs.”
The traditional asset management business model has withstood the test of time, persevering through multiple market cycles and across shifting geopolitical landscapes. Riding a 30-year wave of steadily rising equity prices and falling interest rates, this model delivered stable management and performance fees, healthy profits, and rising assets under management The traditional asset management business model has withstood the test of time, persevering through multiple market cycles and across shifting geopolitical landscapes. Riding a 30-year wave of steadily rising equity prices and falling interest rates, this model delivered stable management and performance fees, healthy profits, and rising assets under management (AUM). As a result, asset management firms felt comfortable and confident investing in their businesses, expanding their infrastructure to meet the demands of a growing investor base. However, the new realities of the marketplace are presenting significant challenges to firms across the industry. (AUM). As a result, asset management firms felt comfortable and confident investing in their businesses, expanding their infrastructure to meet the demands of a growing investor base. However, the new realities of the marketplace are presenting significant challenges to firms across the industry.
Executive Summary— Five Key Challenges Facing Asset and Wealth Management Firms
Poor investment performance
As active portfolio management and mutual fund products continue to underperform, both traditional and alternative asset managers need to expand their suite of products to include more quantitative investment strategies, which have outperformed and are attracting material inflows.
Investor preference for passive strategies and ETFs
Senior executives of asset management firms need to look beyond their traditional products and strategically embrace passive strategies, such as smart-beta exchange traded funds (ETFs). To retain or grow assets in the current environment, they will also need to create products that offer a more customized, solutions oriented and multi-asset approach.
Pressure on trading, technology and operations
Today’s head of trading needs to be globally minded, technology oriented and fully committed to breaking down the barriers between siloed trading teams. By embracing electronification, they will be able to streamline these teams onto one universal technology platform, greatly improving execution, communication and the value added to the investment process, all while reducing headcount and costs.
Rise of robo-advisory
Today’s younger and more digitally oriented investing demographic is focused as much on fees as they are on performance. As a result, they will increasingly turn to robo-advisory platforms. Wealth management firms will need to embrace this technology if they want to court this emerging investor base.
Regulatory and compliance requirements
The new breed of successful compliance officer will aggressively leverage cutting-edge technology and data applications. The only way to ensure confident delivery of the required level of information will be to have highly accurate, enterprise-wide internal reporting systems that can capably assess the firm’s compliance with regulatory requirements.
Impact of Poor Performance— Quant Goes Mainstream
While institutional investors have generally been fleeing hedge funds, they are increasing their allocations to systematic/quantitative strategies. Simultaneously, after seeing large outflows from 2008 – 2013, quant funds have become more transparent and have added more low-fee and mutual fund products to attract AUM. Institutional inflows to quant funds reached over $7 billion in the first quarter of 2016, and these funds were among the best performers during the recent Brexit-driven market gyrations. Bloomberg reported that Brevan Howard Asset Management used artificial intelligence (AI) to mine social media in advance of the vote. Traditional analytics are being transformed by advanced digital technologies such as machine learning, artificial intelligence and predictive reasoning. These technologies, along with new quantitative techniques, are able to provide a competitive portfolio management advantage for those who are able to implement them. This evolution will continue and intensify going forward, as will investor demand for quantitative products.
Recent Market Events
August 9, 2015 — Wells Fargo acquired Analytic Investors, an institutional quant firm with $15bn in AUM
June 29, 2016 — GAM acquired Cantab Capital Partners in order to build out a new quantitative investing unit, GAM Systematic
April 19, 2016 — Fundamental asset manager T.Rowe Price launched three new quantitative equity funds.
Feb 27, 2015 — Bloomberg reported that Bridgewater is building an AI unit reporting to IM alumnus David Ferrucci.
Investor Preference for Passive Strategies and ETFs
There has been a massive shift of assets away from traditional, actively managed funds into passive strategies and ETFs. In the first quarter of 2016, worldwide institutional asset managers saw net outflows of $95.4 billion, according to eVestment. These outflows came on the back of a further $137 billion in outflows during Q4 2015. Equity strategies alone reported $58.6 billion of net outflows in the first quarter, their 12th consecutive quarter of redemptions. The bulk of these equity outflows came in actively managed portfolios, which lost $70.5 billion, while passive equity strategies, in contrast, attracted net inflows of $11.9 billion. This trend is reflected in investor opinion as well as fund flows: a BlackRock survey found that 60% of Millennial and 40% of Gen X investors believe the market will outperform active fund managers, compared to 30% of Baby Boomers. Traditional asset management firms who have shunned ETFs for a variety of reasons, including the desire to safeguard their proprietary active-management investment processes, are at risk of being left behind. The new realities of the marketplace demand lower fees and greater liquidity, and asset managers will have to adapt by adding passive strategies into their suite of products.
Pressure on Trading, Technology and Operations
The most significant technological trend in global markets of late has been the increasing electronification of trading across multiple asset classes. Most asset and wealth management firms have multiple trading platforms for different products, channels and currencies – an expensive, inefficient and outdated execution model these firms can no longer afford. With electronification having already conquered the equity, commodities and foreign exchange markets, the next trading domino to fall will be fixed income, which has stubbornly clung to its outdated voice-execution model. JP Morgan Chase's recently announced partnership with Virtu Financial to use their technology in the dealer-to-dealer US treasury market is indicative of the future of trading. Within the next decade, it seems inevitable that electronic execution will be the standard across all major global asset classes. Gary Cohn, the President and COO of Goldman Sachs, was recently quoted at the Deutsche Bank Global Financial Services Investor Conference as saying, “In addition to capitalizing on disruption in the competitive landscape, we continue to embrace technologically-driven market disruption … there has been a tremendous rise in electronification in the financial markets over the last two decades … We invested in technology in response to feedback from our clients and adapted early to the electronic market in Equities … We aim to provide these clients better execution and lower transaction costs.” The challenges facing trading, technology and operations demand a new breed of technology savvy trading leadership for asset management firms.
Citadel has been at the forefront of recruiting new talent to build its IT capabilities. In Q2 2016, they made a number of substantial executive hires, bringing in Microsoft’s COO, Kevin Turner, as the Chief Executive Officer of its Citadel Securities unit, and Morgan Stanley’s CIO Steven Lieblich as the Chief Technology Officer of its hedge fund business.
Other notable moves include Bank of America’s hiring of Pankil Patel from Credit Suisse to lead electronic trading services in the Americas, Bridgewater Associates’ hiring of Jon Rubinstein from Hewlett Packard to serve as its co-CEO and Point72’s hiring of Timothy Shaughnessy from IBM to be its Chief Operating Officer.
Rise of Robo-Advisory
The robo-advisory industry continues to see rapid growth, focused primarily on the mass-affluent market segment. Robo-advisors have built up over $200 billion in AUM over a relatively short period of time and are projected to increase to $2.2 trillion over the next five years. As PwC wrote in its January 2016 “US Asset and Wealth Management M&A Insights,” “Due to their robust technology platforms and low human involvement, the robo-advisors are able to provide high end wealth management advice at a low fee to their price-sensitive customer base.” PwC also stated that, “Morgan Stanley, Bank of America Merrill Lynch, Wells Fargo and Deutsche Bank have all recently publicly stated an intention to significantly invest in developing or acquiring digital advisory capabilities” and noted, “While it is unlikely that robo-advisors will completely replace their human counterparts, the optimal model will combine a robust digital experience with the ability to interact with a human advisor.” Robo-advisors are here to stay, and wealth management platforms will need to adapt to this new reality to remain relevant. A BlackRock survey revealed that 58% of Millennials are interested in using a roboadvisor platform. If wealth managers can establish digital relationships with this emerging demographic of potential clients, they can then introduce more traditional products to achieve a greater share of wallet. Despite being digitally disruptive, robo-advisors will enhance, not replace, the wealth advisor.
Regulatory and Compliance Requirements
The current regulatory environment, which has consumed the attention of the banks for the past several years, is now asserting itself on the buy-side. To meet the new wave of regulatory requirements, asset and wealth management firms will have to invest significantly in their legal and compliance capabilities, which will be a further drain on profitability. There is little room for error, as the ability to deliver a credible risk-governance model to the regulators has never been more important. Accurately measuring, monitoring and managing credit, counterparty and liquidity risks have become enterprise-wide imperatives, not only because of greater regulatory scrutiny, but also because of the overwhelming financial implications of non-compliance, which can threaten the very survival of an asset management firm. The traditional path for compliance officers within asset management firms has been almost exclusively through the legal and compliance silo. In our analysis of the background of incumbent CCOs at global asset managers, we found that 68% have risen to their current roles from a purely asset management compliance background. For firms to build systems and processes in a way that is mindful of new market realities and regulatory demands, they will need to employ compliance officers who are digitally savvy and technology-oriented.
Recent comments by executives
"Upward pressure on regulatory and compliance cost is expected to continue throughout 2016."
"“Regulation is increasing at an almost exponential pace. This adds significantly to the complexity in compliance requirements for asset managers.;"Joseph Sullivan , CEO, Legg Mason, Fiscal Q3 2016 earnings call
What's Next for Asset and Wealth Managers
The asset and wealth manager of 2020 will be vastly different from those of today.
Kurt Harrison leads the firm's Global Asset and Wealth Management practice. He is based in New York.
Eric Girma is the firm's Global Knowledge Leader for Financial Services. He is based in London.