Author: Daniel Celeghin
The asset management industry is going through a period of profound transition. There are five ‘waves’ of change which will completely transform the landscape, argues Daniel Celeghin, Managing Partner at INDEFI.
The asset management industry faces five waves of change the likes of which it hasn’t seen before. Each of these waves forces leaders to rethink core aspects of the industry’s business model which were, until now, truisms we could all count on:
- Globalisation: steadily integrating capital markets, converging regulations and investor expectations, and increasing demand for global products and strategies - not so anymore.
- Institutional leadership: investment innovation and best-practices come from serving the world’s largest institutional investors - think again.
- Focus on returns: what constitutes risk assets, and the ultimate objective of the investment process itself - not so clear anymore.
1. Individual Investors Dominate
Institutional investors powered the growth of today’s investment management industry. Institutions have long ceased to play this role: the fees generated from institutional channels (defined benefit pensions, charities, sovereigns, insurance general accounts) account for less than 20% of global industry revenues. Policy and demographics are behind this shift. We expect it to pick up steam as emerging markets, notably China, are dominated by retail investors: there is no emerging market-based “institutional” cohort to make up for the decline in American and European defined benefit (DB) pension assets.
The implications for asset managers are profound: an industry driven by individual investors has a different value-chain than an institutional industry, with the balance of power tilting decisively towards distribution. Institutional investors enabled low barriers to entry by supporting boutique-formation: high-quality investment teams were able to reach scale without costly distribution or mass-market brands. The industry’s tempo will be retail-driven: innovation, managers’ focus, even language, will all be oriented around how to better serve the individual. Historically standards were set at the institutional level and worked their way “down” to retail, but this is no longer the case.
2. Returns Redefined
Returns used to be simply defined: beating the benchmark. Over time this definition was augmented to include achieving a high peer rank, over multiple timeframes, and doing so without taking “too much” risk. This statistical construct is at odds with the ultimate purpose of the industry, which is to meet investors’ financial objectives with the greatest certainty.
Going beyond financials returns, investors and policymakers have embraced non-financial “alpha”, clearly seen in the explosive growth of sustainability. We define non-financial alpha as quantifiable portfolio attributes valued by investors which do not contribute to near-term outperformance. Managers should acknowledge the substantial change this wave represents. Life was easier when maximising excess returns was the sole investment objective. Defining additional non-financial objectives and calibrating the right balance between potential erosion of short-term returns versus the degree of impact desired takes work, and investors have not yet been clear where they draw the line. In some markets we would go a step further and state that ESG has become the norm. In those markets, failing to include sustainability in investment decisions is now a form of negligence.
3. Expanded Investment Toolkit
Active managers can improve their odds of outperformance by expanding their investment toolkit: rethinking private asset classes, incorporating new(er) asset types, and rethinking tokenisation. Private alternatives have largely been the purview of institutional investors. Friendlier packaging (tender-offer funds, European Long Term Investment Funds, Long Term Asset Funds) already exists, which could be deployed for investment strategies designed specifically to own both private and public assets, fueling innovation for decumulation products.
Could digital assets represent an extension of the risk spectrum beyond equities? This newer world encompasses crypto currencies, non-fungible tokens (NFTs), and virtual assets. Crypto is the most developed and largest of these three. Crypto’s volatility and retail ownership have resulted in a trading environment where legacy investment strategies and heuristics long ago exhausted in public equities have a high information ratio.
Finally, tokenisation: blockchain technology enables the tokenisation of virtually any asset, and in turn “bite-sized” tokens can be owned by individuals (or funds) and traded. The mainstream adoption of tokens requires (i) an institutionalised contractual and operational infrastructure linking cash flows to tokens and (ii) the embrace by exchanges and institutional market-makers of these standardised tokens. Intellectual property (IP)-related cash flows are likely the earliest candidate for tokenisation, as opposed to say real property or exotic assets such as rare art or wine.
4. Artificial Intelligence Tipping Point
Investment managers should take a close look at how legacy business processes in the front office (investment, distribution, business leadership) can benefit from advances in data science and predictive analytics. Technology’s impact on front office activities has been limited to “dumb” tools which enable human capital. An equity portfolio manager or an institutional sales professional teleported to 2022 from twenty years ago would find merely superficial changes to how they fulfilled their primary responsibilities. We expect this will not be the case for today’s professional being teleported to 2030.
Within investments, the role of artificial intelligence (AI) is most discernable as a function of the investment horizon and liquidity (public or private). For public assets, the ability of technology to accelerate and potentially improve investment decisions is starkest in trading-oriented strategies. As the investment horizon extends to months and then years, technology’s value-add is focusing senior portfolio managers’ time and effort away from lower-value-add activities, flagging non-financial factors, and serving as a feedback mechanism on their decision-making success, predicting when decisions are most likely to be correct.
Private asset managers have been slower to adopt advanced techniques into their investment processes. The potential upside is greater for privates: origination, asset improvement and ESG monitoring are all natural candidates for technological enhancement.
5. Globalisation Goes Local
Perhaps the most widely accepted “truism” guiding business decision-making over the past few decades was that globalisation moved in one direction. The goal was a “hub-and-spoke” model where a single platform housing investments, operations, and business management, ideally in one location powered a common set of strategies and products for sale globally in local sales offices. There was a recognition that the spokes should be localised, but the business model was global. The reality is that this model only worked for serving large institutional clients, and as those clients become a marginal source of revenues, this model is no longer fit for purpose. Addressing the majority of global revenues requires a locally driven business model, with thinner linkages across markets.
Four major markets (US, China, Europe-ex-UK, UK) account for 80% of industry revenues, and are mutually exclusive, with limited cross-selling opportunities across them. These four markets are diverging when it comes to policy priorities, regulatory approach, demographic requirements, and buyer preferences. Leadership in any one of these four markets requires a deeply local effort, including local manufacturing, local vehicles, close relationships with local regulators, and local distribution. This scale in any one major “anchor-hub” will prove to be a competitive advantage, especially in smaller markets. Managers based in smaller markets should carefully consider which of four major anchor-hubs they would like to “localise” in. Managers based in the big four markets should tailor their expansion strategies accordingly and be selective about where to make the (sizeable) commitment to localise.
Asset management can help tackle the great challenges of our age—funding the responses to climate change and demographic shifts—but only by rethinking what it means to be an asset manager.
Daniel Celeghin is Managing Partner of INDEFI’s New York office