The global asset management industry grew every year between 2008 and the outbreak of the Covid-19 pandemic – bar a 3% drop in 2018, from which it bounced back strongly, with AUM growth of 15% the following year.
But revenues as a percentage of AUM fell steadily in that same period, due to the continued decline of active core products and the shift to passive funds.
Costs remained a stable proportion of AUM, with established asset managers hampered by legacy technology and process inefficiencies. Consequently, asset managers' profit margins have been gradually narrowing.
Covid-19 compounded these twin pressures of declining fees and persistent costs. Volatility in stockmarkets caused some funds to report huge outflows of capital and latest estimates place overall AUM growth in Europe in 2020 at a subdued 3%.
The pandemic also accelerated the growth in market share of retail investments, creating a larger volume of smaller deal sizes that magnifies the impact of individual transaction costs.
Cutting costs via tech solutions
Asset managers are turning to technology to address cost, regulatory, and revenue challenges. There are two key cost-related issues driving technology change.
The first is the need to replace legacy platforms with modern architectures. Legacy systems are not just expensive to run and maintain; they also present an operational risk, as staff with the requisite knowledge to maintain them are becoming scarcer.
The second is the push to replace inefficient, labour-intensive processes, in areas such as allocations matching, with a streamlined, globally consistent, end-to-end workflow.
This allows managers to accommodate new transaction volumes within their existing systems, avoiding the headcount-to-volume dependencies that necessitate hiring additional staff in lockstep with new workload.
Another driver of technology change is the need to comply with regulations and accounting standards. Major regulatory issues currently facing European asset managers include best execution, uncleared margin rules and LIBOR transition.
Transaction costs still place high up on asset managers' agenda and, in 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 will take effect for buy-side firms with derivatives of a notional value exceeding €50bn value from 1 September and those exceeding €8bn on 2 September 2022. These new requirements around uncleared margin, especially initial margin, will necessitate technology solutions.
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.
Tech investment driving revenue growth
Investment in technology solutions for cost reduction and compliance purposes alone is unlikely to ensure success. There are also significant opportunities to increase revenue by leveraging technology, such as by improved execution, enhanced ranges of asset classes and investment strategies, and superior digital offerings.
In 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.
Asset managers need to move away from siloed legacy systems and develop the capability to seamlessly execute across asset classes and manage multi-asset portfolios.
The underlying data model needs to be capable of handling disparate asset classes and their nuances, as well as normalising across the portfolio to compare performance.
It is crucial that this includes alternative asset classes: higher-fee products such as private equity, private debt, real estate and infrastructure accounted for 46% of global asset management revenues in 2019.
Recent research by Gartner and Fidelity showed that a fifth of institutional investors already hold digital assets and almost half are considering them, attracted by their uncorrelated returns. The buy-side should consider a digital asset capability, bearing in mind the lack of custody services and regulatory clarity.
Sustainable investing has also become increasingly prominent in Europe. Until there is 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.
Finally, Covid has changed client expectations in terms of the shift to digital and mobile across asset classes. Managers need systems based on modern cloud-based architectures that support remote working without disrupting clients' access to relevant data or investment activities, with communication tools embedded into the application.
This minimises costly operational errors and maximises revenue generation. This can only be achieved by a step change in the technology being used, not by incremental fixes to legacy platforms.
While the long-term impact of Covid disruption on investor confidence is unclear, it will be those managers that address their cost base issues and enhance capabilities for alternative investments and ESG factors who will be best placed to survive any flight to safe-haven assets.
Kenan Maciel is director of strategy at Lab49