In the past year, 'complexity' has become a dirty word in financial services, particularly when it comes to investment products. Everyone's favourite buzzwords for 2009 have been 'transparency', 'simplicity' and -- winner of the AsianInvestor Cliché of the Year -- 'back to basics'.
This time last year, AsianInvestor wrote about how Neeraj Sahai, New York-based global head of securities and fund services at Citi, commented on the increasing complexity of the asset management industry.
Sahai had been arguing that complexity was the result of various trends driving the funds business, just as executives seemed to be doing everything to portray themselves as anything but.
One year on, on a catch-up with Sahai at the Sibos conference in Hong Kong last week, he made the distinction between the kind of products that fund managers and distributors want to sell (easy to understand) and the business models required to achieve this (not easy to implement).
The financial crisis has added to the number of liability-driven institutional investors, retail investors and pension fund members looking for straightforward beta or enhanced products. These products are also more in demand among sophisticated investors seeking core asset allocations.
But this does not mean investors are looking for cookie-cutter products. They all have different objectives, so asset managers and their distributors are coming up with a 'mass customised' service. The products may look simple, but tailoring lots of simple products to a variety of client profiles is not.
Another trend driving complexity of platforms is that, as regulations change, particularly with regard to how investment products are sold, and as investors demand more transparency (even of their hedge funds), asset managers and distributors need to amend their platforms and reporting systems. This requires capital expenditure and introduces new complexity in operations and infrastructure.
Moreover, Sahai repeats a theme he outlined a year ago: how asset managers are adjusting their business models to fit one of three basic categories. The BlackRock acquisition of Barclays Global Investors demonstrates one route as offering as broad an array of products as possible, to cover all needs and capture economies of scale. This leads to M&A, which requires a lot of integration work across the organisation.
The second category is driven by the notion that investing is more art than science, a model espoused by boutique providers that try to be very good at a particular thing. Alpha models are changing, particularly among hedge funds, because leveraged strategies are no longer possible; instead, more managers are adopting high-frequency trading strategies. This requires massive commitments to systems and connectivity.
The third model is that of wise portfolio construction rather than selling products. More than an investment product, this approach, which includes multi-managers, is most effective when tailored for a client.
Sahai's division sells fund services, so his basic argument hasn't changed; more complexity in the business model means more asset managers need to work with third parties to realise their ambitions, particularly as they grow their cross-border businesses.
He reckons asset managers with AUM in the range of $25 billion to $250 billion are big enough to compete, but will struggle with the capex that is required. This is changing the nature of outsourcing.
Outsourcing has in the past often been pitched as an all-encompassing move designed to reduce costs. Sahai says this conversation is becoming more specific with regard to function. Cost reduction is also no longer sufficient for many clients. Citi is pitching outsourcing as less a service at arm's length and more a relationship that makes fund managers more flexible and nimble, so they can respond to regulatory or market changes, and better manage risks.
This can extend to help with distribution in new markets, Sahai says. Here he declines to talk about specifics. Citi is a huge distributor of investment products and its wealth management arm is meant to pick best of breed; it is meant to act as a fiduciary (a role that in some markets is required by law). Therefore, simply hiring Citi as a custodian or fund administrator is not a ticket to getting on the shelf of its wealth management division.
On the other hand, operating full straight-through processing on a Citi platform can reduce transaction and other costs, so it could give some products a competitive edge when sold via Citi's wealth managers -- thus allowing the bank to argue it remains true to its fiduciary role.