Post-crisis, asset management gets complicated
As asset management becomes more complex, fund houses will rely more on service providers, according to one such provider.
The credit crunch is accelerating changes to the structure of the global asset management industry, forcing companies to adjust in order to succeed, argues Neeraj Sahai, New York-based managing director and global head of securities and fund services at Citi.
Noting the "breaking the buck" at Reserve Fund Management, the US-based money-market funds specialist, nearly led to a run on the asset management industry, Sahai says fund houses must consider new factors in their business models.
One is consolidation among service providers: what happens if a custodian goes under? Do fund houses have access to sufficient liquidity if custodian banks merge? What happens to hedged positions if a counterparty fails?
Second is de-leveraging: what is the fate of portfolio strategies based on shorts, including 130/30 and equity long/short? Can these still generate alpha? What due diligence is required to understand counterparty risk, or product suitability for different clients? What kind of disclosure will regulators start to demand?
These questions must be added to a more long-term mix of trends that are shaping the future of asset management. Sahai is confident that the industry will return to its fast rate of growth (CAGR of 12-15% in developed countries, faster in big emerging markets), as investors' needs haven't been changed by the crisis. But the future does look more complex for fund management companies, he says.
Sahai identifies five profound trends shaping the industry. First is demographics: today about one-fifth of the world's population is over the age of 50; this portion is going to rise to one-third by 2050. This will lead to a requirement for more stable, predictable sources of investment income, and a new structure for service, asset protection and intergenerational transfers of wealth.
That suggests a bright future for passive and structured solutions, but the second trend heralds demand for active management: the rise of high-net-worth and mass-affluent investors. As aging populations in the developed world reduce demand among pension-fund members for equities, rich people will take up the slack. They will however insist on more tailored products and many of them will behave like small institutional investors. Again, this will call for new technologies and better delivery platforms.
Thirdly, globalisation, specifically cross-border investment flows, will increase. Some of this will be more rich-world money flowing to emerging markets, as places like the US reduce home bias. A lot will come from intra-emerging market flows, notably between the Middle East and East Asia, turning these places into sources of capital as well as destinations for Western investors. But this suggests a far more complex world, in which fund companies will succeed if they have 'passportable' products.
Fourth, the rise of sovereign wealth funds and Asian central banks will change the shape of institutional asset management. These groups are in some ways similar to orthodox pension funds or insurance companies, but involve local political realities and must also play the role of the local market stabiliser. Catering to them will require new risk-management and compliance capabilities among fund managers.
Lastly, the infrastructure for asset managers needs an overhaul. New emphases in Asia on know-your-client rules, anti-money laundering rules, best execution, the use of alternative electronic trading venues, increased 'passportability' and new disclosure requirements will all create operational strains.
Sahai says these changes are having an impact on how the fund industry works. More big houses must shift their core business from portfolio management to portfolio construction, and more holistic approaches to each client's risk/return profile and less emphasis on hot products.
This suggests fund managers will fall into one of three general types. First, the big multi-asset class, multi-strategy global supermarkets. Second, the other extreme of niche boutiques. Third, in the middle, managers of managers, or integrators or packagers of investment solutions.
"The front office will become more complex, which will lead to complexity in the middle and back offices," Sahai says. "This will lead asset management companies to rely more on their service providers, and turn them into true partners."
Noting the "breaking the buck" at Reserve Fund Management, the US-based money-market funds specialist, nearly led to a run on the asset management industry, Sahai says fund houses must consider new factors in their business models.
One is consolidation among service providers: what happens if a custodian goes under? Do fund houses have access to sufficient liquidity if custodian banks merge? What happens to hedged positions if a counterparty fails?
Second is de-leveraging: what is the fate of portfolio strategies based on shorts, including 130/30 and equity long/short? Can these still generate alpha? What due diligence is required to understand counterparty risk, or product suitability for different clients? What kind of disclosure will regulators start to demand?
These questions must be added to a more long-term mix of trends that are shaping the future of asset management. Sahai is confident that the industry will return to its fast rate of growth (CAGR of 12-15% in developed countries, faster in big emerging markets), as investors' needs haven't been changed by the crisis. But the future does look more complex for fund management companies, he says.
Sahai identifies five profound trends shaping the industry. First is demographics: today about one-fifth of the world's population is over the age of 50; this portion is going to rise to one-third by 2050. This will lead to a requirement for more stable, predictable sources of investment income, and a new structure for service, asset protection and intergenerational transfers of wealth.
That suggests a bright future for passive and structured solutions, but the second trend heralds demand for active management: the rise of high-net-worth and mass-affluent investors. As aging populations in the developed world reduce demand among pension-fund members for equities, rich people will take up the slack. They will however insist on more tailored products and many of them will behave like small institutional investors. Again, this will call for new technologies and better delivery platforms.
Thirdly, globalisation, specifically cross-border investment flows, will increase. Some of this will be more rich-world money flowing to emerging markets, as places like the US reduce home bias. A lot will come from intra-emerging market flows, notably between the Middle East and East Asia, turning these places into sources of capital as well as destinations for Western investors. But this suggests a far more complex world, in which fund companies will succeed if they have 'passportable' products.
Fourth, the rise of sovereign wealth funds and Asian central banks will change the shape of institutional asset management. These groups are in some ways similar to orthodox pension funds or insurance companies, but involve local political realities and must also play the role of the local market stabiliser. Catering to them will require new risk-management and compliance capabilities among fund managers.
Lastly, the infrastructure for asset managers needs an overhaul. New emphases in Asia on know-your-client rules, anti-money laundering rules, best execution, the use of alternative electronic trading venues, increased 'passportability' and new disclosure requirements will all create operational strains.
Sahai says these changes are having an impact on how the fund industry works. More big houses must shift their core business from portfolio management to portfolio construction, and more holistic approaches to each client's risk/return profile and less emphasis on hot products.
This suggests fund managers will fall into one of three general types. First, the big multi-asset class, multi-strategy global supermarkets. Second, the other extreme of niche boutiques. Third, in the middle, managers of managers, or integrators or packagers of investment solutions.
"The front office will become more complex, which will lead to complexity in the middle and back offices," Sahai says. "This will lead asset management companies to rely more on their service providers, and turn them into true partners."
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