Publication: What does the Future of Asset Management Look Like? 7 Key Trends Reshaping the Industry
What? A disruptive wave is currently reshaping the asset management industry questioning the industry’s operating and fee models.
So What? Incumbent providers need to understand the key trends behind this disruptive wave in order to prepare themselves to future challenges.
Now What? It is in this context that the ICI think tank Redesigning Financial Services analyzed in collaboration with fund-analytics firm Morningstar the key trends behind those structural changes and how incumbents can fight back.
The asset management industry undergoes a structural transformation. The ICI think tank Redesigning Financial Services (RFS) analyses in its most recent publication seven key trends reshaping the industry and what incumbents can do to be prepared for the future. The entire report can be found here.
The asset management industry is in the midst of an aggressive price war. The primary determinant for investor asset allocation is currently fees – even ahead of performance. Moreover, innovative technologies such as artificial intelligence and robo-advisory question the existing operation and distribution models, while new regulations and environmental, social and governance (ESG) considerations reshape the regulatory landscape. Both sides of the cost equation – eroding fees and rising costs – put enormous pressure on the industry’s margins.
In order to better contextualize those key drivers, the ICI think tank “Redesigning Financial Services” (RFS) identified seven key trends reshaping the industry in collaboration with fund-analytics firm Morningstar:
1. Rising cost sensitivity among end clients
Cost sensitivity among end clients has become the primary determinant of fund flows through the global asset management community. Cost sensitivity explains global fund flows even better than past performance. Morningstar data, e.g., suggest that, since 2015, all-in costs for global managed investment products have been four times more effective at explaining cross-sectional differences in organic growth rates than whether the investment is active or passive or a fund’s past performance. As such, the data suggest that investors care more about cost than investment philosophy or a funds “track record”.
2. The rise of factor investing
Factor investing chooses securities based on style and macroeconomic attributes that are associated with higher excess returns (returns above market returns). Examples of such factors are momentum (buying past winners and selling past losers) or low volatility (buying low risk stocks and selling high-risk stocks). As most active asset managers are unable to beat their benchmarks after costs, factor investing has attracted a lot of attention as way to offer investors better prospects to achieve above-average returns.
3. The impact of the regulation framework MiFID II
MiFID 2 is a regulation that is reshaping the asset management industry in two fundamental ways: first, the regulation effectively bans commissions, incentivizing a structural shift to fee-based services; and second, the directive enforces rigorous requirements to provide independent advice in the interest of the client. As such, MiFID 2 is set to have a fundamental effect on the way investment products are distributed, business models are run, and to the pricing and cost structures of many players. Firms that comply with MiFID 2 early are likely to be better off than firms that are ignoring the new regulatory framework for too long.
4. Increasing market consolidation
The asset management industry faces huge consolidation pressure, forced by increasing compliance and technology costs on the expense side, and declining fees and slow organic growth on the income side. The industry has a high degree of operating leverage (high fixed costs and low variable costs); as such, gaining scale is invariably an important and effective strategy against margin pressure. However, increasing consolidation leads also to a more concentrated market: Vanguard and BlackRock, two of the world’s largest asset managers, were e.g. responsible for 57% of global net inflows into passive and active funds. Looking ahead, fee pressure, the evolving impact on technology and high regulatory costs will probably further accelerate the global consolidation wave.
5. The rise of Artificial Intelligence
Automation and artificial intelligence applications is set to be used in three different ways in the asset management industry: 1) to automate the investment process, 2) to offer customized solutions and 3) for better customer support. First, so called robotic process automation (“RPA”) can be used for more complex tasks involving different systems in order to replace many back-office tasks. Second, automated investment decisions based on e.g. deep learning can be used to find patterns that allow investment managers to make automated investment decisions that go beyond algorithmic trading. Third, chatbots e.g. can decrease advisory costs to serve customers while increasing speed and availability.
6. The rise of purpose-driven investments
Values matter, also in the investment industry. Morningstar data suggests that nearly 75% of investors intend to incorporate sustainable investing into their portfolios. Thereby, sustainable investment strategies have evolved from focusing only on negative exclusion (e.g. avoiding “sin-stocks” like tobacco or gambling) to positive inclusion (actively seeking responsible investment opportunities) with the goal of outperforming the market while managing ESG risks at the same time. A further driver of purposeful investment is likely to be the European Commission’s (EC) sustainable finance action plan, which would elevate ESG analysis to a legal obligation to fund managers.
7. Robo-advisory and the disruption of distribution models
The asset management industry is being threatened by increased competition from new entering FinTechs offering robo-advisory services. Robo-advisors are digital investments tools that automate the asset allocation and portfolio selection process for investors based on information they gather through customer profiling. The advantages of robo-advisory services are lower costs, constant availability and a transparent investment process. While robo-advisory services were first offered by FinTechs, currently the two largest robo-advisors (as measured by AuM) are run by incumbent firms Vanguard and Charles Schwab. This suggests that the threat posed by FinTechs in the investment management sector is manageable.
Based on these seven key trends, we see basically two ways how incumbent asset managers can fight the current margin Erosion:
- Gain scale to leverage on the industry’s cost structure (high fix-costs, low variable costs). However, this will lead to a more consolidated, commoditized market or
- Develop niche-products, such as factor investing.
It is in this context that we believe that these seven trends will further gain momentum.
More regarding our Research:
- The whole report can be read at: https://redesigning-fs.com/insights/
- For future insights concerning the finance sector: https://redesigning-fs.us17.list-manage.com/subscribe?u=77ec3fa2d561ad9bd89cda530&id=c62d5fa802
- Lead author of report: Dominique Baumann (firstname.lastname@example.org)
- Redesigning Financial Services (RFS) and Morningstar (2019): “The Future of Asset Management – 7 Key Trends Reshaping the Industry” https://redesigning-fs.com/insights/