The investment management industry is seeing existing trends accelerated and background considerations pushed to the top of the agenda. David Morrey gives his view on the major themes that the sector will need to address.
In an increasingly dynamic and complex industry landscape, investment management firms may have to create entirely new vectors of development. The challenge many managers will face is how to deliver the strategic improvements they know are necessary for the long-term success of their business alongside their tactical response to COVID-19.
Consider these 10 priority areas that the investment management industry will need to focus on for 2020:
1 Exchange-traded funds (ETF) and passive trends accelerate
The long-term growth of passive investment management vehicles, many of them in the form of exchange traded funds (ETF), has been in effect for some time, although some questioned how these vehicles would operate under extreme stress and whether active investing would be more resilient in the event of a crisis.
The abrupt market disruptions caused by coronavirus have not, in fact, caused major issues with ETFs. And, perhaps partly due to the rapid bounce-back of equity markets, passive performance has still compared well for many active managers.
This experience will make passive investment management an even-stronger draw for investors moving forward, and the pace of passive investment’s growth at the expense of active strategies will increase. Managers relying on active strategies will find asset-gathering even harder.
2 Investment management market consolidation and increase in M&A activity
The pace of investment management consolidation will increase, with growth harder to come by for active managers and cost savings harder to achieve at lower levels of scale. A drive to consolidate is the likely outcome. But we do not expect purely horizontal consolidation.
There are already business models built on vertical integration, with manager, platform and distribution in the same group. We believe some managers will be more attracted to consolidating with businesses in their value chain, taking that approach to finding margin. Both trends in consolidation were already apparent, but COVID-19 must accelerate them.
3 Search for new revenue sources
Alongside the prospect of greater consolidation, expect active managers with a strong existing franchise to be more active in looking for new revenue sources.
For the largest investment management firms, that might include developing new passive capabilities, which may mean sacrificing legacy business. This will be a better outcome than losing out entirely to passive specialists.
For others, expansion into asset classes or different, and probably more actively risky, strategies will be the chosen means of defending and adding to revenues. These all come with significant business risk. Beyond the costs of development, the costs of effectively controlling unfamiliar styles of investing will be potentially high, and the chances of spectacular failure greater.
4 Accelerating cost reduction and restructuring
Given the severe economic impact of COVID-19, investment management will need to replan in-flight cost reduction and restructuring initiatives.
Smarter choices are needed to prioritise capital and resource allocation from periphery activities, which can be outsourced, to those that are essential. Many system developments and platform technology changes that have been desirable, but not a priority, will be accelerated. For some of the largest players, there will be more consideration of whether their technology assets can be offered as industry utilities.
5 Addressing fund liquidity expectations for investment management
Fund boards, already under scrutiny from international regulators, can expect to face an even faster-rising bar of expectations. This is due to the round of asset price dislocation and suspensions that have accompanied some funds during lockdown.
Equipping their organisations with the analytical tools, early-warning indicators, and war-gamed and tested decision-making processes necessary to show the board is really in control will be a challenge for most. The arguments over who should be on a fund board, and the possible conflicts they may have with other roles may become redundant if the industry decides that sitting on a fund board requires too much focus for another significant role to be maintained at the same time.
6 Prudential regulation and systemic risk oversight
After the COVID-19 situation has ended, the debate over whether the largest asset investment managers should be classified as Global-Systemically Important Financial Institutions (G-SIFIs) will need to be revisited, and whether the prudential regulation of those firms will move to the Prudential Regulation Authority (PRA).
It is hard to argue that larger managers can and do have a systemic impact on the stability of UK financial markets. The new prudential rules for investment firms will come into effect during 2021 and with the Financial Conduct Authority (FCA), Prudential Regulation Authority (PRA) and HM Treasury all taking leading roles in the implementation, that would appear to be an appropriate transition point.
7 Rebuilding, optimising and creating resilience in the supply chain
The coronavirus situation has tested, and in certain instances broken the third-party supply chains that had been designed and built within rigid operating models over the last 10 years to perform near- and off-shore services. There will be a rethink in how best to optimise or collaborate with new third-party suppliers to perform services with greater business continuity over a more flexible, disaggregated value chain that provides agility, stability, and innovation.
8 Pensions and investment management advice market dislocation
The intensity of the outbreak will not be permanent, but poor advice and rushed decisions made at its height could have a lasting impact on retirement income. Wealth managers should be concerned about financially distressed consumers seeing their pension assets as a solution to making ends meet.
There is also a lesson from the past, which is that a crisis will frequently reveal to customers, firms, and regulators the consequences of poor advice provided in the past. Wealth managers may be facing the challenges of correcting past errors as they work to prevent new ones from occurring.
9 Redistribution and new locations of the future workforce
Adjusting to the post-coronavirus environment will require a remapping of the workforce to locations and functions. This will result in a more-distributed model and increased rotation in workspaces, including:
increased working from home
reducing large concentrations of real estate
adopting more-collaborative technologies
enabling better ways of working
This is an opportunity worth seizing, and brings with it a significant cost advantage. However, the potential challenges - operational, security and cultural - are going to be a focus.
For the investment management industry, there is a further challenge with many investment vehicles, depending on a concept of national domicile, based on physical presence and local decision-making that will need to be maintained, even as the rest of the ecosystem moves to remote working.
10 Environmental, social and governance (ESG) and climate change focus gathers pace
Coronavirus has brought the “E” and “S” in ESG even more to the fore, as investors and the wider public focus, necessarily, on social, community and health issues. Air quality and other environmental indicators continue to improve during lockdowns across the world. However, it is difficult to see that focus doing anything other than increasing exponentially. As the initial pressure of the situation eases, investor focus will swing to the “G” in assessing how investment management firms’ governance reacted and adapted.
To continue the conversation about the challenges facing the investment management industry, contact David Morrey