What are the biggest challenges and opportunities in the investment management industry this year? David Morrey looks at seven key themes for investment managers to consider.

As investment management firms prepare their strategies for the rest of the year, the focus remains on maintaining sustainable investment and consolidation measures in a volatile market and handling margin pressures. Managers must also navigate the continued investment in digital transformation, with new tools at hand to improve the user experience and provide operational efficiencies within a firm. Creating a shared sense of purpose around these new models will be key to meeting compliance and handling macroeconomic impacts across the industry.

We've identified seven key areas for investment management firms to consider this year. 

1 Macroeconomic environment

The Bank of England base rate increased to 4.25% on 23 March which, although high, isn't as extreme as many market commentators were expecting. However, ongoing uncertainty around geo-political conflicts – and subsequent pressure on energy supplies – combined with post-pandemic supply chain issues are driving inflation and the cost-of-living crisis. These factors have had a particularly strong impact on the UK.  

For investment managers, the macroeconomic environment will naturally affect market confidence, with a drop in value for many client portfolios. Managers that, in hindsight, make the right investment calls will be those who can pull in new money from investors, and protect and grow existing client portfolios. Every change in investment conditions produces new winners and losers in the investment management marketplace, and this coming year will likely be no different.

2 Consolidation

The high degree of market consolidation in the investment management sector continues. This is being driven by margin pressures, large banks looking to refresh their investment management business and private equity investors buying into the sector. The pace of deals is slowing somewhat, as buyers reassess the long-term outlook for the sector, but we don’t predict any break in the trend to consolidate.

Aside from the globally significant players, and the truly boutique, niche houses chasing specialist alpha, all other investment management houses are subject to potential consolidation activity. Some managers are trying to grow their way out of the consolidation trap by pursuing a vertical integration model, adding other parts of the investment distribution chain to their groups as a way of gaining a greater share of value.

Mergers are never easy, and it’s essential to create post-merger synergies that unlock cost savings, build greater profits and realise growth opportunities. These factors are at the heart of most deals. The better deals also include a focus on improving the customer experience, bearing in mind the new Consumer Duty rules.

3 Sustainable investing

Environmental, social and governance (ESG) concerns remain prominent, with hard rules starting to emerge that managers will need to comply with, such as the UK sustainability disclosure requirements. The risk of greenwashing will feature in almost every manager’s key risk analysis. Managers are consequently working hard to ensure they have the controls to deliver on their goals and claims around sustainable investment. That means many managers are also having to invest in better ESG data and processes in order to monitor their own performance.

The approach to sustainable investing is also evolving, with increasingly focused investment strategies and themes. These often support the transition to Net Zero, which can mean investing in emerging technologies where the investment return is inherently less predictable. Delivering these investment strategies requires different skill sets from those targeting more established businesses, and this is becoming evident in many managers’ hiring practices.

FCA consults on sustainability disclosure requirements
FCA consults on sustainability disclosure requirements
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4 Consumer Duty

Consumer Duty comes into effect this year, introducing a new overarching principle to deliver good outcomes (and avoid foreseeable harms) for consumers. It also includes three cross-cutting rules that sit across all processes, behaviours and products. For investment managers, one of the biggest challenges is working out what’s in scope, and how the rules apply to depend on their role as a distributor or manufacturer. The regulation brings new expectations for fair value pricing, ongoing support for consumers, and a greater focus on marketing and consumer understanding. The new rules require greater oversight and accountability at all contact points throughout the customer journey.

While the rules build on existing conduct expectations, they affect all areas of the business from product design to third-party relationships through to ongoing client maintenance and aftercare. This makes it an inherently complex piece of regulation to implement and to adequately demonstrate compliance – even for managers with sophisticated and mature approaches to managing conduct risk.

5 Cryptoassets

While greater crypto regulation has been in the works for some time, the pace is still slow. As a high-risk asset, crypto has remained outside the investment universe for most mainstream managers, with events such as last year’s collapse of the FTX exchange further highlighting the ‘Wild West’ nature of this emerging field.

That said, the Treasury’s recent consultation paper is charting the way forward and intends to give stablecoin assets (in the UK at least) a similar regulatory regime and protections to more traditional asset classes. With similar regimes emerging in other leading economies, cryptoassets will soon become a plausible investment class and managers should be thinking about how and when they will start to develop their business models to accommodate it.

6 Regulatory change and the Edinburgh Reforms

On paper, deregulation is gathering steam in the UK, with the Retained EU Law (REUL) bill and the Edinburgh Reforms. REUL is proving controversial, however, and there are significant doubts that the FCA, PRA and HM Treasury collectively have the resources to deliver it any time soon.

The Edinburgh Reforms are also controversial, with proposals to water down ringfencing and the Senior Managers and Certification Regimes, both generally accepted as part of the furniture of the UK regulatory environment. At this point, fewer than half of the proposed changes are supported with any detail. But the list of planned reforms includes changes to the Securitisation Regulation, repeal of the (semi-defunct) European Long-Term Investment Fund (ELTIF) regulation, a new regime to regulate short selling, replacement of the packaged retail and insurance-based investment products (PRIIPs) regulation and further updates to the Markets in Financial Instruments Directive (MiFID) framework, likely focused on current rules on research unbundling.

In February 2023 the FCA also issued DP23/2: Updating and improving the UK regime for asset management. This provides an interesting case study of potential significant divergence for UK firms from existing EU regulation, as it discusses potentially fundamental changes to the Undertakings for the Collective Investment in Transferable Securities (UCITS) regime.

Collectively, these regulatory changes aim to keep the City competitive and draw investment to the UK. In practice, they mean significant, ongoing regulatory change over the next 10 years. This will be expensive to implement and potentially resource-heavy. Controlling costs while continuing to maintain regulatory compliance will be key to maintaining good margins as the changes take effect.

Man conducting an agile meeting with co-workers.
Edinburgh Reforms – key announcements
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7 Technology: blockchain and AI

So far, blockchain has had a relatively limited impact on the investment management industry. Although 2023 is unlikely to be the year investment managers collectively embrace the technology, we do expect some meaningful steps forward in the use of blockchain.

One of the most affected areas could be the settlement and holding of assets, where blockchain could create major cost savings. Blockchain could, and should, allow instantaneous settlement, with in-specie transfers completed at the touch of a button. This would redefine the role of transfer agents and investment platforms. This would bring significant business model disruption, however, which may be why firms have been slow to adopt it and may continue to be.

Blockchain is likely to have a more immediate impact on asset classes that are currently the least electronic, such as real estate and private assets. If those asset classes can be tokenised, it will have a substantial impact on how they are held and traded.

The use of artificial intelligence (AI) in the investment management sector may also have a greater impact this year. A number of market participants are investing heavily, or have plans to invest, in ‘hybrid’ investment advice models. These combine personalised human interactions with automated, data-driven inputs. The hybrid approach will enable the efficient delivery of hyper-personalised interactions throughout the client life cycle, including ongoing suitability, portfolio rebalancing and management of significant life events. This will provide a more sophisticated product than some of the earlier ‘robo advice’ propositions.

Similarly, the middle and back-office use cases for AI are becoming more compelling. Using AI for market abuse surveillance, portfolio risk management, conduct risk management and data reporting (both internally and externally for regulators) can improve efficiency and cut costs.

All of the above is predicated on firms allocating capital towards technology innovation projects. As such, the economic environment and margin pressure may make those investment allocation decisions less clear-cut and affect the direction of travel for investment managers in the year ahead.

For more information on investment management challenges, contact David Morrey.


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