Many Asset Managers Stick to Outdated Models Despite Being Active

Asset managers are either optimistic (Coalition Greenwich) or complacent (Northern Trust) about the future of active funds.

That’s a conclusion from a recent report, “The Evolving Asset Management Landscape: Only the Fittest Will Thrive,” which was published by Coalition Greenwich, on behalf of Northern Trust.

The analyst firm’s level of concern is not widely shared across the asset management industry.

“The senior investment management professionals involved in this research have an appreciation of the depth of current and future challenges, yet many take the view that they will remain on their current path: looking to make improvements in areas such as technology and operations, but not implement larger scale redesigns,” the report says.

“I am very concerned and that is one reason we’ve published this paper,” said Grant Johnsey, head of client solutions at Northern Trust. He said the number of active manager firms could contract.

“I do not believe that’s a foregone conclusion. But it is a strong concern of mine and is one of the reasons that we worked with Greenwich to understand their growth initiatives and the forward looking thinking of traditional asset of managers,” he said. “Active, long-only strategies remain an important component in our clients’ investment mix. Information from this research can help guide our continued development of outsourced trading, investment operations outsourcing, foreign exchange and other solutions integrating the whole office to support the business environment of tomorrow for asset managers.”

The confidence asset managers have in their existing operating models may be misguided, the consultancy suggests.

“Three of the top four asset manager priorities are centered on growth, either through the launching of new products and investment strategies or battling for market share in existing strategies. Increasing AUM via improved sales, new products or growth in existing products will be managed alongside the other top strategic priority: cost-cutting,” said the report.

Gerard Walsh, global head of capital markets client solution at Northern Trust cautioned that this could be difficult.

“Managers plan to deploy new technology and implement more cost-effective operational approaches, which can be difficult to do in a contracting market,” he said in the bank’s announcement of the study.

Both analysts at Coalition Greenwich and executives at Northern Trust expressed concerns about the investment industry’s lack of urgency.

“The investment industry will continue to rapidly change even if the tumult decreases. Yet, according to our research, some asset managers are comfortable with their existing platform, despite concerns that it is perhaps not optimized for the future,” said the report. The strategies of 2025 will not succeed if they are run on platforms designed for the environment of 2018.”

Johnsey said he was surprised at the low level of concern about the threats active managers face from direct and indirect competition. He noted that that 84% of respondents are planning on organic growth.

“Without making a specific prediction, we think the pressures on traditional, long-only asset managers could lead to contraction in both number of firms, through consolidation or closures, and assets under management net of market movement. A number of long-only specialists are successfully adopting to the changing market and demographics. However, responses to our survey indicate that many asset managers are not evolving fast enough.”

He is concerned about the lack of concern shown by asset managers who responded to the survey. When asked about direct and indirect competition, the responses were low, he said. That surprised him because a lot of equity investment has already moved to passive funds; now he sees a growing threat from the private equity market.

Stephen Bruel, a senior analyst on the market structure & technology team at Coalition Greenwich, said that since 2020 the pandemic, rate volatility and geo-political conflicts took up a lot of mind share. Asset managers were putting out fires for several years, but now is the time they need to re-examine their operating model.

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“Our research indicates that there is a gap between how firms ought to be preparing and the actual level of preparation,” he wrote. “Significant changes are coming, and these changes should create a sense of urgency within the asset management community.”

But urgency isn’t happening.

“Managers appear ready to double down on existing strategies and don’t plan changes to address performance concerns,” the report says.

Asset managers need a strong alignment between their operating and technology, strategic growth plans and their investment philosophy, Bruel said. If managers are shifting their strategy and offering new products without a redesign of their operating model, that can be a challenge, he added.

“Moving into a complex security like bank loans requires an entirely different mid-office than treasuries, gilts and equities. To raise funds you need a good diversity of different products, but you also need the operating model to support it. The middle and back office should never be a hindrance to the front office.”

Outsourcing some activities can be one solution. It is hitting its stride at different levels in different parts of the investment process, Bruel added. Custody and fund accounting have a pretty well worn path to outsourcing.

“FX outsourcing, collateral management, trade execution, all are at different levels of maturity, but the interest at each of those stages is increasing because outsourcing has become an important tool to help manage the changing economics of the business. You might keep equities in-house and outsource FX,” he said. “Some firms believe their traders add differentiated value for equities, but maybe not for FX, so you need a flexible partner.”

Johnsey at Northern Trust, said the factor most likely to increase outsourcing is the cost to maintain a firm’s current platform, with 40% of respondents stating these costs increase the likelihood they would outsource.

Coalition Greenwich says managers should take a comprehensive look at costs, including implicit costs such as how execution quality could be improved if it were outsourced and if that would also reduce risk through improved settlement rates. Sophisticated asset owners want to see risk mitigation strategies across different areas, including how to prevent losses from failed trades, Bruel said.

Johnsey divides the outsourcing decision into two buckets.

On the defensive side, cost savings is a clear catalyst.

Playing offense, an asset manager might use outsourcing to invest in internal operations.

“If performance is the number one challenge, outsourcing allows them to deploy assets into analysts and added research. We see firms look across the industry and say clients are paying us for portfolio construction so let’s focus on that rather then on the middle and back office. From an offensive standpoint that lets firms be more nimble and achieve better risk return.”

Hi Tom,

If not too late, here is Grant’s response:

“Without making a specific prediction, we think the pressures on traditional, long-only asset managers could lead to contraction in both number of firms, through consolidation or closures, and assets under management net of market movement. A number of long-only specialists are successfully adopting to the changing market and demographics. However, responses to our survey indicate that many asset managers are not evolving fast enough.”