Fund managers in the City are bracing themselves for a tough 2019, writes Matt Long, a capital markets specialist at Accenture.
Turbulent market conditions indicate choppier waters are ahead as European markets await certainty on the outcome of the UK’s relationship with the European Union, economic growth continues to slow in China, and US economic forecasts are more pessimistic than expected. But should buy side firms be worried when they have cruised on profits so far? Are they well stocked to weather a storm?
Globally, capital market looks like an industry in strong health – at least on the surface.
Thanks to the longest historical bull market, the industry topped $1 trillion in annual revenue and more than $100 billion in economic profit in 2018. Buy-side firms were the jewels in the industry’s crown, having registered 10 to 15 cents per dollar of revenue as economic profit on average.
But change has already started to bite.
In Europe, firms have surpassed one year of implementing regulatory changes from MiFID II. This year, we expect research revenues to continue to decline, loss of headcount and more consolidation in the market to come. And while a market downturn will put pressure on profits, it’s when you look under the bonnet of firms and their operations that you see healthy profits disguise a precarious lifespan for the industry.
The real tremors are not those posed by economic volatility or regulatory changes – the biggest threat to asset managers is themselves.
Organisational complexity represents a massive cost for the industry.
For example, investment banks, corporate banks, asset managers and wealth managers spend more than $100 billion a year just reconciling their differing views on the same underlying trade and holdings information. In particular, asset managers dedicate only half their cost base to support their core function of manufacturing and distributing investment products. The other half is consumed by asset servicing, compliance and trade execution.
Inefficient industry structures have built up over decades, and firms are not fast enough to challenge the status quo. When growth was the priority, quick responses were required, and scalability was often only an afterthought.
Asset managers seem to defy economic logic. While structurally these firms in the capital markets industry should be a scale game, in practice they are not. Our recent research, ‘Capital markets vision 2022’, found that even the biggest asset managers create the same economic profit margin as some of their mid-sized peers.
But what do we predict for 2019? In the short term, a market downturn will put pressure on asset managers profits, and many may use this as an opportunity to take both a more tactical and strategic look at their cost bases as they seek to trim fat.
Asset managers are not just victims of market volatility. There is a silent killer in the wings – that of digital disruption, which will contribute to fee pressure dominating in the coming years, with fee contraction to likely offset – or even overcompensate – future growth in assets under management. Buy-side players should prepare for a squeeze scenario in which volume will likely grow but margins will continue to shrink. The only question is by how much.
Technology is not a threat, as much as it is an opportunity. Artificial intelligence will bring a high degree of automation to the corporate deal-making process, as well as to investment research and risk analysis.
But it’s not just transactional business changes asset managers need to prepare for. Firms would be wise to focus not only on how AI will make those areas more robust at what they already do, but also on how AI will open up avenues for understanding how new data can supply new services, and better serve their customers – particularly a generation of customers who will prioritise experience over returns.
AI should be used to develop the next generation of client relationships. It enables firms to better understand and serve their customers, fit for the 21st century.
Running an asset management business is all about data, analytics and fact-based insight. This is the modern bedrock of winning trades and portfolios. But it is not how most firms are being developed strategically.
Beliefs—and sometimes myths—have endured as cost bases, and their contributions generally remain a mystery.
All this could be sustainable if the years ahead promised a continuation of the competitive and regulatory environment of the past. But the era of quantitative easing and negligible interest rates are ending.
Asset managers will need to truly industrialize their businesses and capture scale opportunities going forward to remain successful.
The objective for fund managers is not to stabilize and return to the pre-financial crisis era – but to return to profits and operate for an industry that will be complexly transformed by 2022.
Matt Long is head of capital markets for Europe at Accenture
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