The active asset management industry received a surprise in August 2018 when Fidelity threw down the gauntlet and confirmed it would launch the first ever zero cost passive product. While passive funds have always operated on significantly lower expense ratios than active managers, Fidelity’s announcement was worrying for an industry which has found itself under regulatory and investor pressure over fees and performance.
As investor and regulatory scrutiny of active asset management deepens, it is becoming likelier that disruptors – such as cheap passive providers, robo-advisors and big tech companies – could step in and fill the return vacuum by delivering more cost effective solutions to end investors, a hypothesis which has been supported by Calastone research.
In our white paper – “The Impact of Technology and Regulation on Funds” – we found that industry participants believed technology companies such as Google and Microsoft were the most likely to disrupt their businesses. Meanwhile, online retailers – including Amazon and Alibaba – followed. (1) Investors are already turning their backs on active management in search for lower cost alternatives. Morningstar, for example, reports active managers in the US saw $8.4 billion of outflows in May 2018 in contrast to passive products, which accumulated $29.1 billion of inflows. (2)
Lessons learned at ALFI
I attended the ALFI (Association of the Luxembourg Fund Industry) Global Distribution Conference in Luxembourg in September, and it was reassuring to see the industry has recognised these challenges and the long-term threats they pose to their operating models. I was also encouraged to hear that asset managers are not simply brainstorming ideas to fix these existential problems but are in the process of implementing tangible solutions and effective strategies as they aim to attract new clients and avoid disintermediation.
One of the most striking panels of the conference featured Kate Webber, Head of Product at Calastone, which provided an articulate, fresh and forward-thinking summation about what asset managers need to do as they deal with a multitude of different tailwinds, primarily their climbing operational and regulatory spend. It also discussed the steps managers ought to take to effectively reach out to younger investors, a demographic which many believe has been overlooked by the industry.
Converting new investors
The traditional investor base, which has been a reliable source of capital for decades at asset managers, is changing and irrevocably so. Kate told the audience that asset managers were increasingly gravitating towards emerging markets whose middle classes are growing sharply and need investment solutions. She also said women are investing more than previous generations as they have acquired much greater financial independence. This is backed up by HMRC data, which found women invested on average £9,853 into stocks and share ISAs during the 2014/15 tax year, which is £300 more than men. (3)
Equally important are millennials, a generation in line to receive a cash windfall as they inherit their parents’ wealth and benefit from potential income growth. (4)Millennials account for 27% of the world’s population, and hold around $17 trillion of all global wealth, but this could reach $24 trillion by 2020. (5) Despite millennial’s looming inheritance dividend, Kate acknowledged the size of the wealth transfer could be offset by a legacy of stagnant wages, growing healthcare costs and rising house prices. This, she argued, would mean younger investors are likely to write smaller ticket sizes to asset managers than their parents.
Asset managers seize the day
Asset managers are responding to these changing dynamics by peppering their strategies with Environment, Social and Governance (ESG) criteria to accommodate younger people’s entrenched beliefs in sustainability and supporting positive causes, a point made by Alexandre Gerbaud, institutional ETF sales at Lyxor Asset Management. Another panellist said a handful of asset managers are trying to lure younger, tech-savvy clients by sidestepping conventional financial instruments and investing instead into tokenised assets, initial coin offerings (ICOs) and cryptocurrencies as a means to generate tantalisingly high yields.
Beyond these strategic approaches, it was satisfying to hear at the conference that many asset managers are trying to install basic efficiencies into their legacy transactional and operational processes to make it easier and cheaper for investors to purchase fund units. Calastone is playing a leading role supporting this change through our distributed market infrastructure, a DLT enabled digital distribution chain, which we estimate could reduce frictional transactional costs at mutual funds by around £1.9 billion.(6)
A reduction in distribution costs will benefit millennials in particular, as they are likely to invest smaller sums of capital across managers. By scaling down distribution charges, net returns may ultimately increase for clients. Digitalising distribution, automating trading and settlement, and then integrating these processes fully with front end investor channels will help the industry deliver a more seamless and lower cost end-to-end customer experience, allowing asset managers to evolve in parallel with technological change. As ordinary consumers increasingly use smart devices in everyday life – including fund investing – a digital distribution infrastructure will make buying and selling funds more efficient, which could lead to further inflows.
A bullish future lies ahead
Actions speak louder than words and for the last five years, the funds world has conversed extensively about reform and embracing new technologies. I was impressed that attendees at ALFI appear to be making genuine progress and it is comforting to see that so many managers are now implementing and executing programmes, which will help firms attract a wider pool of investors and generate business efficiencies, helping them to better compete with new challengers.
- Calastone – The Impact of Technology and Regulation on Funds
- City Wire (June 27, 2018) Passive flows still dominate but there is a caveat
- Money Observer (July 23, 2018) Young females are investing more than ever before
- Deloitte – Millennials and wealth management: Trends and challenges of the new clientele
- Deloitte – Millennials and wealth management: Trends and challenges of the new clientele
- Calastone (March 6, 2018) Preparing for digital fund distribution: how Blockchain can save billions for the funds’ industry
