It was wonderful to see so many clients and friends in person at Fund Forum once again. Although life does appear to be slowly returning to normal, the funds industry is facing some tough headwinds ahead.
Challenging macro conditions – together with a difficult fundraising environment, fee compression, mounting competition from cheap passive providers and rising operating costs – are all creating problems for active asset managers. This is evidenced by EY analysis – which found a cohort of the largest asset managers saw their operating margins slip by 1.7% in 2020, with margins expected to shrink further from 31.6% in 2021 to 28.5% by 2025.
In response, the industry is looking for ways by which to rejuvenate itself. We heard a number of speakers at Fund Forum talk about how the industry’s fortunes could be transformed through changes to the existing fund distribution model and the emergence of new asset classes.
A new look distribution model is vital
A recurrent theme at Fund Forum was distribution. Already, the warning signs of disintermediation are there. Our recent white paper – “The Future of Fund Management” – highlights 78% of EMEA fund managers reported they had lost customers to digital competition in 2020, rising to 93% in APAC. This is only expected to increase and it became very clear at Fund Forum that asset managers need to commit more resources into improving their distribution and customer engagement activities.
So how can this be done? Speakers highlighted aggregating data on investor trends and buying patterns, and then using ML (machine learning) or AI (artificial intelligence) to gather useful insights from that information. Through this, manufacturers can tailor their distribution models according to bespoke client requirements.
At the same time, managers need to acknowledge that people’s buying habits have irrevocably changed. Our white paper notes this could result in managers increasingly incorporating D2C into their distribution strategies, while also offering more investment advisory-like services which have traditionally been the domain of wealth management. A number of experts at Fund Forum concur with our findings, noting that a growing chorus of managers are increasingly developing advisory solutions to complement their existing product range.
Crypto-currencies attract millennials, but they are not without risks
The timing of Fund Forum was fortuitous – coinciding with some spectacular price volatility in the $1.3 trillion crypto-currency market, fuelled by the collapse of two so-called StableCoins.
Simultaneously, a major institutional crypto-custodian sparked alarm in the same week following a filing it made to the SEC (Securities and Exchange Commission), in which it stated that crypto-assets held in its custody could be subject to bankruptcy proceedings, meaning customers might be treated as general unsecured creditors during an insolvency.
Although the crypto-custodian in question is purportedly not facing bankruptcy, traditional incumbents told Fund Forum that the company’s SEC filing reinforces how important it is for there to be greater oversight of this nascent marketplace.
While some of the more conservative institutions are eschewing crypto-currencies altogether, citing concerns about volatility; price opacity and regulatory risk, this is not true of younger retail investors.
One study notes that 56% of Generation Z adults and 54% of millennials are currently looking to include crypto-currencies and non-fungible tokens (NFTs) in their long-term retirement strategies. So how can the funds industry make itself more relevant to this audience?
These highly gamified (albeit risky) crypto-markets illustrate that people will invest in assets if the process is both straightforward and enjoyable, a feat which digital asset providers to their credit have enabled. This is a lesson, which should be onboarded by conventional fund distributors and managers.
Tokenisation could reshape investing
But digital assets do not comprise of just dicey crypto-currencies, however. We believe tokenisation is a type of digital asset that could be leveraged by fund managers to help grow their AuM share among younger investors, especially those who have less disposable income.
Tokens are highly flexible, and can be traded 24/7. As tokens can be broken down into smaller pieces, they are more accessible, and this can be applied to fund structures too. As fund structures comprised of tokens linked to underlying assets are divisible and fully digital, it will become cheaper and more efficient for retail allocators to invest – at least in comparison to a traditional mutual fund – in what could precipitate a potential increase in inflows. Tokenisation will also open up new investment channels – including digital exchanges and peer to peer networks – which could improve the overall fund buying experience too.
In addition to democratising investment and enabling allocators to access a wider range of asset types – including illiquids and exotics – operational savings could also be realised through tokenisation as a new, more streamlined, DLT-enabled fund servicing model is likely to emerge off the back of it.
So what does this mean for managers? It is clear that the existing fund structures could be challenged by the emergence of tokenisation. Those responsible for product manufacturing will therefore need to take into account the impact of tokenisation when creating funds if they are to be successful over the next few years. Tokenisation is certainly an opportunity that should not be missed, and it is something we are working on with a select few clients
ESG markets are popular but face scrutiny
Environmental, social, governance (ESG) has been a topic of conversation at Fund Forum for some time now. According to our Fund Flow Index, two thirds of the £1.58 billion in inflows which went into global funds in April 2022, was allocated into ESG funds.
It is clear that appetite for ESG investing will continue to grow in 2022 and beyond. Moreover, ESG is something which is close to millennials’ hearts, with many younger allocators investing into funds, whose values correspond with their own. ESG will be a key differentiator for fund managers if done correctly.
Although demonstrating a commitment to ESG has helped managers raise funds, experts have expressed concern that the asset class is potentially open to abuse. Outside of the EU, regulation of ESG investing is somewhat haphazard, while the abundance of ESG and sustainability standards has created enormous complexity, particularly when gathering and analysing data from underlying issuers. In turn, this has allowed green-washing to proliferate in funds.
Macro factors are also creating dilemmas for ESG funds. For starters, surging oil and gas prices have made it harder – from a fiduciary perspective at least – for some funds to expunge pollutant commodities from their portfolios. Speakers also highlight that managers should be thinking about investing into so-called ‘brown’ companies, namely polluting industries which are gradually greening themselves. Nonetheless, managers can sometimes find it difficult explaining their brown asset exposures – especially to retail clients.
However, one speaker notes ESG investing is undergoing an evolution and maturing. If confidence in the asset class is to be retained and greenwashing avoided, the speaker says managers must be wholly transparent with clients about their ESG strategies and objectives. ESG will ultimately form a vital part of fund managers’ manufacturing goals and capabilities moving forward.
At a crossroads
Asset managers are at a critical juncture, but the industry has reason to be optimistic. Despite many fund managers previously deriding millennials and Generation Z’ers as being short on cash and long on financial illiteracy, young people are starting to invest. Moreover, a number of younger investors are also likely to benefit from an unprecedented wealth transfer from older generations, and this money will need to be invested if people are to properly insulate themselves against looming inflationary risk.
Through digitalisation and adoption of innovative technologies such as tokens – together with a thoughtful approach towards ESG – investment managers will be able to target a wider demographic. This will be critical in helping managers future proof their businesses moving forward.