2019 was a challenging year for the funds industry, with fund suspensions and a spike in client redemptions. Ed Lopez, Chief Revenue Officer, Calastone, reflects on what the year ahead may bring for the industry.
The active fund management industry has faced some serious challenges over the last 12 months. According to our most recent Fund Flow Index, inflows into equity funds were well below their average, coming in at just £1.3 billion or 1/5 of 2018’s total. Incidentally, had it not been for a strong rally in December, equity funds would have suffered from unprecedented net outflows last year. Similarly, property funds – owing to Brexit and the weak outlook in retail and commercial real estate – were also hit by client withdrawals totalling £2.2 billion.
In contrast, passive/index products have continued their ascendency and now account for every £3 of inflows for every £100 invested, while active funds shed £1.20. This comes amid growing impatience among investors about underperformance and high fees at active funds relative to passives. Data from ETFGI, a consultancy, indicates that ETFs have doubled in size in Europe over the last four years and now control more than $1 trillion.[1]
This year, the industry must focus on cost reduction if active funds are to remain competitive. There are several areas the industry will be looking at to help achieve a reduction in cost, from further automation, to more transformative innovations like tokenisation.
Transformation through tokenisation
Tokenisation was a topic that was discussed extensively at our events during 2019. Through digital tokens – which represent an underlying asset – ownership could be fractionalised or carved up into smaller and easily tradable denominations, potentially making it much cheaper for people to invest, while digitalising the end-to-end investment process.
Even though tokenisation is largely untested and unproven, it could play a pivotal role in revitalising active asset management. Moreover, a number of providers are already launching practical solutions aimed at supporting digital asset trading, including custody. Over the year I expect discussions to develop further around tokenisation. At Calastone we are actively investigating the concept and look forward to sharing with you further insights over the year. In a few weeks we plan to host a live webcast where we’ll be discussing the concept with several industry experts.
Time for the big techs to emerge?
The likelihood of ‘big techs’ entering the asset management space seems to become more real each year, as we have discussed in some of our recent articles. Their extensive levels of customer penetration and sprawling geographical footprints makes distribution a natural and lucrative fit. Such a move will have a disruptive impact on the funds ecosystem and given the scale of the opportunity, the perceived barriers to entry, such as regulation, may not be a deterrent.
We saw last year from our research into millennials that most would happily purchase an investment product from such a tech company. This could further incentivise some tech providers – who are already moving into financial services – to either build or buy a funds business.
We have already seen big techs encroaching directly into the investment space, particularly in Asia. It is perhaps only a matter of time before their Western counterparts do the same.
Fund operations in 2020
Concerns around inefficiencies in fund trading processes will continue throughout the year, but we believe money market funds will become a particular area of focus. Despite the strategic significance of the liquidity markets, some of the operational processes behind them continue to be rather weak. It is true that improvements have been made, including the introduction of electronic money market portals which display all the data needed by treasurers to make their investments, but these changes do not go far enough.
In particular, the reporting of cash holdings, positions, rates and accruals by money market funds is widely seen as being inconsistent, making it difficult for treasurers to effectively manage their positions. As reporting formats are interchangeable, treasurers are often forced to integrate their data sets through manual processing or spreadsheets. Calastone is looking to facilitate greater efficiencies in liquidity markets through our Money Markets Service, a fully integrated, digitalised solution that automates investment and reporting activities. We have already onboarded several new clients onto the service, and we expect that interest will continue to grow in 2020.
Another key area of inefficiency to be mindful of this year are asset transfers, which can often take weeks to complete within the current operating model. This can have a detrimental impact on the service offered to the end investor and through seamless, fully digital connectivity we can work to address this issue.
2020 in summary
2020 may see further pressure placed on the funds industry, and cost reduction will be central to navigating it. In the long term, tokenisation could be a solution. For now, there are a number of areas the industry must focus on to generate efficiency, such as money markets and asset transfers.
I very much look forward to working with you all over the coming year and please do not hesitate to get in touch if you have any questions.
[1] Financial Times (January 5, 2019) Passive investing boom reaches Europe as assets hit $1trn
