The world has seen unprecedented disruption from technology in many sectors, as major trends such as Cloud Computing, Big Data and Internet of Things converge to what some say is the fourth industrial revolution. Therefore, we are living in really interesting times as the change seems to accelerate.
Fourth industrialization impacts asset management
Now this trend is also reaching asset management. The Finance sector, in particular the asset management industry, has broadly been slow to adapt this change. The industry has enjoyed comfortable margins for many years and has therefore not been forced to optimize its processes. Operating margins in the asset management industry have been in the thirties for the last years. On top of that, running an asset manager requires very little capital since employees are the key assets and capital expenditures can be low (basically offices and IT equipment). Consequently, the return on invested capital is high. No wonder that we have seen many players from banks over insurers to new boutiques entering the space offering products to clients. This lead to a situation where for example in Europe there exist more equity funds than listed stocks. The industry is furthermore very fragmented with no player having more than a ten percent global market share in terms of assets managed.
When technology hits, the change can be rapid
However, we have seen technology already making inroads into asset management with examples such as Exchange Traded Funds (ETFs) using technology to easily replicate indices or the rise of the Internet triggering transparency on products, performance and styles. In our view, the industry is just about to see now the full impact of technological change. Despite rising equity and bond markets over the last couple of years, fees already came under pressure, and we see even zero fee funds being offered as core products commoditize. In 2016, all net inflows into US based equity funds went into passive on the expense of active managers, and the trend has continued in the first half of 2017 despite equity markets on a run. In Europe, the trend to passive investments has started later and is less advanced. Roughly 15 % of the net inflows in the first half of 2017 and half of all equity net inflows went into ETFs. In Europe, roughly 6 % of all assets in the mutual fund industry are invested in ETFs, well below the level in the US. In the US, over the last ten years more than US-$ 1 trillion changed from being invested actively in equities to being passively invested. Especially Vanguard as specialist for passive investing is profiting from this trend but also ishares, the division of Blackrock, the world largest asset manager.
This trend is hitting margins and we are seeing active managers cutting fees. Given the speed of change, the industry needs to find new efficiencies fast. That is why we finally see the industrialization of asset management coming.
Blockchain technology on the front door
In the search for efficiencies, new technologies such as Blockchain could be interesting. Isn't it an anachronism that we can deliver milk in one hour but shares settle three days later? While the technology is still nascent the potential is enormous. In theory, shares may be immediately settled once the transaction is initiated. Reconciling transactions, checking cash status or the identity of the buyer are all examples of applications which will be normal one day on the Blockchain.
However, in the short run there are many more inefficiencies in a still very paper based industry which can be addressed. Other industries such as retail have optimized their processes for years by using a modular approach. We expect this to be on the forefront of industry efforts in the coming years versus Blockchain technology to be more a longer term project.
Are the tech giants taking over?
Are the Alphabets and Amazons about to take over in asset management like they did in advertising or retail? We believe that this is a potential longer term threat if the industry does not act and modernizes itself. However, in the short term those tech giants have easier targets given that the finance industry is highly regulated and requires an approach which varies by country.
Some think that Uberization stands for tech companies replacing banks and asset managers. In our view, Uber stands though for the 'gig' economy, for a highly efficient, mostly outsourced operation that uses the latest technology and increases the efficiency of underutilized assets. Netflix or Apple demonstrated what ease of use means, Tesla shows that your product feels fresher if your car comes with a regular software update. Hence, the Uber Moment of Asset Management will create an avalanche of new, easy to handle tools and new players who are betting on this technology are likely to gain share.
Death for funds?
The technological change will allow to create fully personalized products. This bears the question if those products are still be funds or other customized vehicles to save money.
This is only one example of how drastic the asset management industry is about to change. The new efficiencies to be found will likely be good news for the investors as saving money becomes cheaper in this process. However, very similar to other industries a massive change will end the state of deep slumber asset managers have been in.
The world has seen unprecedented disruption from technology in many sectors, as major trends such as Cloud Computing, Big Data and Internet of Things converge to what some say is the fourth industrial revolution. Now this trend is reaching asset management.
Our predictions for asset management in this new world are:
The Finance sector, in particular the asset management industry, has broadly been slow to adapt this change. One reason for this is that the sector is quite conservative but it is also in our view due to financial regulation actually protecting the incumbents.
Technology had already an impact
However, we have seen technology making inroads into asset management. Let us list three examples:
Zero fee funds coming?
In our view, the industry is just about to see the full impact of technological change. Despite rising markets over the last couple of years, fees already came under pressure. This likely has been only the early inning as they say in baseball, and we may see even zero fee funds being offered. Commoditized offerings simply cannot be differentiated by definition and the price approaches the cost.
According to Morningstar 70 % of all net flows in equities went into passive products in 2015, hence this trend is affecting the whole industry. Passive funds have typically lower fees than actively managed funds and reached already a 40 % market share in the US fund market for equities.
Industrialization next stop
Where is threat, there is also opportunity for agile players. The industry is mostly still not using the latest technology, has not cut all the processes into modules and automatized them as the manufacturing sector did many, many years ago.
Here, new technologies such as Blockchain could be helpful. While the concept may be close to its peak in terms of the Gartner hype cycle, we see a lot of areas where the technology can be applied. Isn't it an anachronism that we can deliver milk in one hour but shares settle three days later?
Will the Alphabets and Amazons take over?
We do not think so as those companies have other, easier targets first. Finance is highly regulated and complex, and you need domain expertise to be successful. However, the asset management industry could profit from implementing the customer centric obsession tech companies demonstrate. Where is the Amazon type recommendation engine for financial products?
Some think that Uberization stands for tech companies replacing banks and asset managers. Yes, firms such as Alibaba have demonstrated their ability to raise $ 100 bn quickly via using their platform. Uber stands though for the 'gig' economy, for a highly efficient, mostly outsourced operation that uses the latest technology and increases the efficiency of underutilized assets. Netflix or Apple demonstrated what ease of use means, Tesla shows that your product feels fresher if you car comes with a regular software update. Hence, the Uber Moment of Asset Management will create an avalanche of new, easy to handle tools and new players who are betting on this technology are likely to gain share.
They did not believe it in the taxi and hotel industry before it was too late. Be warned it may happen also in asset management!
There are many more themes we could address here but leave them for a later blog post (please visit www.hcp.ch). For those in Switzerland, please feel free to attend my presentation at the CFA events in Zurich and Geneva this week.
Bolko Hohaus, CFA; HCP Hohaus Advisory
HCP Hohaus Advisory is a company based in Switzerland focussing on state of the art, innovative asset management solutions.