CREATE-Research |
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| July 2009 |
Welcome
Jervis Smith
Managing Director, Global Head of Client Executive,
Global Transaction Services, Citi
The past seven years have witnessed two of the four worst bear markets to have occurred in the past century. The last one wiped out $15 trillion in assets and destroyed 15 years of capital gains in the space of 18 months. What does that mean for the investment landscape going forward? How will it affect client attitudes and therefore the market dynamics of the asset management industry?
In this issue of Spotlight we report on a major study conducted by the consultancy CREATE-Research. The study, co-sponsored by Citi, surveyed 225 asset managers in 30 countries to assess how client behaviour is expected to change in the wake of the bear market – and how firms should respond. In particular, it looked at what would distinguish winners from losers over the coming years.
What is clear is that the prospect of business returning to normal is slim. There is a chance that the impact of big losses will combine with changing demographics to drive out a whole generation of clients, as has happened in Japan. That, however, need not happen if firms refocus on what they do best, work to understand what different client segments want and deliver it in a high-service environment.
Change is the only option
Amin Rajan,
Chief Executive Officer
CREATE-Research
The CREATE study surveyed a broad swathe of the global asset management industry, with respondents managing a combined $18.2 trillion in assets. Post-survey interviews also included 18 pension funds, wealth managers, distributors and industry regulators. Together they provided key insights into recent events and their future impact.
The study explores how the market dynamics of the fund business will change in the wake of the recent crisis and how its workplace will reshape.
One message stands out: once the worst of the current turmoil is over, there will be a flight to quality, simplicity and safety. Quality will be defined by consistent, risk-adjusted returns; simplicity by transparency and liquidity; and safety by capital protection. Mainstream asset classes will dominate. Clients' new mantra will be 'back to basics' – even though safety and liquidity imply low returns. Each client segment will have its own preoccupations:
- Defined benefit (DB) clients will be drawn towards indexed and global equities together with investment grade bonds – with a slant towards opportunism.
- Defined contribution (DC) clients in the English-speaking world will favour equities in some areas and refined target date funds in others. In Continental Europe, insurance contracts will continue to dominate.
- Retail clients will be drawn into products offering capital protection and tax efficiency, with periodic opportunistic forays into absolute return or cash products. As baby boomers head for retirement across the OECD, loss aversion will remain rife.
- High net worth clients will venture into active long-only space as well as alternatives, with a strong opportunistic slant in both cases.
How will these trends affect the asset management industry? There are three possible outcomes. One is that they will result in a commoditised industry where investment choices are largely driven by capital protection. The pace of commoditisation may accelerate in the event of regulatory overdrive. Just over a third of respondents subscribe to this view. However, many are not tooled up for products with low return, low risk, low volatility and high liquidity features.
Nearly half of respondents expect the industry to segment, resulting in a fragmented food chain and a focus on different client segments. Each segment will have a special theme: liability-driven investment in the DB space; advice in the DC space; capital protection in the retail space; and active management in the high net worth individual space.
The third possibility is the most vibrant. This envisages a revitalised industry in which the interests of clients and managers are aligned through value-for-money fee structures, products that are 'fit for purpose' and high quality service.
The implications of these findings are that, to succeed in the future, firms must tackle historic cost rigidities. A new, variable-cost model is emerging in which costs are linked directly to revenue via variable pay, slimmer product ranges and strategic outsourcing. On the cultural side, this is being reinforced by enhancements in senior management ranks and improved client service and incentive systems. On the structural side, it is reflected in increasing outsourcing.
The worst of the crisis may be over but it has triggered a chain reaction that will endure long after the markets recover. Worryingly, a majority of respondents expect at least one more systemic crisis in the coming decade. The message is that asset managers need a new narrative on what they stand for and what they can deliver in a world where trust in them has been shaken. That implies change in the way the industry is structured, the way it remunerates its people, the products it delivers and the way it services its clients.
Three winning steps
Jervis Smith
Managing Director, Global Head of Client Executive,
Global Transaction Services, Citi
While the future shape of the asset management industry is uncertain, subject as it is to different pressures, the CREATE study makes plain that there are three steps all firms can take to improve their chances of emerging as winners: they need to review their business model, streamline the product range to focus on what they do best and adopt a client-focused governance approach on charging, reporting, service and administration.
Review the business model
Any review of the business model must start with costs. The industry suffered a 35% fall in revenue last year. A further 15% drop is in prospect in 2009. A variable cost model is essential in providing a cushion against exceptional revenue falls. Yet only 13% of survey respondents say their costs vary 'to a large extent' with levels of activity.
The psychological barriers to a variable cost model are now crumbling. More firms are introducing variable pay structures and considering outsourcing elements of their front, middle and back office activities to create economies of scale. Some 37% of respondents have already outsourced the back office. The number is expected to double in the future. One in five firms has outsourced the middle office. Again, the number is expected to double.
The effect of this process is to create a distinct craft focus at the investment end, together with customised distribution and standardised administration. Actual and virtual boutiques are being created. These moves are important in blowing away entrenched processes that have long conspired against client interests and operating leverage alike.
Streamline the product base
The second step firms need to take is to streamline the product base. Increasingly, large firms are now recognising that they cannot be 'Jacks of all trades'. They are forced to make a choice between manufacturing and assembly. Already, 17% of respondents have outsourced manufacturing and their number is expected to quadruple. Assembly is emerging as a major competency in its own right, underpinned by external sub-advisory alliances, and a new supply chain is emerging in which fees have a low fixed but high variable component.
The pruning process is clearly underway. Two in five respondents say they have already cut products. In some firms, as many as 300 products have gone. Many firms recognise that product pruning has to have a strategic intent that clarifies what the core capabilities of the business are and how they can best be deployed.
Put clients at the centre
The third, and perhaps most vital, step is to raise the game on client engagement. The study clearly shows that tomorrow's winners will be those firms that put the client at the centre of all they do. In the past, the asset management industry has been too supply-driven. Firms have sold what they have in their range, not what clients have needed. That must change.
The industry needs a radical shift in governance and attitudes to align managers' interests with those of clients. In addition to a value-for-money fee structure, successful firms will have performance-based incentives and transparent compensation systems and execution costs.
They will offer products that deliver what is claimed for them. Respondents say that means investing in people talent, fundamental research, disciplined replicable processes to ensure deep insights into asset allocation, cross correlation and the trade-offs between risk, return, liquidity and volatility.
Above all, successful firms will offer service excellence. That means understanding client needs, giving accurate and timely information, providing periodic investment reviews and establishing internal panels to protect and further client interests. In short, the winners will be those firms capable of seeing the world through their clients' eyes.
