Fund management: Asset managers advised to adopt both defensive and aggressive strategies

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 20, 2019 - May 26, 2019.
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The global asset management industry has reached a critical juncture due to a combination of external factors, like market volatility, and industry-specific issues such as ongoing pressure on margins and fees. To stay ahead and come out on top, fund management firms should adopt a two-pronged approach — defending the firm’s franchise and taking aggressive steps to move forward — says Boston Consulting Group (BCG).

In a recent report, titled How Asset Managers Can Win in a Winner-Takes-All World, the management consulting firm indicates that three key defensive strategies that can help firms shore up performance and ensure that they operate efficiently are focusing intently on cost, reviewing portfolios and optimising pricing.

Paying more attention to cost allows asset managers to combat margin pressure and free up investment capacity. “Most managers already focus on reducing the workforce and adjusting bonuses. However, a more structured approach may be required in tougher times. One powerful tool is zero-based budgeting, which can generate significant savings, create transparency around the cost base and help foster a culture of cost consciousness,” says the report.

Asset managers can apply technologies such as automation and artificial intelligence to drive down costs and can pay down the technology debt accumulated by legacy IT infrastructure. However, investments in structural change may be hard to justify in a downturn.

“One way is to consider outsourcing and offshoring middle- and back-office functions. Such moves can reduce costs, allow for greater scale and bring about tangential benefits such as enhanced capabilities. We estimate that a firm with assets under management (AUM) of US$100 billion can save 15% to 20% of total costs through such initiatives — a US$16 billion to US$21 billion opportunity across the industry,” says the report.

Asset managers also need to adopt an investor mindset and ruthlessly assess the value of existing positions and be decisive about cutting losses. The report proposes three focus areas — presence, projects and products.

Presence calls for exiting or consolidating underperforming and non-strategic markets and client segments. In terms of projects, leaders can review key ones across the organisation and drastically reprioritise them to focus on only the most critical and strategically aligned. Finally, fund products that no longer meet profitability expectations or offer no strategic value should be closed.

“This portfolio approach should be reviewed regularly to ensure that capital allocation is aligned with strategy and that the firm is striking an appropriate balance between leveraging its core strengths and placing strategic bets in adjacencies or new frontiers,” says the report.

On price optimisation, firms should use a strategic approach by equipping themselves with analytics, rather than adopting tactical cuts, says the report. This allows for continuous analysis of price elasticity and customer behaviour.

“In particular, firms should identify key gaps in pricing by channel and market relative to their competitors. Pricing-efficiency programmes are also useful for identifying ‘stickiness of money’ and repricing selected products, mandates and funds. The key is to standardise and industrialise to facilitate closer monitoring,” says the report.

“In general, we have observed that only a select few products — channel-market combinations, for example — are able to support sustained differentiated pricing. Everything else is in a race to zero. The onus is on the asset manager to identify and act on these combinations so that it picks its battles on the most favourable grounds.”

On the other hand, aggressive strategies can provide highly effective defence, hence taking proactive and aggressive steps can be “the key to unlocking value, particularly in a challenging macroeconomic environment”. The report highlights three keys to call for strategic action — combat client attrition, invest in data and analytics, and consider mergers and acquisitions (M&A).

Client attrition can be combated by using firms’ volumes of data and faster, more powerful algorithms as these can generate deeper insights into client value and behaviour. This helps with the development of a more tailored proposition on a “segment-of-one basis”, thus allowing firms to spot signs that a client may be considering a withdrawal of funds and focus on optimising their responses.

Data analytics is becoming an essential driver of operational efficiency, smarter decision-making and better customer service. Firms risk being left behind if they do not invest in these areas.

Customer interfaces that are attractive and accessible can increase engagement while digital tools can help customers review their portfolios, access research and analyse their decisions.

“Internally, data analytics can supplement decision-making through, for example, strategies that are based on real-time sentiment analysis. In distribution and marketing, it can help advisers understand customers better so that they can offer products on the basis of individual needs,” says the report.

Leaders should give serious consideration to their desired business models and, thus, consider M&A. According to the report, “the aims should be to exploit points of difference with competitors and to align operations and activities in a unique proposition. In short, firms need to be crystal clear on where they will play and how they will win”.

When carefully prepared and well executed, consolidation is one high-impact option, says the report. Potential benefits include a broader product offering, new business lines, greater scale, cost efficiencies, enhanced distribution power and access to new locations. “At the same time, as part of the broad portfolio strategy, firms should look for opportunities to place select strategic bets focused on obtaining new capabilities, securing fresh talent and capitalising on enhanced technology.”

According to a BCG analysis, large and small firms perform relatively better from a cost perspective than those squeezed in the middle. “For example, firms with US$100 billion to US$250 billion in AUM post average costs of 17 basis points (bps) of total AUM while those with assets exceeding US$750 billion incur an average cost of 12bps. Firms in the US$250 billion to US$500 billion range, however, incur an average cost of 19bps — more than either their larger or smaller peers,” says the report.

“As margins and fees continue to be squeezed, firms that operate at scale will likely have greater freedom to make game-changing decisions. However, that does not exempt smaller firms, which must also be willing to focus on where they play strongest and to allocate sufficient capital to compete.”

Firms considering M&A, particularly those in the squeezed middle, should draft a wish list and monitor valuations and competitors’ balance-sheet positions. They may also create an M&A playbook, setting out funding plans for different scenarios, says the report.

Earlier this year, economists were predicting slower global growth going into 2020, with the length and depth of the slowdown likely to be a key determinant of the performance of underlying markets. “Uncertainty in the macroeconomic environment means there is a fairly wide distribution of potential outcomes in terms of margins and AUM growth for asset managers. We see two main scenarios.

“One, there is a return to AUM growth and profit margins as a percentage of net revenues will fall from the 36% at end-2018 to 28% to 33% in 2023. Two, a market correction sets in and the recovery is slow. In this case, margins could drop to 25% to 28% by 2023.”