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Tech Disruption on the Horizon: Asset Management in Asia

Aamod Gokhale

Managing Principal, Financial Services, EPAM
Blog
  • Financial Services

By any standards, the asset management sector has generally been one of the most profitable businesses globally for many decades, and Asia has been the best performing region, registering nearly double digit CAGR in assets under management (AUM) since at least 2008. It is easy to be complacent, confident in the projections of continued growth to the doubling of AUM in the next five years. And yet, that is exactly what the industry can least afford to do, for many trends that have recently taken the wind out of the sails of asset managers in the US and Europe are visible and quickly gaining strength in Asia. 

Disruption on the Horizon

The biggest of these forces is the move to passive strategies, such as ETFs. The number-one strategy by net funds inflows in 2018 in Asia Pacific was passive equity. ETFs are already growing far faster than mutual funds in Asia and the pace is only increasing: China, Korea, Taiwan and India had total inflows into ETFs of $24.2 billion in the first half of 2018, compared to $8.1 billion for the whole of 2017. Demand from customers for lower fees, and from online DIY robo advisors, as well as robo-enabled advisory services launched by banks, is going to continue in the coming years.

In the past, AUM growth had a direct correlation to revenue, profits and fund manager bonuses. It didn’t matter whether the flows were into equity or bond or through which channel. Fund flows into ETFs break that correlation because of significantly lower fees and high dependence on technology.

This is disruptive for two reasons:

  1. Traditional asset managers have built up a high cost base that requires high fees as a percentage of AUM.
    Already, the cost/AUM is actually much higher in Asia compared to the US and Europe. So, if the revenue suddenly slows down considerably because of the rock bottom fees, margins get squeezed sharply and suddenly as the cost base is far less elastic.
  2. Asset managers need to adopt digital technologies because passive strategies require sophisticated analytics and artificial intelligence (AI) for both fund management and distribution.
    Even external advisors on whom many fund companies depend for sales and distribution expect strong technology backbone and support. So, margins that are already under pressure due to lower fees get impacted further with this additional investment burden. 
Slowly at First, then All at Once

One may be tempted to dismiss the warnings as overdone, as it’s easy to expect another five to 10 years of rapid AUM growth, extrapolating the graph from the last 15 years. Most asset managers in the US and Europe had that belief at a similar juncture in those markets when the passives started outselling active funds because on a cumulative basis, they only represented a small fraction of the overall industry AUM. Then, the unthinkable happened.

New technologies and trends impacted sector after sector slowly at first and then all at once—that is why it is called disruption. It’s not a secular change, not just a bend in the road that you can quickly steer away from.

A Bloomberg report reveals the extent of disruption, the speed at which many fund managers in the US and UK have gone from a robust growth and profitability to severe de-growth and survival issue/consolidation. Giants with many decades of history like Franklin Templeton and Aberdeen have for the first time seen more than a 15-20% drop in AUM, even as markets soared. Some other tier-one firms, such as PIMCO and DWS, have seen their AUM shrink by 10%. The AUM would have dropped far more precipitously, threatening their very survival had markets gone down at the same time—something that is bound to happen sooner or later. Profits have dropped even sharper than expected: Now they are at a level last seen after the financial crisis

Winner Takes All …

Amid the industry-wide shakeout, there are still a few clear winners. The likes of Vanguard and Blackrock quickly embraced the trends—they are the largest ETF managers now—and technologies, such as robo advisory tools, to grow even faster, bigger, stronger. “Winner takes all” is not just true for a digital business after all—it is also happening in asset management within the same set of players, as these giants have grown mercilessly at the cost of most small, medium and even large tier-one fund houses.

And then there are others, like Amundi, who have invested in technology aggressively to remain competitive. Amundi achieved a cost/income ratio of 52% against an industry average of 66% to maintain its profitability despite a skew towards active fund strategies facing withdrawals by investors. What’s more, its technology investments allow it to adjust its product focus to passive funds, which have started to offer a hedge against the outflows

Prepare or Perish

The bottom line is that asset managers in Asia can hardly afford to relax for the fund flows can turn very quickly while product portfolio, operating model and technology changes are more complex and, therefore, take longer to take hold. Even among active strategies, there are areas of promising growth, such as ESG funds, which would require significant investments in technology—both in automation to reduce operational costs and in data/analytics/AI to intelligently capture and process data on the ESG (environmental, social and governance) factors.

Some fund managers have realized this and embarked on the digital transformation journey seriously, dedicated increasingly larger amounts. When they started on the journey, most of them discovered that their core platforms would not support their digital ambitions. So, some have gone through the complex task of upgrading, rewiring or replacing their core platforms already. They have now started moving on digital transformation, with initial focus on digital channels (customer experience) including chatbots, automation and looking at AI/ML use cases.

Lowering costs is a non-negotiable and non-delayable measure in order to bring down cost/AUM ratio radically to align with the lower fee structure not just for the passive funds but even for the active ones. That is now the new normal. Besides aggressive automation, delayering and revamping operating models is equally important, if not more, to reduce costs while at the same time speeding up decision making and cutting wasteful expenditure. It is also imperative for adopting Agile across the organization, getting everyone focused on clear goals and lean and nimble operations. Agile and digital is as much or more about mindset than a framework or technology.

There is bound to be increasing consolidation as revenues and margins plummet. The asset management industry is extremely fragmented—a legacy of the decades of stable high margins, positive growth and little to no differentiation in products and customer service. That reality is rapidly changing, making the current industry structure unsustainable. Technology leadership will play an increasingly important role in mergers and acquisitions (M&A) from valuation to achieving successful closure and integration to truthfully achieve or exceed the synergies and other benefits sought from M&A.

Asset managers in Asia have a window while the fund flows are strong to pivot to a new target operating model across business, operations and IT to ride the perfect storm that is brewing on the horizon. Movement to passive strategies is accelerating at a breathtaking speed, while the cost/AUM ratios are still highest in the world and sticky. Growth in the emerging markets in Asia is driven by the retail segment, rather than institutional, making it more vulnerable to a switch to passive. As emerging markets mature, the opportunities to generate alpha will also decline, further boosting the fund flows into passives and away from actively managed funds. Asset managers will do well to accelerate their digital and data programs with strong agile execution at scale. 

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