Institutional asset management is the sharp edge of the business – clients demand more sophisticated service than much of retail and the increasing use of investment consultants drives regular transfers of mandates. In this world, in order to gain market share, firms must demonstrate specialist alpha or beta with its various enhancements.
Many of today’s asset managers have yet to define their value propositions which, in most cases, will in turn require a radical overhaul of the investment process, culture, organisation and business management processes. In parallel, asset managers need to re-examine their cost structure and distribution strategy. Without this shift, there is little evidence to suggest that managers can improve the underlying profitability in the business beyond that arising from asset value rises. However, rather than addressing these fundamental issues, managers are once again focusing on growth, encouraged by the recovery in asset values. Product development and performance have returned to centre stage and other concerns have been pushed aside.Two of the side-lined challenges still facing the industry are costs and distribution.
The structural cost problem requires a fresh approach. Over the last two years, most of our clients have reduced the costs of production by 15% through a series of initiatives centred around rationalisation of European activities and reductions in product complexity and compensation. However, most of this cost cutting has simply trimmed excess fat and there is still much to do.
In each area of the business, managers need to go through a rigorous process of evaluating each step of the activity chain to understand where they are best placed – in terms of either cost or performance – to compete with external providers. For instance, in research there is still a tendency to think incrementally about staff numbers rather than start from a blank sheet and assess what internal research resources are required. Are internal resources best placed to gather data, undertake basic analysis, look at event driven arbitrage, provide macro-economic input? Each question may have a different answer.
In trading and execution, the buy or build question is more complex to evaluate given the bundling of capital, content and connectivity paid for with commission and opaque spread. However, the increasing transparency demanded by regulators around the world is making these calculations easier. In the middle and back office the internal versus external question is equally important and requires an assessment of each element of the processing engine to evaluate the advantages of keeping the process in-house compared to outsourcing. Finally, at the client interface, asset managers have much to learn from corporate banking models. The proliferation of individual benchmarks, reporting requirements and general customisation of mandates has dramatically increased complexity and costs of managing client relationships. This trend needs to be reversed.
Turning to distribution, asset managers need to focus on improving both the efficiency and effectiveness of their approach to clients. Too few managers understand the unique distribution requirements of different types of institutional clients. Pension funds have different requirements from endowments, family offices, insurance companies and retail aggregators. UK clients have different requirements from Italian clients, and so on. Managers need to understand the unique distribution needs of each segment they aim to serve. Then in terms of size, will the smaller institutional clients switch to a core and satellite strategy? What is the asset or revenue cut-off for provision of a truly customised service compared with a standardised offering with few variations? The answer is clear but, as always, hard to implement.
Detailed historical and forecast information is required on each client segment. At a minimum there must be an understanding of predicted asset levels, asset mix, margins, revenues, targeted wallet, costs and buying behaviour for each major segment (by type and size) and region (eg,UK pension funds, German insurance companies, Italian retail aggregators, French government agencies). Without this basic information it will remain hard to develop a successful approach to the institutional market.
The current investment consulting business is in a period of rapid change – growing in some countries, under pressure in others. Ensuring the right balance between direct marketing (eg, selling guaranteed product to retail aggregators) and consultant-led marketing (eg, UK pension funds) will be essential to position in a world where consultants compete for space with multi-managers, investment banks and direct propositions from asset managers.
While much is written on consultant-led marketing, direct marketing is less well managed. What services do you offer when you sell direct to a pension fund? If you decide to offer asset/liability analysis, do you get paid for it and if so, how? Does the asset management business model work providing this type of potentially free consulting service as an add-on? Once managers understand the target mix between direct and consultant-led marketing and the client segmentation, success will come through better hit rates, marketing efficiency and improved productivity of the distribution machine.
In future, an improved understanding of the liability requirements of clients may lead to an overhaul of the current service offering and a new way of working with clients. This is an idea that has not gone unnoticed by the investment banks who are already competing for the potential space and revenues.
European institutional asset
management will certainly be a business of rapidly growing profits for some firms. No doubt, product development and performance will play an important role, but equally crucial to long-term success will be better cost management and more effective distribution.
Scott McDonald is with Mercer Oliver Wyman based in London