The asset management industry finds itself in the odd position where the search for new assets is accelerating the pace of adoption on the one hand, while legacy systems and legacy thinking are slowing it down on the other, producing asset management inertia. In the first article in this series on the state of the industry, we looked at the recent history of asset management innovation, with proliferation of products and low-cost, passive strategies leading out of the 2008 recession. Today, innovation takes the form of digital transformation. But in a business that has been used to making easy margins of 30 percent and more, there isn’t a burning incentive to digitize, modernize, or in fact do things differently in any way.
An Oil Tanker’s Momentum
In fact, those putting the brakes on adopting these new models—I’ll call them ‘moderators’ here—and those in favor of moving ahead with digitization and innovation—which we’ll call ‘accelerators’—are playing a tug-of-war. As in insurance, advertising, and many other industries, the clash between the old guard, who may have the business expertise but lack the technical understanding to be daring, and the IT-savvy innovators, has most often led to the compromise of a patchwork digital framework that’s part new and part old. In a world of exponential change in speed and capability in automation, this layered approach isn’t working—indeed, often leads to a standstill in innovation.
The burden of legacy IT systems coupled with the issue of the innovator’s dilemma—namely, that companies critically need to know how and when to implement new technologies—implies that like many others, the asset management industry is mired in history.
At the same time, the structural trends identified in our previous article have diverted management’s attention from long-term growth to short-term survival. As a result, senior executives—who should be using their longtime experience to think creatively about business solutions—have of necessity become preoccupied with the day-to-day running of the business, while inadequate forward spend on digital skills and regulatory issues have further slowed things down. Add to this the high investment cost of innovation and change management, and it becomes apparent that although idea generation is one thing, execution of those ideas is quite another.
Asset Management inertia and ETFs
Yet, even in the face of this inertia, there are plenty of accelerators that are currently working to counteract the moderators. Fees and charges are becoming a major differentiator with the inexorable rise of passive investment vehicles, such as ETFs. At the same time, customer needs are changing as digitally innovative offerings are being adopted as the norm. End investors are becoming more self-directed, and thus more demanding about their investment returns and client experiences. Furthermore, the threat of market entry by fintechs and/or internet giants, along with the impending consolidation in the industry through “winner takes all” mechanics, is calling into question what constitutes an asset manager and how it should operate.
Typically, it is the moderators—those old-timers who still wield the power of financial decision making—who dominate the implementation cycle in its early phase, as we are currently witnessing. It comes as no surprise that 80 percent of firms surveyed in one report have stated that digital was a key priority. However, only 6 percent are creating meaningful value through greater investments in digitizing their operations and technology functions. In fact, most are barely scratching the surface, as 62 percent of firms felt that they were still at the “getting organized” stage, while only 50 percent feel that their digital agenda is innovation-led, and 33 percent stated that the focus was on wholesale change in their operating model.
Margins and change
Indeed, anything not backed by a sound track record has long been frowned upon in an industry where margins have historically been high and appetite for change correspondingly low. And most of these new technologies, by their very disruptive nature, haven’t had the chance to build a solid reputation. Over time, however, the accelerators—tech disruptors, whether internal to the company or external challengers—gain the ascendancy as early innovators break the mold, making the status quo untenable.
With this mass of isometric tension, the digital transformation in asset management has the momentum of an oil tanker. We may not see much on the immediate horizon, but a landslide is coming our way. Or in the words of Bill Gates: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”
Can Digital Offset Asset Management Inertia?
As the asset management industry finds itself well along on the cusp of digital disruption, by new business models, digital transformations, and new market entrants, evidence on the benefits of digitization is somewhat patchy and at times contradictory. One McKinsey report on digital reinventors outlines this contradiction. Survey respondents said, on the one hand, that if no action were taken to address digital pressures, almost one-third of their companies’ revenues could be lost. On the other hand, other research showed that aggressive digitization shrinks both profit and revenues in the most tech-reliant industries.
Nevertheless, what is clear is that there are significant monetary benefits that set the leaders apart from the laggards in the asset management industry.
Several research reports find different types and ranges of benefits with digital transformation. Another McKinsey report, for example, extrapolated 51 percent profit margins for digitally transformed firms, versus 30 percent for the industry as a whole. That report found digital leaders growing their assets under management (AUM) at a rate of 6 percent, versus 3 percent for the industry as a whole. Benefits included excess revenue growth of 8.6 percent; an 11 percent jump in company productivity; and a 6.3 percent improvement in market share. In addition to stronger overall financial performance, the McKinsey research found that those asset managers identified as digital leaders reported lower technology costs than the full sample.
While the exact impact will certainly depend on both the efficiency of the firm—measured in cost-to-income ratio terms—and the complexity of the operating model, the benefits of digital transformation are clearly significant.
Such benefits for early and stringent digital adopters seem to involve not only actual cost reductions relative to the current baseline. Just as importantly, future cost uplifts will be avoided as a business grows and capitalizes on new areas for expansion, including lowered operational and tech costs.
It may seem obvious that global asset managers will have the greatest potential to capture efficiency gains from revisiting their operating models. But the bigger the oil tanker, the greater the potential for asset management inertia.
Next time we’ll look at the positive and negative impacts of fintech startups on the industry.