3: Shaping the strategic agenda: Shifting raisons-d’etre
Taking all of these external pressures into account, how do asset owners turn pressures into projects? What considerations are front-of-mind in designing a transformation agenda - and what do they risk overlooking?
Scale and safety - before costs
Whilst their fund managers and brokers focus heavily on costs and resiliency, asset owners' are busy building a new operating model based on two core principles: scalability and safety.
The rise of 'operational agility' to the top of the priority list underlines the collective impact of the many pressures that asset owners are facing today. The burden of addressing each single requirement individually (be it ESG reporting or the ability to handle private debt instruments) is simply too large - particularly for those relying on spreadsheets to make the journey - and so asset owners are now seeking to make deeper, more fundamental changes that can support the multitude of market changes that lie ahead.
That this agility is accompanied by risk management optimisation as a driver puts this priority into context. Larger, mature asset owners in North America and Europe are driving change and building in scalability not because it's cheaper in the long-run, but because it's safer.
Their peers in Africa and Asia (who are generally smaller and therefore closer to the inflection point of diseconomies of scale - see "When does scale start to cost?") continue to see cost reduction as a key driver of change today. As smaller organisations (on average), asset owners in these regions feel the P&L impact of market and regulatory change more acutely and so are unfortunately caught in a challenging conundrum: how to build in scale and safety, whilst reducing costs at the same time?
Achieving scale: more than one solution
At the heart of the asset owner change agenda is the need to drive scale is at the heart of the change agenda for all asset owners, not just those in Africa and Asia-Pacific. Whether it be driven by regulators, investment horizons or policyholders, the need to reduce unit costs today and tomorrow is a consistent theme for asset owners of all profiles.
But there are many potential answers to the scale question - and asset owners across the globe appear to be focusing on different solutions:
1. Grow scale internally A key source of scale (particularly in Europe and Australia) is the insourcing of investment management, where businesses are building their own fund management operations to support parts of their overall needs in-house - from portfolio managers through to middle and back office staff. This is often done with differing needs in mind - plain vanilla investments are often insourced as a simple cost efficiency play (i.e. why pay experts to track a liquid index?) but asset owners are also building specialist fund management teams to manage highly niche areas where their expertise may already exceed those of third party investment managers (e.g. China private equity).
2. Scale through consolidation An obvious way to achieve scale is through the merging and combining assets with peers, and we see this across all markets to a degree. In Australia (which stands out with 13% of respondents rating this as a strategic priority), regulatory factors are making the scale question an existential one. South Africa's dramatic market consolidation has reduced total pension fund numbers by 80%. Meanwhile, while at a smaller scale versus other markets, provider consolidation continues North America as a by-product of ongoing corporate mergers and the increased feasibility of multiple employer plans (MEPs) due to recent regulatory change.
3. Scale through third party provision
This stands out for Canada as a country where 10% of respondents state this as a priority. It is especially relevant amongst endowment funds who are offering asset management services or administration services to other endowment funds in order to achieve critical mass - generally where endowments are affiliated. University pension plans such as University of Toronto Asset management (UTAM) part of the jointly sponsored pension plan (JSPP) are examples where, while serving the needs of their own plan / members they are looking to win the business of others within the sector.
"The consolidation trend is only going to lead to more mega-funds - no one wants to end up 'desperate and dateless' "
The shop window vs the engine room
But what about future scale? Our research highlights an important trade-off being made by asset owners today as they seek to reconcile the needs of their members or policy holders with those of their own future efficiency.
In an effort to service the needs of policy holders (and in some cases regulators), the majority of asset owners are focusing their investment dollars on re-equipping their front-to-back investment processes to embed visibility around Environmental , Social and Governance (ESG) impacts at every step of the chain. From pre-trade oversight to fund manager monitoring; and from performance reporting to internal MIS, budgets are being spent on building a new operating model that evidences sustainability and governance at every stage.
But in a world of finite budgets, every investment dollar that is spent in one place is not being spent in another. And where ESG is seeing a significant increase in investment spend, operations is seeing a significant reduction over the coming few years. Despite having been a recent priority, areas such as reconciliations, asset servicing and registry are being deprioritised at a rate of over 60%.
The trade-off is clear: sustainability is set to come at the expense of operational efficiency in the next 3 years. As asset owners service the vocal needs of their members, they must do so to the cost of the engine room. In that context, it is critical that investment budgets be deployed to deliver significant ESG outcomes for asset owners in the coming 3 years - in order to offset the likely costs of decreased operational efficiency.
"We had a situation where the front office purchased a water derivative which literally no one in the back office could store or value"
A front office problem is really an enterprise problem
Whilst the engine room may be escaping attention in one way, its needs are fortunately seeing greater accommodation in another. In planning operational transformation, asset owners are clearly aiming to make a step change in the scale and design of their projects: shifting away from the established patterns of front-office-led change towards a more coherent, enterprise-wide approach.
Our survey underlines a well-known past behaviour where the front office would (independently) make decisions to purchase complicated assets, leaving the middle and back office to deal with the challenges of valuing, storing, and assessing the asset's risk - often post-fact. After the portfolio manager has taken up exposure to complex derivatives, for example, the back office has scrambled to "find a home" for these new assets and to accommodate them in their position keeping, valuation, risk management and reporting systems. That 82% of change projects in the last three years have been triggered in this way highlights a significant market inefficiency and hidden cost to asset owners globally.
Fortunately that is changing, albeit gradually. Over the next three years, two-thirds of asset owners plan to run their change projects on an enterprise basis (almost double the volume compared with the last three years) - taking the front, middle and back office needs into account ahead of the change and significantly reducing the need for the familiar, last-minute fire-drill.
We expect the benefits of this approach (manifest in a greater focus on data centralisation and data sourcing, for example), are expected to be significant. With the majority of asset owners looking to invest into new asset classes and markets in the near future, the need to house increasingly complex and exotic assets is certain to grow - and with it the need for efficiencies of organisational alignment from front-to-back.
"Is it the people that determine the operating model - or is it the operating model that determines the people?"
People first, then platforms
It is easy to see operational transformation solely as a technological or data question. But despite having spent the last three years focused on system replacement and automation, asset owners clearly see transformation as a 'people' priority today.
In keeping with their increased, enterprise-wide focus, asset owners are turning to team-restructuring as their #1 lever for change in the coming three years. By realigning resources around specific asset classes, the ambition is to ensure that the right competencies and focus exist to optimise the end-to-end trade flow of a complex swap or, for example, an illiquid, frontier-market security.
It is striking that this change is seeing more focus than any area of technological or data change - especially amongst those using external fund managers. As we move into an era of increased investment complexity (driven by new assets and by a transformed governance around those assets), asset owners clearly see specialisation and resourcing as an equally compelling lever in change as any system replacement.
Is this because re-organisation is a cheaper (and quicker) alternative to system change? Or should we interpret this focus as a need to set the right skill-sets in place first, as a precursor to more fundamental changes to the underlying technology stack?
Anecdotal evidence is that both go hand-in-hand. Funds have highlighted a recent shift in their hiring preferences - moving away from traditional investment management profiles towards those with complex programming experience. As they look to grow their alpha by maintaining increasingly sophisticated levels of market oversight and investments, asset owners are relying on the right people to run the right systems to find the right investments.
