1. Today’s Operating Model:
Beyond Excel
What is the asset owner baseline operating model today? What factors do they need to have in mind as they reshape their models to accommodate countless external pressures?
With Excel as the starting point, the cost implications of growth are not as they appear.
Many of the world’s asset allocators rely on Excel
In an era of digitisation and of technological transformation, is it right that the world's asset owners continue to rely on spreadsheets as their primary mechanism for managing their asset allocations?
Excel was first released in 1985 and remains the the 'tool of choice' for asset allocation management today, with just under half of those surveyed (45%) relying on it for their overall asset allocation. We may not believe it to be the right thing to do but there appears to be a strong consensus (across different geographies and investment profiles) that it continues to be the tool of choice today.
However, that is not to say that it's the only way to manage an asset allocation today, .
First, there is a strong link between those who outsource their fund management and those who outsource their asset allocation view - with 38% of those using external managers relying on their master custodians to provide a coherent and consolidated view of allocations on a daily basis.
Second, the use of Excel also diminishes as funds grow in scale (and complexity). Amongst those with the highest levels of assets under management (AUM), the prevailing operating model is a 50/50 split between master custodians and in-house systems - with the balance depending largely on the organisational character and on their reliance on third party managers.
Larger funds will no-doubt be managing a more diverse, complicated mix of assets, along with having more stringent risk management and regulatory requirements, which spreadsheet-based operating models will increasingly struggle to support. Equally, those managing their investments internally are more likely to have access to systems and technology that can be re-purposed for an asset allocation view (see below).
“It's remarkable how reliant the sector is on Excel, essentially a personal productivity tool, to deliver asset allocation outcomes ” - Geoff Hodge, President of Milestone Group
The hidden cost of complexity...
"What is wrong with Excel anyway?"
Regardless of the journey, the use of spreadsheets no doubt has its advantages, not least of all being cost. For smaller funds (who manage simpler portfolios with lower asset bases), the largely fixed costs of managing allocations in spreadsheets can offer significant economies as asset volumes grow.
But our research highlights a key threshold (of around USD2-3 billion) - beyond which the costs of complexity start to have a material impact on the running costs of an asset owner. Below this threshold, asset owners can safely and economically run a 'no frills' model - relying on simple tools such as Excel to track and manage their investments across a small number of lower complexity, largely unchanging array of investments.
But above this threshold things begin to change. As investment portfolios grow in complexity; as the number of external managers and counterparties expands; as the governance and disclosure obligations on the fund increase; there is clear evidence of a diseconomy of scale. Simplistic tools simply cannot keep up with the many dimensions of complexity that mid-tier asset owners face - forcing them to search for and deploy costly, alternative platforms that can actually increase asset owners' unit costs.
Asset owners must beware of being caught in this expensive middle ground - and they must acknowledge the importance of every operating decision in moving them closer to this critical cost threshold. Whether it be appointing a second, external manager; or beginning to invest in complex products (e.g. level three assets which are typically more illiquid or difficult to value) , every decision will have a clear cost impact.
...and of globalisation
Cost structures do not depend solely on operating models either. Where you are in the world has a material impact too.
At one end of the costs spectrum, North American investors face significant efficiencies. With immediate access to one, deeply liquid home market, asset owners in the US (for example) can run large volumes of their portfolios in a single currency and in a single, regulated market - without the need for complex currency management, multi-market account maintenance, reporting or risk management. As one American asset owner stated "you have to realise that, for us in America, investing outside of the US dollar is a very big deal."
However, as the depth of this home market diminishes, these economies disappear quickly - with asset owners increasingly compelled to run more complex, multi-currency portfolios. In Africa or Asia-Pacific (and to a slightly lesser degree in Europe), local markets are simply too shallow to sustain large asset owners, forcing them to diversify across markets and currencies very early on in their lifecycle. Based on our research, this multi-market complexity clearly has a cost as unit costs run up to more than double those of the US for local asset owners.
The post-Excel "bounce-back" problem
Despite Excel's dominance across asset allocators today, asset owners are clear in their desire to move away from spreadsheets for many of the reasons we have highlighted. In our survey, 66% of asset owners plan to run system automation projects in the next three years - with spreadsheets and outdated macros clearly in their sights.
However, the move away from Excel has historically proven to be problematic and even fruitless for many asset allocators - as they fail to acknowledge the workflow subtleties of asset allocation management (as opposed to single-sector management). In their desire to move their data and processing onto a specialist system of some kind, asset allocators have often fallen into the trap of turning to brand-name portfolio management systems to run a consolidated view - using work-arounds to move to a multi-portfolio view within these systems. This, in part, explains why 25% of those managing their own fund management (above) claim to use a system of some kind for their asset allocations. Surely one system can do both?
Anecdotal experience indicates that it can't. Having experimented with portfolio management systems, many asset owners end up disappointed in the failings of these systems (at an asset allocation level) and hence they end up gradually returning to what they know: Excel.
And as each asset allocator bounces-back to Excel, the sense of disbelief grows that any truly viable solution exists outside of spreadsheets.
