Five challenges for asset managers to remain competitive

23 May 2018

While the global asset management industry has grown with double digits in the past four years, the sector faces a number of key changes in its immediate future, including regulatory pressures and a rise in digital-leveraging competitors. Sam Dezillie, a Partner at FRONT Consulting, sat with to discuss how asset management firms can best navigate these approaching forks in the road.

In line with the global financial recovery, asset management has seen consistent growth in recent years. The globe’s 500 largest asset managers have added more than $30 trillion globally over the past decade, taking the total value of assets under management to above $80 trillion. Since 2010, the average profit margin of the top asset managers – including Blackrock, Vanguard, State Street Global Advisors, Allianz, Fidelity and JP Morgan Chase and BNY Mellon – has been relatively stable, with BNY Mellon, Fidelity and JP Morgan enjoying premium performance.

These promising results have been achieved in spite of the challenges of digitisation, fee pressure and regulation – however, while the industry has still been able to generate relatively healthy profits until now, this could quickly change. Looking ahead, wealth managers are set to face sweeping alterations to their industry in the coming years. With MiFID II having come into effect in early 2018, new regulatory concerns are having a huge impact, with more still to come. Meanwhile, an impending talent shortage and cyber skills gap are also putting pressure on firms during their courtship of prospective employees – potentially leading to wage inflation for those with sought-after digital skills.

The skills gap in particular will be a key concern in coming months, due to the speed of technological change which modern businesses face. New technology, including Big Data analytics and agile tech are increasingly seen as essential to companies fending off new challenges from digitally-savvy rivals, as well as a key way to improve customer services – something else vital when looking to retain customers from competitors. According to Sam Dezillie, owner and partner at FRONT Consulting, there are five fronts on which asset managers must fight in order to preserve their strong position.

The globe’s 500 largest asset managers combined hold over $80 trillion in assets under management

Business model

As businesses bid to stay ahead of the game, asset managers need to make sure their model remains relevant to clients. Dezillie elaborated, “The business model within the asset management business is changing. In the recent past we’ve seen many institutions turning to outsourcing, offshoring, smart sourcing and the like. The current wave of digital-led change will be much more impactful.”

Dezillie also contended that this makes data and data exchange of prime importance. This is because the approaching world where non-core processes are serviced by a multitude of service providers will make the quest for operational excellence in combination with a goal to improve cost income ratios via lower operating costs paramount. He added, “Business models must become a digital business model, so it must incorporate tech trends such as robotics, machine learning and artificial intelligence at its heart.”

Data is key

Secondly, data is a key avenue toward delivering greater commercial value and improving operations. Nearly half of UK organisations now apply big data for insights; however, the track record still isn’t great, as just 30% of organisations that use Big Data are extracting enough value. This is no different in the asset management industry, and while the majority are working to leverage Big Data, 61% state that they are still only “getting organised”.

Commenting on this state of play, Dezillie said, “We feel that the winning player will be the one which has thought about its data and information strategy, and is already taking action because implementation times are proven to be long.” Data will also be of paramount importance for optimising operations, “as client reporting requirements will become ever more complex. Same for regulatory obligations while regulators will have increased capacity and better tooling to analyse the data delivered to them.”

The important thinking point here, according to the FRONT Partner, is what data is to be used by which function, of which quality and in which frequency. Sorting this efficiently and accurately can help with efforts to introduce concepts like as data virtualisation – where business rules and data hubs will bring sufficient flexibility in the data and information landscape – while making changing reporting requirements easier to deal with.

Quote Sam Dezillie, FRONT Consulting

Alternative investments

One of strategies that is gaining attention rapidly among the asset management community is alternative investments. An alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash, with many alternative investment assets held by institutional investors, accredited, high-net-worth individuals or their family offices. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities and infrastructure.

A recent study revealed that the 100 largest alternative asset managers now hold collective assets beyond $4 trillion. The largest segment of this sector by far is real estate, at $1.4 trillion, followed by direct private equity funds, valued at $695 billion. Direct hedge funds ranked close behind, at around $674 billion.

“Traditional asset classes are showing limited performance and we see an increase of the presence and appetite in passive -and often less expensive- investment forms,” Dezillie said. He added, “The alternative investments area is growing in importance and is getting more and more professionalised.”

Entering the alternative investments arena is easier said than done, however, and industry members should have a clear vision and operating model on alternative investments if they are to succeed. Having a significant presence in alternative investments also comes with a number of consequences. Dezillie warned, “Building successful operations in alternative investments requires a specific operating model to support the specificities of the process of the private markets. We believe that operating models that correctly segregate the specific Illiquid functions from the generic asset management functions will be most successful.”

Operational excellence

As margins continue to face pressure from heightened competition, while new innovative rivals digitise further to reduce their costs, operational excellence remains key for those looking to ward off new challenges. The major cost elements within operations are staff and software – essential components of any business, which cannot lightly be scaled back. According to Dezillie, for this reason it is key to understand where benefits are made and where unnecessary costs are occurring. While it might be seen by some as old-fashioned, activity based costing can be a solution to this.

Breaking down the cost of operations sheds light on operational excellence improvements

“Activity based costing maybe a forgotten technique but it can give a good insight in the analysis of costs of operations. Mostly the conclusion of such analysis is that costs of operations are higher when complexity grows and inefficiencies are more present. A clear service catalogue and a clear focus are most often easy solutions in the quest to operational excellence. Ultimately, a very high level of event based processing, combined with exception based working and straight through processing should be the ambition; leading to increased levels of operational excellence.”

Complexity of technology

Finally, while digital is a key part of an effective strategy, its execution will rely on access to state of the art technology. As pointed out, one of the major hindrances of asset managers looking to leverage Big Data analytics is legacy IT. This is broadly applicable to all areas of a modern, digitalised business. The trouble with overcoming this is that new technologies are increasingly complex.

While technology may become less complex in some regards thanks to the development of smart and cloud solutions – meaning physical storage problems of the past may decline – on the other hand complexity of technology will grow because of higher expectations in automation of very complex processes. Processes that are currently manual will be automated in the near future, including the capture of complex data, administration, and integration with blockchains.

Dezillie concluded, “FRONT believes that there is a huge potential to decrease the total cost of ownership of technology because of the changing concepts. Smaller and more specialised providers of technology will have an easier access to the market and will be able to offer more flexibility in offering technology in combination with services.”

Related: Executives in asset and wealth management sector positive about growth.


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.