December-January 2014

INSIDE VIEW: Where to now?

Road signsThe asset management industry has weathered the financial storm, but there are more challenges ahead, says Rory Gage of Grant Thornton. The financial crisis had a profound effect on UK asset management, with reductions in assets under management (AuM) driving reduced profits, resulting in years of reduced spend. The industry made it, but it’s been a tough journey. Over the past year, the market has seen recovery well under way with average profitability sitting at 32% and AuM bouncing back to pre-crisis levels. Regulatory costs grow daily and consumers are becoming ever-more demanding. Is it time to grasp the nettle and apply the cost-discipline lessons learned in the back office during more challenging times to deliver a paradigm shift in the front office asset management business model? Lower interest rates fuelled a change in investor strategy. We are seeing demand clustering at both extremes of the spectrum; speciality solutions still command higher fees, but the Retail Distribution Review is similarly encouraging growth in low-fee passive funds. Advisers and wealth managers continue the drive to reduce operational cost and ensure a return can still be made in this environment. But is that enough? With this change in investor strategy comes a change in attitudes and, subsequently, focus. The well-worn dogma of middle and back office cost reduction has left the front office, largely, unaffected. This reticence will change. One in six funds available to UK retail investors has underperformed its benchmark by at least 10% over the past three years. The front office accounts for close to 50% of total staff costs. There appears plentiful opportunity to achieve efficiencies. Moreover, aligning fund managers’ remuneration with investment performance and relative peer group performance is a bold step that progressive organisations will adopt; both to obtain cost efficiencies and appeal to an increasingly cognisant marketplace. COST SCRUTINY
Calculating true product profitability remains problematic for managers, largely as a result of difficulties of cost allocation and the ability to measure fully loaded cost. Nonetheless, those products, markets and businesses that fail to deliver true value will come under increasing scrutiny. Many point to the ever-increasing list of current challenges, ranging from pressures on profitability, through the increasing cost of regulation to greater competition and changing customer demands, as the nucleus of increased cost. Yet, the most pressing cost-related concerns lie in the legacy impact firms suffer as a result of years of undisciplined growth. Firms have expended great effort, resources and money in the recent past trying to unravel the web of organisational inefficiencies that became institutionally embedded during the pre-crisis era. Many managers believe that the vast majority of cost reduction opportunities have been realised through repeated initiatives focused on “low-hanging fruit”, middle and back office staff reductions and the implementation of systems-based processing capabilities. Yet, there remains a fundamental failing when it comes to addressing more operationally entrenched cost bases, such as organisational failings and third-party costs. ISOLATED OR HOLISTIC?
The failure to implement a harmonised, group-wide approach to operational cost efficiency often undermines managers’ best intentions. Addressing isolated instances of ineffective operational process, in most instances, fails to address fundamental institutional failings. Indeed, the symbiotic relationship between customers, products, sales processes, operations and operational technologies is often underappreciated. Operational strategy has long been a “voodoo topic” for asset managers. The past decade has borne witness to a mild erosion in these attitudes, with the increased adoption of outsourced operations and various cost-cutting initiatives focused on the middle/back office and support functions. However, the root cause of the issue has remained unaddressed – the absence of a coherent and holistic operational strategy or, in simple terms, an operating model. A fundamental pillar of a comprehensive operating model is its location strategy. While a central London office was once perceived as the hallmark of the industry’s most serious players, performance and reputation are now far more prevalent criterion to institutional investors’ decision-making processes. With the onset of more ascetic approaches, the “false positives” that hitherto have prevented a candid assessment of firms’ location strategies have been jettisoned in favour of cost-sensitive solutions. The combination of much enhanced remote technologies and evermore attractive “nearshore” options is presenting managers with new dimensions from which to build their operational platforms. Despite the undoubted value of a firm-wide operating model, it is the firm’s underlying business strategy that informs and drives the aforementioned model. While managers continue to grapple with the recurring paradoxical dilemma – to specialise or diversify? – operating strategies will remain reactive. There remains little doubt as to the importance of retaining a specialised focus on core-asset businesses. Yet, the most successful global managers have learnt the importance of capitalising on emerging, fast-growth assets as an additional stream of revenue. Retaining traditional, specialised focus, while exploiting current and future trends will be critical to managers maintaining balanced and sustainable business and, subsequently, operational strategies. While strategic direction will continue to evolve with market fluctuations, cost will endure as a key operational component of firms overarching business strategies. Transparency, cost structure focus and operational discipline will be rewarded, particularly for managers that retain global ambitions. OPPORTUNITY KNOCKS
As is the case with firm strategy, successful managers will adopt a flexible operating model which leverages the full range of solutions available to construct a balanced portfolio that delivers service in the most cost-effective capacity.  Ultimately, those who seize growth opportunities as they arise will differentiate between the progressive and the conservative. Rory Gage is director, financial services advisory at Grant Thornton ©2014 funds europe

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