There Are No Quick Fixes for Foundational Issues with Asset Managers' Operating Models
The asset management industry is caught between a rock and hard place. On one side, investors are clamoring for more transparency and access to data, which translates into increases in back-office technology investment. On the other side, new technologies such as robo-advisors and other forms of competition are negatively impacting commission revenue.
So there you have it. Costs are going up while fee revenue is declining. That's not an easy challenge to solve for in any business.
There's no doubt that our industry is going through a period of extreme disruption. Perhaps the most disruptive thing about the current environment is that real transformation is happening in the back office. When the front office was undergoing its technological revolution in the 90s and throughout the last decade, the cost-benefit analysis for the business was easy to decipher. A faster trading system or a better algorithm could improve portfolio performance. Better performance leads to more clients, more revenue. Pretty cut and dry.
I recently heard someone compare the transformation happening in the asset management back office to repairing the foundation of a house. From the street, it's hard to identify issues with the foundation. But if persistent issues aren't addressed, the house will almost certainly be compromised—it's just a matter of time. To fix this type of problem, you need architects, engineers, contractors and special machinery. And it's not a cheap repair, particularly if the issue is severe.
I like the analogy because it illustrates where we are as an industry. We have bedrock issues that need to be addressed. Regulators have initiated the process, but it's up to us, the industry, to effect real change. The current status quo in the back office is no longer sustainable, and responding only with short-term fixes has resulted in a cobbling together of technology and data management solutions that will ultimately weaken the business.
Imagining What the Future Could Be
Connecting the costs of back-office transformation to potential benefits is not always straightforward, which is a struggle for some firms. For technology and operations teams, building broad internal support for the need to invest in a more transparent operating model is a lot tougher than getting budget approval to invest in technologies aimed at improving portfolio performance.
Managers are having to make tough decisions about how they respond to changing investor expectations. Some are looking at long-term implications while others focus on the short-term challenges. I believe one of the hardest things to do in business is to make a bet on what the future's going to look like and then commit to meeting the challenges you face on your way to the goal. Yes, it requires information. But it also requires intuition and staying power. Throw in a lot of unknown variables, and it can become difficult to pull the trigger on your vision.
So it can be much easier to address short-term issues. How do I respond to this client inquiry? Should I hire more people to address increased reporting requirements? Can another spreadsheet help me with this new regulation? While addressing those questions is necessary, focusing only on the short-term is a recipe for disaster.
In many conversations I've had with clients in recent months, everyone is asking "where am I spending money, and how can I compress that to compensate for thinner margins?" It's an extremely reasonable question. The way firms approach answering these questions, however, varies quite a bit.
Investing in Short-Term Pain or Long-Term Gain?
Some firms are making decisions based only on the short-term, and they don't always see that those decisions could be working against their long-term goals. Instead of thinking about how they can engineer a sustainable model, they look for ways to make doing the status quo cheaper. I call that investing in future pain. This only perpetuates inefficiencies and delivers no long-term value.
The smartest firms are looking for ways to improve their full value chain, which includes their administrator, software vendors, distribution partners and their own firm's unique special sauce. They look for ways to reengineer and optimize that value chain to be effective for today and tomorrow.
Many of those firms approach this problem as a city planner does development. Buildings aren't constructed too close to major roads to allow for expansion, and ample room is created and preserved to ensure communities have sufficient residential and commercial resources. Planning is thought out in terms of decades, not months or years.
Inaction is A Sure Fail Plan
The back office is the foundation of any asset management business. It's where business intelligence gets captured, analyzed and acted on. Historically, investors haven't heavily scrutinized this part of the business, but now they want access. And delivering on that expectation will require a retooling of the foundation of the business. It's not an easy or comfortable initiative to undertake.
So the industry finds itself caught between a rock and a hard place, needing to reinvent itself in an era when revenue margin is getting squeezed. Making real changes to position your business for the long term won't come without their costs, which can feel unnerving today. But the alternative—inaction, delay, procrastination, however you want to phrase it—will ultimately put the entire business at risk.