The asset management industry has managed to sustain a high profit margin and level of growth. And still, it is far from business as usual, says Christian Dreyer, CEO of the CFA Society Switzerland, on finews.com.

The relatively young asset management industry owes its explosive growth over the last few decades to the confluence of two factors: It benefited from the growing differentiation and intermediation of the financial services value chains. Secondly, finance theory supplied the conceptual and methodological framework to scale the industry by making the tools of the trade teachable. It is no coincidence that the CFA program grew its global exam sittings from 284 in 1963 to well over 200,000 in 2019. 

Despite its stellar success, the industry has managed to sustain a global average operating profit margin as a share of net revenue of no less than 35 percent.

Jeff Bezos: What Remains Is Relevant

Digitization doesn't stop at the asset management industry of course. Manual labor was constantly supplanted by the inclusion of technology as it advanced, but the operating model as such was never really at risk. Is it going to be different this time?

Jeff Bezos, the founder of online giant Amazon, thinks that what is still the same in 10 years’ time is the far more relevant and interesting question than to identify what will be different, because that’s what you can build strategy on.

So let’s first try to answer that question for the asset management industry:

  • Every successful investment strategy becomes commoditized over time as imitation sets in. Competition and passive replication will drive down fees while alpha slowly becomes beta. 
  • Markets typically evolve faster than their intellectual penetration as academic finance mostly works in a rearview mirror mode. 
  • Every successful investment strategy will sooner or later be constrained by market capacity. 

Both the active vs passive debate as well as the recent explosion of demand for ESG products fall under that category.

Which leaves us with the question what is likely to change materially for asset management in the coming years? I recognize the following four drivers of change:

1. Blockchain

The big talk of town is securities tokenization, of course – or moving the aforementioned securities value chain on the (or a) blockchain. This is largely a matter of back-office logistics, but the operating model implications would be monumental.

2. Artificial Intelligence and Big Data

While being the topic of much frenzied debate, the actual application of new technologies in investment decision making is quite limited. A recent CFA Institute report («AI Pioneers in Investment Management») has identified 3 types of AI and big data applications: use of natural language techniques in processing of text, image and audio data, use of machine learning to improve the effectiveness of algorithms used in investment processes, and using AI to process big data, including alternative and unstructured data for investment insights. These applications will allow investment professionals predominantly in the quant strategy space to spend less time on routine tasks, but they have not been shown to displace human intelligence / expert judgment in investment management.

3. Fee Models

The most widespread compensation model for asset management is an ad valorem fee expressed in basis points of assets under management. Although these fees tend to be on a downward trajectory over time, which seems to be beneficial for the investor, the model as such is open to criticism: It incentivizes managers to constantly attract net new assets with little regard to the interest of current investors, whose return potential will be reduced by approaching capacity constraints. Sophisticated asset owners are beginning to ask for a combination of a fixed nominal management fee plus performance fees.

4. Private and Public Markets

The traditional interaction between private markets as incubators for public markets has run into some disturbance as of late. Many public markets have started to give back capital to investors (share buy-backs) on a net basis rather than to serve as a source of capital for enterprise. Privately held firms tend to stay private much longer than in the past. Investing in private markets is very different from public markets and requires different skill sets. 

Of these four factors, the Blockchain appears to be the most consequential in terms of its operational and business model impact, provided that it will be adopted on an industry-wide basis. To be effective, the distributed ledger will have to be a shared infrastructure. Industry players need to decide on whether to compete in the status-quo or to cooperate in a transition to a new infrastructure.

If it does manifest, the other three factors could be directly impacted as well: big data by means of the much higher density of available information, fee models by new compensation models, and markets by the blurring of the line between public and private markets.

Christian Dreyer in April 2013 became CEO of the CFA Society Switzerland. He started his professional career in 1994 as an assistent to the CEO of Solothurner Kantonalbank, which was in need of restructuring. In 2000, he became the head of investment research at Basler Kantonalbank. Dreyer most recently acted as an executive director for J.P. Morgan (Switzerland) responsible for relations to institutional investors in Switzerland and Liechtenstein.