Pim Poppe: Scale, vision and execution at asset managers
This column was originally written in Dutch. This is an English translation.
By Pim Poppe, Managing Partner at Probability & Partners
We live in a world where economies of scale are a driving force behind market dynamics in many sectors. Scale determines cost structures, influences consolidation trends and determines which companies achieve the strongest organic growth. This also applies to asset managers.
The question is: how does an asset manager leverage these economies of scale in a world that is increasingly driven by technology?
Asset management is, to a large extent, a cost game. Asset managers who can invest at the lowest cost gain market share and profitability. But how do you reduce those costs? The answers are numerous – and often obvious.
Organic growth. The larger the asset manager, the lower the fixed costs per AUM. Growth through more investable capital helps to reduce costs. But organic growth has its limits – it is not an all-encompassing strategy.
Growth through mergers and acquisitions. Mergers and acquisitions create scale. They deliver distribution advantages and enable cost savings on processes, data and systems. A merger between equals is more difficult than an acquisition of a smaller party by a larger one. After a merger or acquisition, the operating model will – with a bit of luck – remain clear and can lead to economies of scale.
Reduce complexity in the product range. The more the funds and mandates differ from each other, the more expensive they are. Two mandates of 100 million are more expensive than one mandate of 200 million. Having a different LDI overlay for each client made implementation and management more expensive. A tailor-made suit is simply more expensive than a ready-made suit – even in asset management.
Reduce the complexity of the IT setup. Many asset managers have a landscape of data, systems and processes that has evolved rather than been designed. Choices are often the result of historical forces. A classic example of this is the tension between investors who like to work with the ‘best of breed’ solutions and the COO or CFO who focuses on manageable and inexpensive ‘one-stop-shop’ systems. At Probability & Partners, we sometimes feel that investors, with all their customisation requirements, have unintentionally contributed to the cost increases.
Outsourcing. Smart outsourcing saves costs. It effectively creates scale outside your own organisation. Development and maintenance costs fall, flexibility and speed increase, and risks due to staff or knowledge shortages are mitigated. Middle and back office functions – such as compliance, risk management and performance measurement – are obvious candidates, but there are also opportunities in the front office: think of research, quantitative research, trade execution and portfolio analysis. Based on our estimates, many asset managers can achieve material cost and quality benefits through outsourcing.
Employee costs. The nature of work is changing. Different skills are needed. Sometimes fewer people are needed, sometimes fewer or more skilled workers than in the past. Some tasks can be performed by AI. Work can also be done more easily remotely, for example from Eastern Europe or India. There are many opportunities to save on personnel costs. This may not be pleasant for the staff, but ultimately it is all about profitability – and therefore the viability – of the asset manager.
Use of AI. There is no doubt that we are experiencing an AI revolution. It is disruptive. Many processes are becoming cheaper. Think of customer reporting, modelling, coding, research, junior work, standard tasks – all of which can be automated. Smart use of AI reduces costs. It is difficult to predict how quickly this will happen, but it is worth making a conscious effort – probably not on your own, but in collaboration with specialised parties.
Consolidation among suppliers
Several large parties are trying to become one-stop shops. This touches on the three themes mentioned above. It is a combination of reducing IT complexity, outsourcing and lowering the costs of the workforce. They start, for example, with the accounting book of record, buy other parties and string them together into a single integrated solution. The end result: a party that offers accounting and investment books of record, pre-trade compliance, risk analytics, performance measurement and attribution – and sometimes also data.
By working with such a party, an asset manager outsources a large part of the integration issues. The result: cost benefits in the process chain and lower total costs.
Scale and profitability
Various studies – by consultancy firms and custodian banks – comment on the scale and profitability of asset managers. Some argue that large parties are by definition better positioned. Others claim that scale does not automatically lead to cost advantages – it depends on integration and choices regarding sourcing and outsourcing.
Our own observations are limited and mainly Dutch in nature. We assist with system transformations and know these parties well. Often well enough to see where the cost leaks are. In general, we see many opportunities to reduce costs – with the rough list mentioned here in mind. Economies of scale can be achieved with a well-designed system landscape and a well-thought-out outsourcing strategy.
Vision and execution
Two things are crucial to achieving cost benefits: vision and execution.
Vision is needed to determine what the landscape should look like. What is ‘good enough’? What do we do ourselves, what do we outsource? Where are the economies of scale and how do we leverage them?
Execution is the rigorous planning and implementation of what you have devised. Keeping to agreements. Sometimes there is vision without execution. Sometimes execution without vision. Sometimes both are lacking. And very occasionally, there is both vision and execution.
Things can be better. They must be better.
