Buy Side Turning to Technology to Meet Today’s Challenges

Whether automating non-critical tasks with AI to improve efficiency or leveraging data analytics for increased competitive advantage, the buy side no longer relies solely on the sell side for all the answers. Asset managers instead are turning to technology, and they are putting their money where their mouths are – technology spending and staffing rival that of the sell side in some cases. TABB Group head of fintech research Monica Summerville examines the buy side’s technology priorities, the challenges they face, and the future of the buy side-sell side relationship.

The buy-to-sell side relationship is undergoing an adjustment, to put things mildly, and asset managers are turning to technology for answers, which means relying less on the sell side. TABB Group research found that the buy side is adapting to the new reality by leveraging technology across a spectrum of activities and functions. The key buy-side challenges revolve around data handling and analysis, as evidenced by TABB Group’s research, which shows that the buy side’s top three technology priorities for 2019 were cyber security, artificial intelligence and Big Data (see Exhibit 1, below).

Exhibit 1: Asset managers’ overall technology priorities for 2019

Source: TABB Group


Analyzing these results in aggregate, it is clear that data issues – whether security or analytics – frame the asset management industry’s technology focus; whether firms wish to leverage data to improve efficiency or increase revenues, they are turning to artificial intelligence (AI) technologies for help.

While benefits of AI vary, more than half of the asset managers TABB Group interviewed in a recent survey said their primary expected benefit of AI is to provide actionable insight, while one-third said it is mainly to help increase efficiency and improve automation (see Exhibit 2, below).

Exhibit 2: Asset Managers expect AI’s primary benefit to be actionable insight

Source: TABB Group

This aligns with TABB’s research, as buy-side workflows can still involve a high degree of manual intervention. For example, TABB Group research found that more than half of asset managers do not have an integrated portfolio and execution platform, with numerous workflows requiring manual or other forms of intervention (see Exhibit 3, below). Similarly, front-to-back workflow was described as “very integrated” by only about half of asset managers, with 15% of asset managers overall describing it as having “little to no integration.” However, nearly one-third of respondents from small asset managers (under $1 billion AUM) described their front-to-back workflows as having “little to no integration” (see Exhibit 4, below).

Exhibit 3: Portfolio and execution platforms are not integrated at most asset managers

Source: TABB Group

Exhibit 4: Only about half of asset managers are ‘very integrated’ from front-to-back

Source: TABB Group

The practical reality of this means robotic process automation (RPA), as opposed to AI – e.g., machine learning (ML) and Natural Language Processing (NLP) techniques – are more likely to be implemented to start.

Tech Spend & Staffing Increase as Buy Side Faces Enterprisewide Challenges

Many firms, including asset managers, are finding that implementing artificial intelligence techniques is challenging, as it often exposes underlying problems with how the firm has historically managed data. TABB research found that more than two-thirds (67%) of buy-side firms listed data quality as the top challenge when implementing AI approaches. Talent recruitment and compatible infrastructure were a joint second (11%), with regulatory/compliance restraints and budget issues next (about 6% each).

The top challenges, whether data quality or infrastructure, can only be adequately addressed by enterprise-driven approaches to technology upgrades, something that the buy side has not historically had to do very often. Leading investment management firms have clearly realized this, with annual technology spend in the billions of dollars. Last year Fidelity spent $2.5 billion, while BlackRock’s IT budget was $1 billion. Perhaps more striking is that the percentage of staffing for technology can rival that of the biggest investment banks (see Exhibit 5, below).

Exhibit 5: Leading asset managers rival leading banks in terms of percentage of techies

Source: TABB Group

However, while the interest in AI is quite high, our research found that only one-third of buy-side firms have an AI process in place, with the remainder either still at a Proof of Concept (PoC) stage or earlier; and of those, the majority are focused on the investment process, including idea generation. (see Exhibit 6, below).

Exhibit 6: Only one-third of asset managers are in production with AI

Source: TABB Group; respondents gave multiple answers for ‘areas using AI/ML’

When it came to front-office workflows, technology is being used across a spectrum of activities, including increasing automation, improving execution quality and wringing more value out of their broker relationships (see Exhibit 7, below).

Exhibit 7: Asset managers’ top trading initiatives

Source: TABB Group

Is the Buy Side Outgrowing the Sell Side?

In the US, with the spirit of MiFID II proscribing any inducements to trade (e.g., research or systems support) and the sell side focusing on agency trading, the buy side has become less reliant on the sell side.

Meanwhile, the sell side is doing its own soul searching about its business models. Profits from investment banking are being hit as revenue from equity capital markets, which includes IPOs, is down an inflation-adjusted 43% since its 2000’s peak. While there are signs that the IPO market may be rebounding, last year there were more than 6 times as many $100M+ equity financing rounds for US VC-backed tech companies than there were IPOs from this same group (see Exhibit 8, below). Similarly, fees from deal making are also down (see Exhibit 9).

Exhibit 8: US VC-backed technology companies favor mega-financing over IPOs

Source: CB Insights data on US-headquartered VC backed tech companies on major US exchanges

Exhibit 9: Sell side under increased revenue pressures

Source: Thomson Reuters, FT

When it comes to trading businesses at investment banks, while revenues from both equities and fixed income and commodities (FICC) have drifted slightly downwards over the past few years, trader headcount has fallen at a larger rate. Overall, headcount of front-office staff at the largest investment banks has fallen for the past eight years. This has directly impacted buy-side firms that are finding it difficult to maintain sales desk coverage and have shifted flow and commission dollars to low-touch, lower-cost providers, accordingly.

The buy side is experiencing its own pressures. Profit margins of US investment managers are compressing, as formidable factors and trends adversely affect fees and costs. Investors are embracing passive index and ETF options; in the past nine years passive flows have outpaced active by $3 trillion. Passive equity funds are on pace to overtake active funds in 2019 (see Exhibit 10, below).

While total assets under management (AUM) have grown – for example, between 2007-2017, AUM at BlackRock, Vanguard, State Street and Fidelity jumped from $7 trillion to $16 trillion – lower demand for active strategies, combined with pressure from institutional investors, has dragged down management fees for active manager and the entire asset management industry.  Mid-sized and smaller firms may struggle; consolidation is occurring to improve scale.

Exhibit 10: Passive equity funds may overtake active funds in 2019

Source: Bloomberg, TABB Group

Conclusion

Whether automating non-critical tasks or leveraging data for increased competitive advantage, the buy side is certainly no longer relying solely on the sell side for all the answers. Asset managers instead are turning to technology, and they are putting their money where their mouths are – technology spending and staffing rival that of the sell side in some cases. Regulatory and industry drivers such as MiFID II’s research unbundling provisions, the decreased availability of capital on the sell side, and the increased popularity of passive funds with investors have forced the hand of asset managers. TABB Group research found that asset managers are now re-evaluating their business (see Exhibit 11, below) and believe technology investment and innovation on the buy side will be critical to their success.

Exhibit 11: MiFID II and active to passive have buy-side firms re-evaluating their business

Source: TABB Group

Technology offers the promise of lowering costs through increased efficiencies and increasing revenues. Increasingly, firms are turning to advanced technologies to unlock hidden value within their own data sets or to find competitive advantage and continue to rein in costs through automation and workflow integration. Asset managers are certainly taking more control over their technology, but this is not a trivial change for the buy side, which historically has relied on the sell side for its technology platforms and direction. It requires the right employees and integration partners to tackle the enterprise-level change that must occur. TABB Group believes that investment managers that have the foresight, resources and commitment to develop more scalable, efficient workflows, coupled with advanced data analysis capabilities across the investment decision lifecycle, will have a clear advantage over their slower-moving peers.

TabbFORUM is an open community that provides a platform for capital markets professionals to share their ideas and thought leadership with their peers. The views and opinions expressed are solely those of the author(s). They do not necessarily reflect the opinions of TABB Group, its analysts, TabbFORUM and its editors, or their employees, affiliates and partners.

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