Technology is changing the nature of investing, intensifying the pressure on active equity managers. But this is not the end of active management. TABB Group founder and research chairman Larry Tabb investigates the challenges and offers a guide to help buy-side managers compete successfully in the age of passive investment. Not surprisingly, the solution starts with technology.
Technology is redefining the trader’s job – and it’s reshaping the capital markets business. Many trading decisions are executed, if not driven by, machine. As advances such as algorithms, data science, cloud infrastructure, and open-source software enable firms to analyze information more quickly and reduce tick-to-trade times and investment turnaround, technology is changing the nature of investing.
In addition, social media, satellites and the Internet of Things are providing firms with more information to analyze than ever before. Even with all this new alternative data, however, traditional active equity managers continue to struggle. With so much technological power at their fingertips, why aren’t active investors’ jobs getting easier?
It is precisely because new technology, data science, and investment structures are increasing competition. This makes money management more difficult, especially at the institutional level. In addition, ETFs and other low- (or no-) fee passive products are driving traditional management fees into the ground.
Is this the end of active management? Absolutely not.
There are three major focal points that active managers must have at the forefront of their minds in this age of compressed timeframes: product, implementation, and process.
First, active managers need to hone their product, pricing, and marketing to tie into investor demand. They need their investment strategies to perform, be fee-sensitive, and manage downside risk without giving up too much performance. That is a tall order.
Second, active managers need to rethink their alpha implementation ideas, moving away from traditional rich/cheap value analysis and toward more complex strategy implementation ideas that cut across traditional asset class barriers. They need to think seriously about how to more adequately implement an investment thesis.
Third, as firms move away from siloed investment implementations, they need to rethink their infrastructure (read: technology), so that portfolio managers can run their investments across asset classes. They should see their positions aggregated across strategies and implement them in either multi-asset solutions or very tightly integrated solutions, so equities, debt, options, futures, swaps, financings and other products can be analyzed, traded, settled and viewed as part of an integrated strategy.
Of course, infrastructure is part of the challenge. Money management firms today not only need scale, they need efficiency as well. As fee pressure mounts on managers, they no longer have the leisure to worry about asset collection and infrastructure rationalization. They need to harvest corporate synergies by quickly consolidating operations, technology, and infrastructure.
This means rationalizing multiple processing infrastructures into fewer and maybe even one; from single-product platforms per management silo to multi-product platforms that can process across currencies and regions. This is directly aligned with institutional equity firms’ strategic initiatives, as 47% of the 100 buy-side head U.S. equity traders we interviewed in 2018 mentioned that automating their non-critical functions and improving their technology infrastructure was their most significant business initiative (see Exhibit 1, below).
Exhibit 1: Major Buy-Side Technology Initiatives
Source: TABB Group
In addition to providing efficiency, and perhaps more important, a consolidated platform opens a fund to an array of new capabilities.
Fees and return pressures are polarizing the market into two categories of asset managers: pure beta (passive) and exceptional alpha generators. As investors vote with their flow away from the lower-quality and more expensive active managers toward passive strategies, the flow concentrates in benchmark securities (those within indices). This trend further pressures sub-standard managers and swings flow either to the truly exceptional alpha generators or the increasingly bland index-style offerings.
Firms will need to understand, and take advantage of, differing ways to find alpha, through asset selection and implementation of investment ideas. While managers have typically gained corporate exposure through buying equity, increasingly, firms will need to analyze how equity exposure aligns with corporate debt, equity options, credit default swaps, whole loans, and even sovereign debt. They must learn how to capture the upside (or downside) of an investment while limiting risk. This could be captured through options, debt, or traded through a total return or equity swap. To be one of the truly exceptional, firms will need to adopt different investment strategies.
The implementation of these strategies is not particularly easy, however. In fact, most of the 100 head U.S. equity traders we interviewed were doing nothing but going with the flow as the investment world pushes toward passive strategies – only 7% were expanding into new asset classes.
The problem is that most investment managers do not have the leeway to invest in these complex investment implementations, nor the automated compliance infrastructure to ensure that managers’ investments and allocations fit within their mandates. Their technology infrastructures, bought as best-of-breed, do not bring the integration needed to analyze these opportunities, trade them, and ensure compliance. This requires moving from best-of-breed-type investment platforms to ones that provide a more comprehensive service and compliance offering.
Creating this level of integration across asset classes is not easy. The platforms that can handle the challenge will comprise portfolio and order and execution management, with a consolidated and integrated overlay of portfolio accounting and compliance. These platforms will be multi-asset class, multi-geo and multi-utility.
As the juices get squeezed from traditional asset management strategies by low-cost funds and packaged products, the managers that will survive will either have the scale to compete with the Vanguards and BlackRocks, or have the flexibility, agility and streamlined infrastructure to analyze the market from a different perspective and rethink the investment process. This only can be done, however, through a more highly functional and streamlined technology platform – one that not only handles the traditional, but the complex and difficult strategies with ease.
To learn more about how active managers must adapt to survive, download Larry Tabb’s latest research note, “The Multi-Asset Buy Side: Overkill, or Table Stakes?” below. Courtesy of Eze Software.