Drivers of Innovation in Fund Management

research study published last week by London-based think tank Create Research deserves a closer look. Amin Rajan, who is both CEO of Create and an early mentor to Closir, conducted a study into how digitisation, and the intrusion of internet and mobile players, looks set to reshape the asset management industry during the coming months.

Fund managers themselves have been slow to embrace technological innovation, although in the last 12 months a number of global trends have started to help the process along:

  • An exponential growth in number of affluent investors
  • An increasingly tech-savvy population
  • Greater flexibility in pension contributions and longer life expectancy
  • Increasing demand for transparency and synchronisation from regulators
  • Growth of geographically ‘portable’ investment products such as ETFs
  • The popularity of social media channels spilling over into the finance community

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The report outlines the emergence of several new models:

In the evolving marketplace, virtual advisors offer the mass affluent market a streamlined communication process through mobile and digital media, enabling them to take advantage of technology while retaining some of the personal touch.

Online advice platforms, or ‘robo advisors’ as they are being called by some, have already started to offer retail clients the chance to build personalised portfolios using proprietary algorithms.

Fund consolidation portals will help them to aggregate and manage investible funds across multiple platforms.

Given the obvious opportunities these trends present for ambitious and resourceful technology players, it’s unsurprising to hear Google and Apple mentioned as potential disruptors. Create’s report suggests mobile phone providers may also be well positioned to enter the fray.

Although industry players have been losing sleep over the tech giants for some time, there are obvious hurdles for data-sharing social technology companies in an industry which is defined by a strong risk culture, regulatory oversight and the importance of data security.

Strategic partnership with finance players may be a good option for technology and mobile companies, as it offers them a way to mitigate these concerns while making the most of complementary skill sets. There have already been some high-profile collaborations, with Aberdeen Asset Management forming an alliance with Google and Canadian mobile provider Rogers Communications partnering with Canadian bank CIBC.

Change may be gradual in an industry traditionally resistant to technology. Create points to the airline industry as a successful model, where both customers and providers quickly adapted to the increased efficiency offered by technology as concerns over security proved to be exaggerated.

Source: Create Research

ETFs in 2020

A comprehensive paper published by PwC last month entitled ‘ETFs in 2020’ paints a very detailed picture of how the Exchange Traded Fund business is likely to evolve globally over the next five years. According to the analysis, the market will double to $5tn by 2020, and its impact has the potential will be felt much more widely within our industry than previously imagined.

A few takeaways from the report we found particularly interesting:

  • Despite fragile economic growth in developed markets, the global AM industry is predicted to grow at a healthy pace. Having doubled over the past decade (to $70tr), PwC predicts professionally managed financial investments will grow by 6% per year , due to both asset inflows and value appreciation. The US & Europe will dominate asset flows in absolute terms, but the highest rates of growth are likely to come from developing markets. Passive funds currently account for around 35 per cent of all mutual fund assets in the US.
  • New types of indexing (also referred to as ‘smart beta’) are perhaps the most important area of innovation within theproduct class. As they continue to evolve, a growing number of investors are likely to opt for index weightings based on factors other than market capitalisation, which by itself can lead to overly concentrated exposure to certain markets, sectors, or securities. The size and scope of actively managed ETFs are also set to grow (there are currently 55 actively managed ETFs listed in the US with AUM of $9.6 billion).
  • The regulatory environment in the US and Europe is expected to have a significant impact on the evolution of ETFs. New regulations could spark further growth if they permit further product innovation or lower distribution barriers, but they could also dampen demand, particularly if new tax rules make ETFs less attractive or convenient. For instance, MiFID II could be a game changer in Europe, where the adoption of ETFs by retail investors significantly lags behind the US.
  • Firms offering ETF products to investors will need to consider rapid changes to the way asset management services are created and consumed, with the most dramatic changes enabled by technology.

If the predictions do come true, they will no doubt have an impact on a future shareholder register structure and consequently on corporate IR strategy.

A few questions for companies to consider:

  • Do I monitor my shareholder register on a fund level, for the activity of the largest three ETF fund providers: Vanguard, Blackrock (iShares), and State Street (SPDRs)?
  • Am I familiar with which are the largest and most active ETFs in my asset class? I am aware of key trends and drivers of their growth?
  • Do I know which indices is my security a constituent of?
  • Am I staying on top of developments in the active ETF space?

Top 10 Emerging Market ETFs

Name of Fund Assets Average Volume 2015 Performance
Vanguard FTSE Emerging Markets ETF $46,331,830 13,908,497 +4.40%
iShares MSCI Emerging Markets Index Fund $31,702,630 55,250,906 +3.51%
iShares Core MSCI Emerging Markets ETF $6,254,856 2,344,426 +3.91%
iShares MSCI India ETF $2,822,917 1,059,985 +10.02%
WisdomTree India Earnings Fund $2,308,956 4,828,908 +8.34%
WisdomTree Emerging Markets High-Yielding Equity Fund $2,256,093 914,679 +5.69%
iShares MSCI Emerging Markets Minimum Volatility Index Fund $2,093,439 446,303 +4.36%
Market Vectors Russia ETF $1,610,733 20,284,920 +23.38%
WisdomTree Emerging Markets SmallCap Dividend Fund $1,470,268 273,755 +3.34%
Schwab Emerging Markets Equity ETF $1,182,924 536,871 +4.23%

Sources: PwC, ETF Database. To download a copy of the PwC paper visit: www.pwc.com/etf2020

Activist Investor’s influence on Passive Funds

The cover story from this week’s Economist caught our attention, particularly as it relates to a number of IR themes we have been observing closely. Academic literature* examining the recent track record of US activist investors concludes that despite their reputation and short term focus they are more often than not a force for good, at least in terms of driving greater operating performance and shareholder returns.

The article draws attention to a polarity in today’s average shareholder structure, one that is particularly evident in the US. On one side of the spectrum is ‘lazy money’ which comprises a growing number of computer-run index tracking funds, ETFs and mutual or pension funds, which generally prefer not to get too involved in radically altering the strategic direction of the companies they invest in. On the other are large funds which buy entire companies, often taking them private and actively dictating strategy.

Activist investors can fill a key corporate governance void by influencing passive funds and ‘lazy money’ to take an interest and support either the activist investor or management’s chosen course of action. The long-only funds holding the majority of the free float generally assume the role of ‘blocker’ or ‘enabler’ for activist campaigns so the more involved they are the better. This involvement looks set to increase as activist funds grow in popularity. In 2014, a fifth of flows into hedge funds went to activist investors, resulting in their AUM rising from $55bn to $120bn over a 5-year period.

The two largest providers of passive products, Blackrock and Vanguard, have already pledged to work more towards ‘long term interests’; this will inevitably include increased contact with company boards. Company management and IR teams may also make a more proactive effort to establish relationships with passive managers, something which was not really considered as recently as a few years ago.

The final angle of the debate centres around the potential for transferring the US-style activism model across the Atlantic, particularly given the arguably limited opportunities in the US (only 76 companies in the S&P 500 registered a poor 5-year Return on Equity and only 29 trade below their liquidation value). European investors will argue that they already have more say than their American counterparts on corporate governance issues such as renumeration and board appointments, and differences in culture as we move east mean that many activist fund demands are often settled discretely and diplomatically.

* Long Term Effects of Hedge Fund Activism, Lucian A. Bebchuk,  WSJ

Historical Returns of International Equities (2000-2014)

We came across one or two fascinating charts over the weekend which make interesting viewing for investors with international mandates. Purely from a returns perspective, there is more than a subtle case for global equities exposure: over the 15 year period, global or EM equities ended the year in top 3 position 8 times each.

Assets


International Stock Market Returns

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EM Stock Market Returns

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Source : Novel Investor,  http://novelinvestor.com/