Leveraging technology to deliver efficiencies in funds
Technology integration is fundamental to improve the efficiency of funds, in a difficult market context for active management companies.
According to recent research, fewer than one quarter of all actively managed equity funds outperformed their benchmarks in 2018, a fall from 53 percent in 2017.1 Some investors have taken note of the disappointing returns, shifting part of their assets out of actively traded funds into passive products such as ETFs (exchange traded funds), many of which charge fairly nominal fees. For instance, Morningstar data found US large cap equity funds tracking indices now manage more investor money than their active counterparts. It said passive mutual funds, ETFs and smart beta look after $2.93 trillion whereas active managers control around $2.84 trillion2.
Aside from reallocating more capital into passives, a number of retail and institutional investors have become increasingly outspoken about the fees some asset managers are charging, animated by the UK Financial Conduct Authority’s (FCA) own criticism of the industry’s weak price competition. With more regulation being thrown into the mix, cracks are starting to emerge in active asset management. While the industry is undoubtedly going through a tough cycle, Mathieu Maurier, country head for Luxembourg at Societe Generale Securities Services (SGSS) – speaking at Fund Forum International in Copenhagen – said technological innovation would play an invaluable role in supporting active management.
Beginning with the basics - outsourcing
Through outsourcing middle and back office activities to external vendors, asset managers can transition away from their own – often expensive – proprietary legacy systems, allowing them to accumulate the benefits of automation and scalability. However, Maurier accepts that while outsourcing provides intrinsic value for managers, firms need to exercise caution when deciding on what processes to externalise. For example, a manager may obtain a number of strategic efficiencies through outsourcing, but it might like to retain control of a particular operational process(es) in-house. Maurier adds approaches to outsourcing will vary across managers, depending on their strategies, geographical locations or growth stories, principally whether businesses have expanded organically or through acquisitions.
Innovation at service providers
Simultaneously, providers are attempting to distinguish their service offerings through innovation. Again, this is a process that needs to be implemented carefully and thoughtfully. Maurier says it could prove challenging to uproot a legacy system and replace it with an altogether new piece of technology infrastructure. The suddenness of such transitions can generate operational risk, while the changes may not even net long-term cost savings. Instead, providers could focus on how new technologies can interoperate with legacy systems.
As a result, more providers are leveraging APIs (“Application Programming Interface”) to unlock siloed data held across their entire organisations, and consolidating all of the information into a single framework giving them a holistic view of their internal operations and those of their clients. If banks can share accurate data through APIs with their fund manager clients more seamlessly and rapidly, it will help customers make better informed decisions. Such data could be used by investment firms to better predict their cash flow forecasts or collateral requirements, facilitating improvements in how they manage their cash and collateral holdings. This will ultimately generate savings for asset managers, potentially offsetting return slippage elsewhere.
Likewise, operational enhancements can be acquired by upgrading existing legacy systems as opposed to discarding them, adds Maurier.
“If contractors are renovating a building, it is not always necessary or logical to remove the foundations or the walls. The same is true of banking technology. New technologies have the ability to rejuvenate older, legacy systems provided they are both compatible with each other. It is not always in the best interests of an organisation to replace everything,” says Maurier.
While adoption of disruptive technologies serves a purpose, providers need to be pragmatic about how they apply it. Most importantly, technology changes at the provider level need to deliver value to clients.
The integration of distributed ledger technology (DLT) into the funds’ ecosystem is one such example. While the number of applications for DLT has declined, Maurier says the technology could solve number of inefficiencies facing the funds and post-trade industries.
“There are currently 36 DLT projects underway at Societe Generale on a group-wide basis, of which one third are dedicated to post-trade. We believe DLT could also play a role in streamlining the client KYC (know-your-customer) process, in addition to speeding up fund distribution settlement times. In fact, we are already seeing providers such as FundsDLT in Luxembourg and Calastone leverage DLT to bring efficiencies to fund distribution,” he says.
Fund distribution is very fragmented. It is a process which is heavily intermediated and costly too, while a number of providers have still yet to move away from fax-based instructions. The results – so far – of DLT’s integration into cross-border fund distribution have been impressive. FundsDLT has already processed a handful of end-to-end cross-border fund transactions using Blockchain, creating widespread efficiencies, greater scalability and simplified KYC3. As this technology becomes more commoditised, fund distribution costs will fall, delivering meaningful savings to both the managers and investors.
Nevertheless, it should be borne in mind that many questions remain open, particularly on regulation, interface between securities and cash, guarantees provided to investors that will enable them to have confidence in new digital processes.
Maurier adds Societe Generale is also playing an instrumental role in facilitating the development of tokenised securities through its collaboration with Societe Generale FORGE, one of the start-ups integrated into the Group. Societe Generale and Societe Generale FORGE recently issued EUR 100 million of covered bonds in token form via the Ethereum blockchain, generating extensive efficiencies in the process, most notably in facilitating better transparency; faster transferability; quicker settlement; and reduced intermediation4. As the issuance of tokenised securities or digital assets becomes more prevalent and accepted, the pool of investable assets will grow and so too will market liquidity volumes, providing new opportunities for fund managers to exploit.
A model innovation approach
Hidden and unnecessary operational costs are pervasive throughout the asset management industry, but service providers are working hard to deliver dynamic solutions (DLT for fund distribution; asset tokenisation) to help firms achieve operational savings and identify new sources of alpha. However, innovation can also be subtle, illustrated by the introduction of APIs to improve connectivity between new technologies and old systems; or just upgrading legacy platforms.
However, marginal improvements should not prevent a real reflection on the technologies, especially if they become too old and no longer make it possible to meet the current challenges of the business.
Finally, the human aspect shall not be forgotten while implementing these new disruptive models. A proper change management framework must be considered in order to optimize the transformation.
1FT Adviser (February 4, 2019) Active managers struggle to beat benchmarks
2 Bloomberg (February 12, 2019)
3Banking Technology (February 7, 2019) Banco Best and Credit Suisse bring DLT to fund transactions
4 Societe Generale (April 23, 2019) Societe Generale issued the first covered bond as a security token on a public blockchain