Change: The New Normal in the Asset Management Industry

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by PwC AM on March 25, 2014

By Tim Mueller, PwC US Alternative Asset Management Consulting Leader

As I stare out my office window in March, I can’t help but think about change. After a tough winter on the East Coast, we are certainly ready for a change in the weather – which, fortunately, will arrive anyway whether we like it or not. So it is in asset management industry as well, and specifically in the alternative asset management space, where change is happening endlessly whether we like it or not. Changes in strategy, changes in competition, changes in investor needs and preferences and changes in the regulatory climate are all impacting alternative asset managers in profound ways. And if change is the new normal in the industry, then managers need to be prepared to change as well.

So what’s changed?

We have already seen dramatic changes in alternative managers’ businesses as they see a need to continue to grow assets. Hedge funds have adopted new strategies and businesses like PE and debt trading. PE shops have developed hedge and fund of funds strategies. Fund-of-funds managers dabble in direct investing in addition to their traditional approaches. These shifts have all placed extraordinary demands on existing business operations and staff to be able to deal with these shifts.

The investor landscape has also changed dramatically in the past decade. While wealthy individuals still represent a significant emphasis for alternative managers, the bulk of their assets now come from institutions and sovereigns. And just as institutions have become the primary focus of a lot of the industry, the emergence of retail investors and products is shifting the landscape yet again. In the “decade of the investor” for the alternative industry, there have been significant changes in demands placed on managers by investors. More information, better terms and conditions, more liquidity, separately managed accounts and tailored products among others are all ways in which investor demands have placed additional burdens on managers.

The regulatory environment has, not surprisingly, shifted as well. Requiring a previously, largely unregulated industry to register with the SEC was obviously a huge shift for managers. The emergence of additional regulatory scrutiny over trading and other business practices was another, with high-profile investigations and prosecutions. Evolving reporting requirements like Form PF in the U.S. and AiFMD in Europe have placed extraordinary demands on managers in the current environment. And this may just be the beginning of the regulatory changes as the rest of the world wakes up and wants their requirements met as well.

So how are asset managers reacting?

For some managers, this is not what they bargained for, and they are finding ways to exit the business or turn back third party money. For others, dealing with the profound shifts in their business and industry is now a way of life, and those that deal with the shifts better will likely emerge as winners in the future. “It’s not just about creating alpha anymore,” as one manager recently put it. “It’s about developing an agile, scaleable and well-controlled business model as well.” And that’s something the industry has not necessarily always been known for.

To deal with the significant changes facing the industry, many leading companies are looking at their businesses and operations anew, taking a bit of a “blank sheet of paper” view of the world. While many managers take pride in their ability to generate returns and to cater to their investor preferences and needs, not many take as much pride in how the “factories are running.” Many managers have outsourced important parts of their back offices (NAV, onboarding, investor statements, etc.), largely as a reaction to investor pressure following high-profile scandals. In fact, according to PwC’s newly released Alternative Administration Survey, 75% of alternative managers currently outsource some portion of their back office to administrators, including 90% for hedge funds alone.

While the initial experience had been mixed in many respects, it has helped managers consider those things that they do well and things that may be better for others to do. For many managers, the recent regulatory demands have represented a significant shift in how they think about their ability to continue to things the same old way, by throwing people at problems. In many ways, these regulatory shifts have created an important decision path for managers. Do I invest in internal capabilities and technology to create a more agile organization or do I look hard at areas where I create value add (investor servicing, investing) versus areas where third-party service providers increasingly create value (middle office, back-office activities)?

Answering the question of how do I continue to deal with the pace of change and run and grow my business requires a pretty significant timeout to look at where you are going. Once there is a bit of clarity around the business strategy, managers can then look at their overall operating model and begin to make some decisions. Internal investment in capabilities and technology can be expensive, particularly if you don’t have the right talent or plan, but can also retain a degree of control and agility. Outsourcing is not as novel or scary as it used to be, but requires a thoughtful approach to deciding the right partner and the types of services that make sense. Outsourcing can provide scale and quicker market entry in many cases, but can also reduce flexibility and can result in higher initial costs.

Whatever the approach ultimately taken, the significant pace of change in the industry requires a thoughtful look at how businesses are being run in the current environment. To the extent that current operations are not well-suited for the future direction of the business, a long, hard look at the operating model (front, middle and back office) and what companies do well and don’t do well is required, even as existing time pressures make it hard to do so. There are many more choices for managers as they consider their options for moving forward; as consultants, technology providers and service providers have all matured many of their service offerings.

As the calendar and weather turn to spring, and as many managers take a long-awaited deep breath after completing year-end financials and audits and submit their critical regulatory filings, it may just be the time to think about the future. While the pace of change may be hard to predict, if the past four to five years is any indication, future change is likely to continue to be transformative.

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