Delivering alpha in a bear market through automation

Edward Glyn, managing director, head of global markets at Calastone outlines how fund managers can embrace the current downturn and modernise key aspects of their operations in order to lay the foundation for the future.

Against a volatile economic backdrop, markets have begun 2023 in uncertain fashion: even a switch to healthy inflows in March only brought the net total for the first quarter narrowly into positive territory. It is clear that fund managers, while hoping for the best, must continue to prepare for the worst, working under the assumption that the bear market may have legs for some time to come.

That being the case, the question becomes how best they can cut their cloth. For some the first instinct will be to trade their way through the downturn. While no-one could deny the importance of smart asset allocation, this can only be one prong of an effective strategy to fight the bear.

The other is cost reduction. Unflashy and sometimes unheralded, this is also the purest source of alpha, in which every saving can contribute directly to outperformance. Smart fund managers recognise that it is not just what business they do, but how they organise and manage their business that makes the difference between success and failure.

That’s never more true that in the situation we now face, where a long-running bull has given way to a bear of uncertain duration. After years in which assets/capital flowed in like water, suddenly investors are tightening their belts and the need for investment managers to run a tighter ship becomes painfully apparent. The battle for capital becomes a war, every basis point of cost is scrutinised, and relative performance is everything.

In good markets, fund managers care above all about gathering new assets, and in bad markets they want to maximise and retain the asset base they have. Under-optimised business process can no longer be concealed by the steady stream of inflows. Control of costs and efficiency of operations become the surest route to outperformance.

Beyond cost cutting

Part of this equation is relatively simple, and has been underway in the industry for some time. In common with many sectors, asset managers have been cutting jobs, freezing hiring and reining in pay and incentives.

Painful one-off measures may be necessary, but they are far from sufficient for the challenge the industry faces to put its business model on a sustainable footing for the future. Bear market or no bear market, asset management is under pressure: between the final quarter of 2021 and the third quarter of 2022, the largest players in the business saw revenues decline on average by 22.9% and operating margins slide by 12 percentage points. To turn the ship around, managers cannot just rely on short-term cost cutting; they must also address fundamental flaws within the business model as a whole.

A creaking machine

Every asset manager faces some version of the same problem. All are tied up in a complex value chain of vendors and counterparties, with data having to be moved back and forth, often in highly inefficient ways. Even simple transactions such as moving client funds from one provider to another can be tortuous, involving multiple manual processes and sometimes weeks of delays. According to recent research by Calastone into the state of automation in fund management, 68% of fund managers and asset servicers globally are still using fax machines.

Our study also suggests that asset managers plan to use automation to address the evident shortcomings in fund operations: in the same survey, the most-cited future priorities for automation were order management (53%), client account opening (50%) and clearing and settlement (47%). Fund managers are set to make those improvements with savings in mind: cost reduction was one of the biggest drivers for automation efforts, mentioned by 60% of respondents, after client service (73%) and before revenue expansion (50%).

Automation may be an important part of the answer for asset managers trying to rationalise their business model and find deeper efficiencies. It is certainly being under-utilised as things stand – just 15% of respondents described their organisations as ‘fully automated’.

Closely linked to the need for automation is the requirement for fund managers to tackle their data problem. Much of the inefficiency that allows costs to balloon comes back to the inability to access trading data and move it through the asset management value chain in seamless fashion. Research from BNY Mellon found that, while managers want to do more with data analysis and insight, many are struggling to get their arms around the data they have: around half cited problems turning fragmented data sources into a centralised source (50%), getting high-quality data in real time (49%) and ensuring the ‘reliability, completeness and freshness’ of their data (46%).

The time to act

Counter-intuitively, there is no better time for fund managers to address these issues than in the current downturn. When living off bull market momentum, fund managers could reasonably convince themselves that addressing their legacy tech stack was a problem that could wait for another day. Now that day has come, and the need to find meaningful, long-term efficiencies in fund operations is rightfully seen as a priority.

The tools already exist for fund managers to modernise key aspects of their operations – automating transfers, moving workflows into the cloud and harnessing APIs to connect disparate data sources. These are not complex reorganisations but relatively straightforward optimisations that can meaningfully impact margins without incurring huge set-up costs. Other more ambitious ideas are also starting to come into reach, such as fully digital investment models enabled by the tokenisation of assets.

By embracing these approaches, fund managers, as well as their distribution network, will lay the foundations for the future as well as making a tangible difference today. Every exciting opportunity towards which many in the industry are now looking – from providing more choice and depth to the end clients in alternative assets and private markets, to delivering the kind of seamless digital experience customers have now come to expect, and ultimately moving deeper into personalised investment services – ultimately rests on a ruthlessly efficient back office and supply chain.

These areas of the business have started to become an inhibitor, but if addressed now they could be a catalyst for innovation and long-term value creation. Cutting the Gordian knot of fragmented data and outdated processes will not just help fund managers to deliver alpha during this bear market. Bold action now will also pave the way towards the products, services and profit centres of the future.