As an emerging fintech software startup, we have spent the last few years meeting with hundreds of stakeholders within the asset management community. While our conversations centered around different experiences and pain points, the message was clear - the investment management industry is undergoing a massive transformation.
In this series of posts, we would like to share our perspective of the drivers for this shift and what we see as the path forward for the industry.
Drivers for Change
1. Broader playing field - Globalization and the relative ease of global trade have created a much more interconnected world than ever before. This holds true not only between regions, but also between sectors, sub-sectors, and individual companies. As a result, a fundamental analyst who had previously spent most of his or her time analyzing specific companies within one or two industries now needs to understand and monitor a much larger universe. This universe includes global consumption trends, political climates, commodity pricing, exchange rates, etc. All of which may have a direct impact on the performance of his or her target companies.
2.Risk on/risk off environment – In today's interconnected world where a labor strike in China can have a profound affect on US retailers, there are increased opportunities for crisis. More political systems, more exchanges rates, more logistical headaches, different regulations, etc. Active managers and their risk officers who were previously able to limit risk mostly through a deep understanding of sectors and companies, are now finding themselves exposed to multiple risk factors that had not been part of their daily workflow.
3. Heightened investor oversight – As it appears that higher market volatility is here to stay, fund allocators and investors alike are demanding increased transparency and risk monitoring on their actively managed portfolios. In this environment, managers are being required to truly understand their portfolio's underlying exposures. Fund marketing is now as much about selling your ability to manage risk as it is about selling your core investment strategy.
4. Digitizing world - The world is digitizing at an accelerating rate, and data has quickly proven to be a double edged sword. While there are thousands of insight-producing data sources, most active investors lack the proper infrastructure to leverage the data to gain an edge. In order to extract value from these data sets, one needs to have a meticulous process in place that can systematically ingest raw data sets and churn out derived insights. Those who don’t - a club whose membership encompasses the full spectrum of investors from small family offices to larger institutional managers - are unable to take advantage of these real time economic observations, and are thus lagging behind their more data-savvy peers.
5. Decoupling of market prices from fundamentals – It’s no secret that algo trading funds have driven an explosion in transaction volumes. A significant subset of these funds trade on statistical analysis of past and future prices, and have concurrently decoupled from the longer term fundamentals that drive company performance. While medium to long term fundamentals still matter, managers are often unable to fight the tape long enough to watch their theses play out.
6. Crowded trades – In our conversations, it became evident that the prevailing notion is that there are simply too many actively managed funds. Everyone is trying to generate alpha by sniffing out data points that haven’t been factored into stock price. Given the limited number of available companies and crowded space, the natural upshot is that many active managers (especially sector specific) will flock to the same companies, making it harder for everyone to benefit from any surprises.
As a result of the above mentioned drivers, most fundamental investors (who represent the majority of US institutional investors) are experiencing a divergence between solid investment strategy and performance. They face an uphill battle in attributing alpha or risk to their portfolios, and as a result are having a difficult time raising and retaining capital.
In the next post, we will share our perspective on what this all means and what investors can do to compete successfully.