Buyers’ brief: how tech is helping boutique asset managers compete in a scale game

30 October 2020

Investment managers have been under immense pressure for some time, which is acting as a catalyst for much-needed change across the asset management industry. The monumental shift towards passive investing has stretched fees and stricter regulation has dramatically increased compliance costs. That's put significant strain on margins for active fund managers.

This environment has led to large-scale consolidation across the sector, with 2019 being a record year for M&A in the asset management industry with that trend showing little signs of slowing in 2020. According to PwC’s latest deals insight report, asset and wealth management tie-ups surged during the first half of the year despite the economic fallout and uncertainty from the coronavirus pandemic.

Asset and wealth management M&A started the year on a high with two mega-deals announced in February prior, with Morgan Stanley’s $13.1bn acquisition of E*TRADE Financial and Franklin Templeton’s $4.5bn acquisition of Legg Mason. Instead of drying up as a result of the pandemic, overall deal value during the first half of 2020 climbed to $19.7bn, up 47 percent compared with the first six months of 2019.

"We expect deal making to be robust during the remainder of 2020, driven by continued fee pressures and a desire by some firms to gain exposure to credit and other asset classes," PwC added. "Dealmakers pushed ahead with AWM transactions despite the pandemic, aiming to boost returns through expansion or consolidation."

Consolidation may well provide some protection from the myriad of headwinds the industry faces due to economies of scale. But asset managers are also turning to technology and investing in digital infrastructure to give them a competitive edge.

"Each function within Fidelity International has seen the benefits of technology;  including offering automated  solutions, consolidation or leveraging data for deeper insights, and how we interact with clients, using technology to increase the relevance and impact of each client interaction," Stuart Warner, head of technology at Fidelity International tells bobsguide.

There is a heightened need for technology at boutique firms, however, with it empowering them to make operational changes necessary to drive efficiencies and navigate an increasingly treacherous trading environment where smaller players are often gobbled up by bigger firms obsessed with size and scale. But technology is helping tip the scales.

Innovation accelerates amid uncertainty
‘We are beginning to understand that asset-gathering — too often viewed as the yardstick for success — is, at best, only coincidental with good performance,’ declared Charlie Ruffel, co-founder, managing partner and chairman at Kudu Investment Management, in an op-ed for the Financial Times. "The age of asset gatherers has peaked and the asset management industry is re-entering the age of the boutique, where it began."

The age of the boutique is returning largely due to technology democratising asset management, with smaller firms able to level the playing field by accessing Bloomberg, Amazon Web Services and a host of other tools made available by a wide variety of third party software vendors at an affordable price point.

In the relatively recent past, small boutique firms struggled to compete with their larger rivals due to traditional IT infrastructure being extremely costly and time consuming to implement and maintain. However, with the advent of cloud-based systems, small and mid-sized firms can do more with less and build out IT infrastructure that was once reserved only for the behemoths of the industry.

In the future, bleeding edge technologies like machine learning (ML) will help bridge the gap even further between the David’s and goliaths of the asset management industry. The UK-based alternative asset management firm, Gresham House, has recently started to look at how ML technology can assist it in deal origination for its clients to invest in.

"Within our venture capital and private equity business there is a large universe of potential businesses to invest in but these need to be assessed and reduced down to a smaller number that best fit our investment criteria," according to Andrew Hampshire, chief operating officer and chief technology officer at Gresham House. "Historically, that is a process that requires a lot of manpower, with investment managers proactively reviewing a host of businesses to map the market, while simultaneously reviewing inbound opportunities."

Gresham House, however, is looking to automate this time-consuming operational process with the help of a third-party by utilising ML technology to analyse data sets to find investment opportunities that are best suited to its various venture capital and private equity funds.

"This is a significant project for us and will likely take many years of iterative developments to realise its full potential" Hampshire tells bobsguide. "But our hope and vision for the project is that it will allow our investment team to efficiently identify those businesses that best match our investment criteria from a far larger pool than we ever could imagine with the resources we have, allowing us to compete with firms far larger than us."

Technology tips the scales
In the years to come, technological innovation will ultimately determine the winners and losers in the asset management industry. Artificial intelligence (AI) will one day help organisations shape their investment strategies, allowing them to identify complex patterns and emerging trends that will help even the smallest firms stand out in an ever-increasingly competitive market.

The competitive advantage offered by utilising technology is leading to asset managers to invest heavily in their digital transformation. According to a recent blue paper by Morgan Stanley and Oliver Wyman, total technology spend is now worth approximately $30bn across the asset management industry (15 percent-20 percent of industry cost-base). The pandemic is only going increase investment in technology and accelerate asset management firms’ digital transformation even faster.

"The pandemic has provided a better realisation on the business stakeholders that technology, that if applied correctly, enables a rapid change of direction and a high level of adaptability and resilience, Warner adds. "These are the key words that the pandemic has made more prominent in discussions and decisions: adaptability and resilience. How can we leverage technology to further improve those?"

Fee pressures and rising costs of doing business will likely prompt further consolidation too, as larger asset managers look to cover up outflows and lower revenues via inorganic growth, with Morgan Stanley’s $7bn acquisition of Eaton Vance yet another example of just how crucial tie-ups are to survival in this cutthroat climate.

It is worth noting that M&A is certainly no cure all in a crisis. Franklin Templeton continues to see capital take flight as investors pull their money from its various funds for the sixth consecutive year ahead of its Legg Mason deal. Perhaps this is a sign that the industry’s obsession with scale has its limitations and represents an opportunity for smaller tech-savvy firms to seize upon.

"Watch now for the well-established boutiques, management-owned and operated, managing a fraction of the trillions of the behemoths," concludes Ruffel. "They are big enough to clear all regulatory and technology hurdles, immersed in their field of choice, differentiated by their willingness to constrain their capacity, focused on asset management and not asset gathering, and comfortable with aligned fee structures."

"The scales are tipping — some colossi will survive but the smarter money will flow elsewhere."

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