Following the market collapse of 2008, 2009 was a year when asset managers quietly regrouped in terms of portfolio performance and operational margins, which now stand at about 15% on average across Europe. But what will happen in the sector in 2010? Where will asset managers invest their funds and how will they manage the risks associated with investing in alternative instruments and emerging markets? Is there now a trend for investors to look again for extreme growth – what evidence is there that they are getting ready to increase the risk in their portfolio? And with all that in mind, how can asset managers use technology platforms to balance all of those risks? Has the economic crisis opened their eyes to the need for more structured processes internally to manage portfolios and risk?
The first opportunity undoubtedly lies in investment in equities and debts in emerging markets. The BRIC (Brazil, Russia, India and China) countries in particular are a source of growth, mainly because they did not experience a banking crisis in the same way that Western economies did. Even eastern Europe and Scandinavia, which had less of a crisis (excepting, of course, Iceland) now face more of an uphill economic struggle (because of government lending to the financial services sector) than the BRIC countries, which are rebounding more quickly than western markets.
The second opportunity has been created by the retreat to vanilla products in asset management during the downturn. Pension funds in particular became understandably perturbed by the volatility of the markets and wanted to take fewer risks on returns as well as creating much more transparency on underlying trends and positions. However, asset managers in some countries in Europe, notably in the Nordics, have already made a move towards investing in a wider range of emerging markets, structured products and alternative instruments. There have also been big moves to interest products and equity mutual funds. There’s a focus on inflation and interest rate derivatives, as firms and investors position themselves for inflation (this is widely expected, as most governments are under pressure to keep rates low to fuel recovery).
Alternative investments have recouped their prominence, as asset managers, primarily on the retail side, seek to build returns beyond those achieved by vanilla investments. This has, in turn, sparked a rethink in asset managers’ attitudes towards risk management. The financial crisis acted as something of a wake-up call, exposing the poor quality of internal systems – which were often based on nothing more than standalone spreadsheets.
Asset managers found that it was impossible to build a complete global picture of risk – including exposure, currency and counterparties – across their portfolio using those systems. It was possible to report on positions to clients, but this reporting was either very limited or manual. More advanced reporting was pretty much limited to large clients and institutions. This new emphasis on risk management has led asset managers to take another look at their IT strategy. While it’s been clear for a while that in-house built systems can be expensive as well as inefficient, it has been difficult for asset managers to invest in new third-party software during the turbulence of the past two years.
Now that funds are flowing back to asset managers, the money is again available to implement more robust front-to-back risk and portfolio management systems. One example is Garantum Fondkommision, an independent structured products boutique headquartered in Stockholm. Established in 2005, it has grown to become one of the leading and largest players for structured products in the Nordic market, with close to 700 issues and a valuation in the underlying markets of approximately €3bn.
Garantum is operating in a Scandinavian market that is increasingly focused on alternative investments. This means that the ability to demonstrate robust risk management is vital, both from a regulatory and a client service point of view. A range of different forces are impacting the industry. Regulatory pressure will shape how risk needs to be managed and will set constraints on how the market reacts. Structured products are growing in importance in the Nordic region because organisations need to better manage their risk exposure of their investment in the markets.
The Nordics also experienced a significant banking crisis in the beginning of the 1990s, which led to the introduction of a number of safeguards to prevent this happening again. These safeguards meant that both the state and the owners of some of the big financial institutions acted forcefully to prevent defaults. At the same time, the Nordics have a very strong economic base and a competitive export industry (which also increases volatility), while industry overall is doing well – leading to a quicker rebound than the UK.
Risk management has always been important, but investors are now much more knowledgeable, especially when it comes to credit risk. Regulation and competition in the market has driven the development of tools to help manage risk, but in the past these have been heavily used by traders – they are now being used more widely across the business.
The Nordic asset management marketplace is much smaller than the UK market. For example, the top 10 providers of structured products in Sweden hold over 90% of the market. A smaller marketplace is more volatile – as smaller volumes impact the price more, and this makes the market attractive for structured products to manage risk. Another difference is that a country like Sweden has six state pension funds run by the Government. One of these funds invests national insurance payments into a fund, another focuses on investing in small start-ups.
There is currently a great deal of discussion about the future shape of these funds, and how investment may be managed, but clearly the emphasis in the area has been on safe returns rather than on-the-edge speculation. Fifteen years ago the market was based on trading stocks – now there are also commodities, options, structured products and hedge funds. There are new products, new regulation and new customer service levels. In-house systems designed to deal with trading in the past just can’t keep up with all of that without spending a lot of time and money on them – which is where third-party systems can be useful.
So, technology-wise, asset managers are clearly ready to invest again in new systems, especially in the areas of risk management and customer service. Commentators have described the current picture in asset management as a dam bursting – pent up demand for new systems that was constrained by lack of available funds for investment is now coming through strongly.
The asset management market will continue to pick up in our region – and globally. There will be adjustments on the way. In the near future, the market prices will move sideways, but we expect the next big movement to be upwards – volume will come back and there will be money to be made from structured products and alternative investments. But it’s clear that asset managers are going to have to manage risk differently in order to succeed.
Across Europe, and in the Nordic marketplace in particular, there is a groundswell of movement towards alternative instruments and investments. Asset managers recognise that they need to broaden their range of investments to generate returns, but they also realise that they can’t manage this new layer of complexity – and the risks associated with it – without the right toolset.
There continues to be speculation in the global asset management industry about the legislation and regulation that lies ahead. There is one certainty: that it will be increasingly difficult to rely on home-grown systems that can’t easily accommodate change – whatever that may be.
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