Asset managers are facing a number of tough macro-economic headwinds, which have been triggered by a perilous combination of high inflation, geopolitical turbulence, soaring government debt, and de-globalization. If these firms are to thrive amid these adverse conditions, they will need to make substantive changes to their traditional operating models.

Speaking at the inaugural BBH Insights Exchange event in London, asset management experts from Royal London Asset Management, Global X ETFs and Alpha FMC discussed these challenges and how they are impacting the funds industry, before outlining how firms need to adapt.

Key Takeaways

• Although the investment landscape today is comparable to that of the 1970s, the drivers underpinning the high inflation that the industry has seen in 2022/3 – namely the impact of government stimuli during COVID-19; excessive sovereign debt levels; rising commodity prices sparked by the Ukraine war, and the push to net zero – have no historic precedent.
• Inflation spikes and recessions are expected to become more common occurrences moving forward.
• In order to navigate these macro-economic obstacles smoothly, managers may need to rethink the methods by which they raise money by finessing and tailoring their distribution strategies. Simultaneously, managers should make the investment experience more efficient for clients by digitalizing their onboarding and reporting procedures.
• Diversification across the entire liquidity spectrum will be integral if managers are to hedge their portfolios against risks, such as inflation. Multi asset exposure could also help managers win mandates which they might not have otherwise acquired.

The Not-So Roaring 2020s

Although inflation in major markets may have peaked and is projected to trend downwards later this year, Trevor Greetham, Head of Multi-Asset, Royal London Asset Management, warned against complacency. “We are in an old paradigm, which is more like the investment environment of the 1970s. We are seeing a fundamental shift away from low, stable, predictable inflation to high, unstable and unpredictable inflation. The world is likely to experience a series of inflationary spikes in coming years, a phenomenon we'd describe as spike-flation,” commented Greetham.

However, Greetham noted that inflation today is unique for several reasons. “The high inflation we are suffering at the moment can be traced back to the massive stimulus pumped into the world during the Great Lockdown in 2020 and left in place too long," he said. Factors that lead Greetham to expect continued inflation shocks include tight commodity supply as we transition to net zero, heightened geopolitical risk, deglobalization and high levels of public debt. 

With inflation becoming increasingly ubiquitous, so too will Central Bank interventions, something which could contribute to more frequent recessions. On the upside, current talk of a commodities super-cycle is driving what Alexander Roll, Investment Strategist Associate at Global X ETFs, calls a “race to own rare earth materials” that he believes will be at core of growth in the near future. The question now is how can asset managers position their businesses to weather the current volatile market conditions that lie ahead.

A Thoughtful Approach to Client Engagement is Critical

Capital raising during choppy markets can be a difficult undertaking, even for the most astute money managers. Investment firms, therefore, need to take a more nuanced approach towards how they distribute their fund products, a point made by Adrian Whelan, Global Head of Market Intelligence at BBH. “Managers need to have a coherent distribution strategy, so that they are selling the right products, in the right markets, to the right investors,” he said.

A refined distribution strategy and intelligent targeting of investors will be pivotal in helping firms retain assets.

Ensuring that clients have an enjoyable and frictionless investment experience will also be critical if managers are to maintain and grow wallet share during this recessionary backdrop. “A positive client experience means customers will be stickier in times of poor performance,” said Olivia Vinden, Director, Head of Fintech and Innovation, Asset and Wealth Management Consulting at Alpha FMC. To achieve this, investments need to flow into an operating model where decisions can be quickly implemented, in a cost-effective manner.

How can this be Achieved?

Right now, processes such as customer onboarding and client reporting are plagued with inefficiencies and intermediation as a number of managers are still reliant on manual processes and analogue systems, when carrying out these activities.

“The most important part of the customer journey is the first contact, namely client onboarding. It is critical that activities like AML (anti-money laundering) and KYC (know-your client) checks – together with client reporting – are conducted seamlessly. Getting the basics right is the strongest foundation to building success,” said Whelan.

To enable this, asset managers will need to invest more into technology systems – such as cloud-based solutions – to facilitate automation in client onboarding and reporting. “Spending on the client side, especially during periods of difficult performance, is a really effective way of keeping clients and gaining new clients,” said Vinden.

However, Whelan stressed firms should use disruptive technologies selectively and pragmatically, highlighting tools like Artificial Intelligence (AI) will be effective in augmenting standardized repetitive tasks, such as monthly investor reporting – but they will never be a replacement for nuanced direct client interactions. Vinden concurred, adding that firms should use these tools to remove any redundancy in their operating models and improve connectivity between multiple systems to get at the data they want: “I think the industry as a whole needs to focus on real issues, as opposed to what some have termed innovation theatre,” she said.

Product Diversification is Important

Recent macro-events reinforce the importance of having proper product and asset class diversification. Product diversification may not only help protect managers’ portfolios against risks such as inflation and interest rate rises, but it can help them target a wider investor demographic and obtain new income streams during volatile periods. 

“Historically, asset class diversification has taken the form of having exposure to both stocks and bonds. However, I believe we will have more years like 2022 where both stocks and bonds devalue simultaneously because of inflation shocks. This means investors will need to have access to other asset classes including inflation hedges like commodities and commercial property,” said Greetham.

How are Asset Managers Responding?

Increasingly, managers offering traditional open-ended funds or hedge funds are launching strategies focused on private markets, such as private equity and debt. Buoyed by strong returns since the financial crisis, private market strategies are attracting significant amounts of capital, with Preqin, estimating inflows will reach $18.3 trillion by 2027, up from $9.3 trillion in 2021. “The traditional 60-40 portfolio model is changing, as large asset owners and allocators need to incorporate a different asset mix, in order to manage both returns and liquidity expectations – private market exposures are becoming a larger part of the asset allocation mix globally. There are plenty of opportunities in private markets, especially as fewer companies are choosing to publicly list,” said Whelan.

Conversely, it is not only open-ended managers chasing the illiquidity premia. With higher borrowing costs and inflation weighing down revenues at their underlying portfolio companies, some private equity managers are moving up the liquidity spectrum.

“We have observed illiquid private equity firms launching strategies focused on equities and bonds, while some are developing ETF (exchange-traded fund) capabilities. This will give private market managers, who historically have targeted institutions, the ability to access retail money. Similarly, some mutual funds are starting to seriously consider transforming their products into ETFs. This dynamic is most evident in the United States but the conversation is also rising in Europe and Asia,” said Whelan.

At a sector-specific level, Global X ETFs’ Roll, said asset managers should be thinking about building up their holdings in disruptive technologies, especially cybersecurity. “Cybersecurity is a long-term secular growth trend, which also offers defensive characteristics in the current challenging geopolitical climate. Surveys of CEOs at leading companies repeatedly highlight that they are allocating more budget to cybersecurity, providing the sector with strong pricing power and cross-selling opportunities. Companies do not have a choice, as they need to protect their data from growing attacks and the ever increasing use of cloud infrastructure,” said Roll. “All roads lead to cybersecurity and semiconductors, which are the “pick- and shovel” businesses of the modern economy”.

In order to withstand future market shocks, asset managers should think about adopting these three steps.

1. Refine your distribution strategy, so that you are targeting the most suitable investors in the correct markets.
2. Invest in your systems to make client experiences – such as onboarding and reporting – as pain-free and straightforward as possible.
3. Consider diversifying into new asset classes or strategies to both help protect your existing clients during downturns and broaden your appeal to new investors.

Investing in a New Normal

Asset managers need to start thinking more laterally about how they will operate in a market environment, which is likely to be characterised by inflationary risk and more frequent recessions. In order to mitigate some of the challenges that potentially lie ahead, asset managers need to adopt a more focused approach towards distribution; augment investor experiences through automation, and embrace new asset classes, including those which may be outside of their comfort zones, such as private market investments of various types.

Opinions, forecasts, and discussions about investment strategies represent the presenters’ views as of the date of this panel and are subject to change without notice. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations, nor intended to predict or guarantee the future performance of any markets. The types of investments discussed have varying degrees of risk.

This material contains “forward-looking statements” which include information relating to future events, projected future performance, strategies, expectations, and competitive environment, and regulations.  Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved.  Forward-looking statements are based on information available at the time the statements are made and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in, or suggested by, the forward-looking statements.

The views expressed may or may not be consistent with the views of Brown Brothers Harriman & Co. and its subsidiaries and affiliates (“BBH”), and are intended for informational purposes only. BBH is not affiliated with Royal London Asset Management, Global X ETFs and Alpha FMC.