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Picking NRI's Brain- Yasuki Okai : Asset managers’ source of differentiation shifts from processes to data

Feb 05. 2019

By Yasuki Okai, Executive Fellow, NRI

When I visited the US in late July last year, I had the opportunity to discuss the US asset management industry with local experts. The talks focused on firms’ cost-cutting efforts, reflecting an increasingly challenging earnings environment amid the global shift to passive investing. In their attempts to reduce costs, asset managers are trying to automate and outsource a wider range of operations.20190204_en

Some of the larger firms are using methods such as robotic process automation (RPA) to automate business processes. The use of RPA itself is nothing new—there have been reports for several years now—but recently it seems to have gone to the next level. In the past it was typically used for the automation of certain back- or middle-office operations, but recently a wider range of operations has been targeted. Almost certainly, firms now have enough experience with automation that they can target groups of processes that are well-suited to automation. Specifically, I was told that a number of asset management firms are trying to automate all of the operations involved in the passive investment process. As yet it would appear that no one has succeeded in this effort, but it will probably not be long before someone does.

More processes are also being targeted for outsourcing. Many firms in this sector are relatively small companies that are unable to undertake large-scale investments, which is why they were quicker than banks to outsource their operations. Asset management firms have now been outsourcing back-office processes to so-called custodian banks for more than 30 years. They began outsourcing middle-office processes about 20 years ago, and over the past few years they have even started to outsource front-office operations, such as trading.

In the past, brokers bundled together execution and information services (e.g., corporate analysis) for sale to asset management firms. But MiFID II, which took effect this year, prohibits the bundling of these types of services for the sake of ensuring transparency and requires that they be priced and sold separately. For asset management firms, this means that trading operations, which traditionally had the dual role of executing trades and obtaining investment information from the broker, will now consist solely of the former. Unless a firm is using an investment strategy that targets excess returns with trading, this new environment will be more conducive to the outsourcing of trading operations themselves, which regulatory compliance has made increasingly costly, to brokers or other specialists. Reports that State Street, one of the leading custodian banks, planned to acquire OMS vendor Charles River in July for $2.6bn were viewed by market participants as signaling a further expansion of outsourcer services to the front office.

If outsourcing expands beyond the back and middle office to encompass trading operations, the next question is what that will leave for asset management firms. Possibilities—although this is by no means an exhaustive list—include product development, the generation of investment ideas by fund managers, and sales efforts targeting retail and wholesale customers. Asset management firms will therefore need to differentiate their services in these areas from those of competitors. Perhaps the most important element in those efforts will be the data required for marketing analysis, corporate analysis, and customer analysis.

Traditionally, a key way that asset managers differentiated themselves from competitors was the development of more efficient business processes. This may continue for some managers, as indicated by the fact that some are seeking to automate the passive investment process. In general, however, it is becoming increasingly difficult for asset managers to differentiate themselves on the basis of processes alone. Instead, we appear to be entering a world in which the quantity and quality of asset managers’ data will provide their primary source of differentiation.

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