Asset management firms build muscle, trim fat

Digitalization and outsourcing provide new opportunities

With inflation cooling and markets showing gains, asset management firms are moving out of crisis mode and gearing up for growth. They’re finding it’s like trying to jump back into an abandoned exercise routine.

Asset management firms need to build muscle. But they also need to trim some fat. The two processes go hand in hand as firm leaders work to improve their fitness. When they do so, firms are building muscle by:

Providing superior customer experiences through personalization, client-centric services, digitalization, and scenario-based analysis that’s augmented by technology
Reaching new customers through partnerships, mergers and acquisitions
Leaning into the credit market at a time when high interest rates are leading some customers away from banks
Targeting top talent that can help them develop winning strategies — and deliver on them

'Buoyant' expectations for growth in asset management

6:36 | Transcript

At the same time, firms are freeing up additional capital to devote to growth activities by eliminating costs that might not be core to their businesses. They’re finding cost savings by outsourcing processes and work that can be done for a lower cost by third-party service providers. They’re using robotic process automation and artificial intelligence to perform repeatable tasks and enabling their people to focus on the higher-level strategic work that can drive growth at their organizations.

None of this is easy, as the muscle-building and fat-trimming require the intense effort familiar to anyone who’s ever embraced a no-pain, no-gain regimen. Growing this way requires technology modernization, operating model transformation and post-merger integration — so much change — and there aren’t many people who enjoy change.

But after you’ve been at it for a while, and you’ve built the muscle, trimmed the fat and accomplished the growth you sought, you can take a breath for a moment. And it feels really good.

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A hurdle for growth

“The increasing costs of compliance are really hurting some of the smaller firms.”

Michael Patanella

National Managing Partner for Asset Management

New SEC rules pack a punch

The pursuit of growth for asset management firms in the current environment is tempered by new private fund regulations approved by the SEC in August that have established unprecedented compliance requirements in this sector. Although many firm leaders wrote comment letters pushing back against the changes, the SEC established new disclosure, audit and documentation requirements that will raise the cost of compliance and may alter some of the strategies that funds use to attract certain investors.

As with so many other challenges in business today, some of the requirements can be made less daunting through the use of technology. Automation can provide considerable help with the disclosures newly required by the SEC. But firms that haven’t already invested heavily in technology may be at a disadvantage as they work to comply with the rules.

“The increasing costs of compliance are really hurting some of the smaller firms,” said Grant Thornton National Managing Partner for Asset Management Michael Patanella. “They have a longer time horizon to implement the new requirements, but even with that, becoming compliant is going to be an additional cost and will take time.”

With compliance-related expenses set to rise, firms need to find other areas to cut costs so they can have more capital available to finance their growth objectives. In addition to compliance, finding other nonessential things to not spend on is almost as important as deciding how to invest the capital that you do have.

Grant Thornton National Managing Principal for Growth Advisory Scott McGurl said leading asset management firms are going through an exercise of figuring out how not to spend by focusing on the following questions:

What’s our core business?
What do we “right-size?”
What functions can we integrate?
Where can we use technology to improve efficiency?
What can we outsource to third parties?
Do we have to be a back-office shop?

“As you look at the larger asset managers and do peer comparisons on SG&A [selling, general and administration] trend lines and profitability, there’s room for improvement,” McGurl said. “There’s a lot of overhead right now, and with the markets as they’ve been, the larger firms are really focused on SG&A reduction and establishing expense-reduction control towers.”

The core business for these firms is providing excellent customer service and offering investment alternatives to provide opportunities for their clients to grow their wealth. That’s where they want to spend their money, and anything else is a candidate for outsourcing or use of technology to improve efficiency.

Tax functions, administrative and accounting services, internal audit, compliance, and even human resource services are areas where firms are finding ways to cut costs.

Delivering at the core

Firms work to improve customer service

When firms consider what truly differentiates them from their competitors, they invariably decide that investing in customer service helps them get where they want to go. The trend toward personalization that has transformed business models in other industries is also important in asset management, and technology is providing ways to deliver the personal service that clients crave.

Technological platforms make it possible to give clients volumes of information on their investments that they’ve never had access to before — without needing to spend employee time preparing the documents. Technology also makes it easier than ever to determine a client’s own precise, personal needs and create an individualized portfolio to meet them.

“Firms are really getting to know the objectives and strategies of their end clients and putting together an enhanced client experience to get them into the right assets for their portfolio, using new technologies for decision-making,” McGurl said.

Firms are using AI and machine learning to optimize portfolios, using algorithmic trading and tech-enabled, scenario-based analyses that consider a huge array of market factors to advise on the best investing strategies for a client’s portfolio, depending on their individual preferences.

Meanwhile, Patanella said two particular areas are drawing substantial attention in the current market. One is the credit markets, where the Federal Reserve’s interest rate hikes have cut into banks’ ability to provide loans, opening up opportunities for other investors.

Another market that’s drawing considerable interest is real estate. The COVID-19 pandemic had a significant impact on both commercial and residential real estate. The work-from-home culture caused office space demand to plummet in many areas, and in some cases young people who previously had flocked to densely packed urban residences fled to the suburbs.

With the pandemic subsiding, the real estate market has become volatile, with opportunities and risks for everyone.

“Many firms aren’t focusing on new investments in real estate,” Patanella said. “Typically, that’s when the smart investors get in. As prices decrease and vacancies increase, the managers are looking for deals.”

Other markets that Patanella said bear watching are:

Healthcare, where ongoing technological innovation continues to hold promise for substantial improvements in customer service
Media and entertainment, where upheaval in streaming services and strikes by writers and actors present substantial risks — and opportunities

At the same time, Patanella said portfolios will remain diversified, with investments in hedge funds, private equity and index funds usually being part of the mix.

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Consolidation rules

Opportunities in partnerships and M&A

As some small firms struggle to keep up with technological investments and compliance burdens, M&A opportunities in the asset management sector have increased.

Larger asset managers are taking advantage of economies of scale and acquiring new capabilities in the hopes of attracting new customers. Joint ventures, partnerships and M&A are all on the table.

“Firms are selectively outsourcing and freeing up capital to invest in areas where you can grow and acquire new markets, new customers, new channels, and new products that aren’t in their portfolio and would take a long time to ramp up organically,” McGurl said. “I certainly see consolidation as a significant trend that’s going on in the marketplace.”

Firms also are seeing M&A as an opportunity to upgrade their talent in an environment where finding the right people for key strategic roles has been a problem for some time. Patanella said talent recruiting and retention is an issue that should not be underestimated in the current market.

“I certainly see consolidation as a significant trend that’s going on in the marketplace.”

Scott McGurl

National Managing Principal for Growth Advisory

He said younger employees’ openness to leaving for new jobs is causing employers to think carefully about their strategies related to compensation; diversity, equity and inclusion; and remote work. Some firms are finding ways to provide equity compensation to some of their most important people, and many are carefully considering work/life balance issues.

“Talent is extremely important,” Patanella said. “Asset managers who are trying to bring in talent are thinking about areas from a long-term perspective that maybe they haven’t really thought of before.”

Differing paths on ESG

Firms weigh big opportunities — and a backlash

One emerging area that is important to employees — and investors — is a company’s position on environmental, social and governance (ESG) issues. That’s an area where firm priorities have varied over the past 18 months.

Firms are staying on top of regulatory compliance as new rules get issued by various regulators and standard setters. But particularly during the difficult market conditions of 2022 — which also saw a backlash against ESG investments in some political circles — some firms chose ESG-based programs and initiatives as part of the fat to trim.

Others saw ESG as an opportunity to build muscle, with opportunities to appeal to younger investors and invest in companies that are take advantage of Inflation Reduction Act incentives to build clean energy infrastructure. At the very least, many firms are looking to grow their client bases and assets under management by offering more ESG-inclusive investment opportunities.

“ESG continues to be a big focus, especially with large asset managers,” McGurl said. “They are incorporating ESG considerations into portfolio strategies and investment processes, and they’re looking for ESG-focused products and sustainable investment solutions. There’s a socially conscious investor group that’s particularly of interest to many firms.”

Ultimately, the diversity in responses to ESG mirrors the growth environment for asset management firms in general. Just as there are different routines for improving your fitness, there is a variety of opportunities to grow in the asset management sector. A firm’s decisions on where invest— and where to cut — are a part of its differentiation.

These decisions will appeal to some investors, and perhaps not to others. But finding the right mix is critical to meet the demands of the intense competition to appeal to more investors and to get them to invest more.