Interview with Damien Walgrave
Partner- PwC Belgium
[Banking Boulevard]: In 2014 your firm published a paper (1) which provided insight as to why changing demographics and markets were thrusting asset management to centre-stage.
[PwC]: That’s right, two years later we confirm our statement. We firstly said regulation would continue to hinder banks. Second, as the world ages, we mentioned that retirement and healthcare would become critical issues that asset management can solve. In this context we added that capital preservation and alpha generation would be key. Third, we said asset managers would dominate the capital raising required to support growing urbanisation and cross-border trade: in this respect growing asset classes in infrastructure and real estate play into alternative asset management firms’ areas of expertise. Fourth, we said asset managers would be at the centre of efforts by sovereign investors to invest and diversify their huge pools of assets. In this regard, we mentioned that, alternative asset management firms were ideally positioned to partner with them.
[Banking Boulevard]: So logically, your most recent study is devoted to alternative asset management (2). In this prospective analysis your firm elaborates on the expected changes and challenges the sector will face through 2020.
To start with, the best way to define alternative asset management probably consists in presenting the typology of investments it concerns. What are the main assets categories involved here?
[PwC]: Alternative asset managers specialise in the investment in such asset classes as:
- Private equity
- Real assets [ as infrastructures, transport, real estate, energy ],
- Hedge funds or funds of hedge funds,
- Credit oriented assets (as mezzanine funds, small caps direct lending funds, rescue lending funds), etc.
[Banking Boulevard]: What is alternative assets’ expected growth over a 4 years horizon ( to 2020), and why do alternative asset managers consistently attract more funds ?
[PwC]: Based on our analysis, the first three above categories, namely private equity, real assets, hedge funds or funds of hedge funds are expected to grow from $ 7,9 Tn in 2013 to $13,6 Tn in 2020 in our base case scenario and to $15,3 Tn in our high case scenario.
Growth in assets will be driven principally by three key trends:
- a government-incentivised shift to individual retirement plans;
- the increase of high-net-worth-individuals from emerging populations;
- and the growth of sovereign investors.
This creates the need for more tailored, outcome-based alternative products that provide capital preservation, but provide upside opportunities.
Alternative firms, with their emphasis on investment outcomes rather than products, and specialisation rather than commoditisation, will increasingly attract investors seeking customisation, diversification and genuine long-term alpha. At the same time, alternatives will increasingly occupy a prominent allocation in the world’s economies, both established and emerging. Fast-forwarding to 2020, alternatives will have a centre stage role to play in the investment universe and in the global economy.
So, by 2020, there will be, in our view, a fundamental shift towards alternatives by many sovereign and public pension funds. This is the continuation of a trend that first gained traction in the US and then globally. Actually, it is expected that, by 2020, global pension fund assets will have reached $56.6tn globally ,with alternative assets expected to play a considerably larger role in their asset allocation mix. We actually expect alternative asset management to become synonymous with ‘active asset management’ and, increasingly, ‘multi-asset class solutions’.
[Banking Boulevard]: In this paper, the firm refers to a series of business imperatives that alternative asset managers have to cope with.
[PwC]: Yes. To help alternative asset managers plan for the future, we have considered the likely changes in the alternative asset management industry landscape over the coming years and identified six key business imperatives for alternative asset managers. We have then examined how managers can implement and prosper from each of these six imperatives.
[Banking Boulevard]: Can I invite you to comment some of these business imperatives, as for instance the selection of distribution channels which comes first on your list?
[PwC]: Sure, alternative firms by 2020 will adopt world-class ideas and practices from the broader financial services industry and from traditional asset managers. They will develop more sophisticated market strategies, more focused distribution channels and better recognised brands. Most alternative firms will work out exactly which investor channel or channels they want to target and develop relevant strategies and products. Some will focus more systematically on sovereign investors, pension funds, other sophisticated institutions and private wealth markets. Others will target emerging markets, and still others will pursue the potentially huge asset flows through liquid alternative products. A small number of mega-managers in the alternatives space will operate across all major geographies, channels and strategies.
[Banking Boulevard]: Sovereign investors constitute a major distribution channel. They require a direct and individualistic approach to earn their business.
[PwC]: That’s right. By 2020, sovereign investor assets are projected to grow by 6.2% to hit $15.3tn. Geographically and economically diverse sovereign investors will require a highly bespoke approach due, in large part, to their different economic objectives. Sovereign investors, comprising sovereign wealth funds, public pension reserve funds (PPRF) and other large pension funds, will continue to seek high levels of transparency. They will also seek high standards of governance, reporting and economic alignment with alternative firms.
Sovereign investors will also seek more in-house control and transparency over their assets. They are transitioning from a model of hiring external asset managers to talent insourcing, and are hiring experts across asset classes, industries and geographies. Where they interact with alternative firms, sovereign investors are consolidating relationships and seeking innovative ways to align both parties’ economic interests.
By 2020, there will be more sovereign investor participation in alternatives with the largest increases in allocations likely to be private equity, real estate and infrastructure. Sovereign investors pay a great deal of attention to past performance, regardless of the size of the asset management firm, so distribution to sovereign investors is not limited to mega-alternative asset firms. If long-term performance is outstanding, firms of any size can secure mandates.
Sovereign investors require a direct and individualistic approach to earn their business. Alternative asset firms need to thoroughly understand these non-homogeneous institutions, their individual needs and objectives, and develop long-term relationships with them.
[Banking Boulevard]: Another imperative that your study analyses is the growth strategy of alternative asset managers. In this respect, your paper refers to three models, namely: “build, buy or borrow”.
[PwC]: Yes, to develop their chosen business model [namely diversified alternative firm, specialty firm, or multi-strategy firm], firms will pursue one or more of three growth strategies: building, buying or borrowing.
Whereas, “builders” will grow by building out their internal organisations, leveraging and developing their existing capabilities and investment talent; “Buyers” will expand their alternative capabilities across asset classes and strategies by acquiring talent, track record and scale overnight. As for “borrowers”, they will partner with other institutions, including asset managers, wealth managers, private banks and funds-of-funds, to expand their investment capabilities and take advantage of broadened distribution channels. These ‘borrowing’ relationships will include, but will not be limited to, distribution arrangements, joint ventures and sub-advisory relationships.
[Banking Boulevard]: The next business imperative I would like to touch upon is the operational excellence. How can alternative asset managers bring their activities to the next level and meet their clients’ as well as the regulators’ expectations?
[PwC]: Successful companies in the manufacturing sector can readily adapt to product changes and the level of production. In a rapidly evolving environment, they are able to regularly overhaul their operations and retool their factories.
They do this cost-efficiently and without disruption to operations.
Likewise, alternative asset management firms need to be adaptable to changes in their product mix and the demands on their operations. From now until 2020 and beyond, they will consider how they can revamp their operations to provide customised solutions to institutional clients, support new asset classes, products and investors, and keep pace with regulatory and tax requirements.
They will seek to do all this in a cost-effective way that is not disruptive to their day-to-day business and in a way that focuses resolutely on profitability.
Owners, investors and regulators will raise their expectations beyond the standard of ‘institutional quality’. Having institutionalised their businesses, alternative firms will seek the higher standard of ‘industrial strength’.
Global regulators too will require varying and ever-increasing degrees of risk management, stress-testing and transition planning. Oversight of the firm’s risk management function will remain particularly acute, with an emphasis on independence from portfolio management.
To match these expectations and get to the next level – whether in terms of profitability, growth or diversification – alternative firms increasingly recognise that incremental change won’t necessarily move the needle. In some cases, transformational change is required.
Fees will continue to come under pressure as firms enter different markets and offer different – and, sometimes, lower fee or lower margin – products. So an increase in AUM will likely not result in a corresponding increase in profitability. Pressure on margins reinforces the need for firms to build agile, scalable and economically viable infrastructure.
An agile operating model requires firms to streamline operations more aggressively, automate processes and delete inefficiencies.
To do this, firms will build in more resource bandwidth with change agents who can drive process improvement while others will continue to drive the day-to-day operations.
Value-enhancing opportunities will include:
- Improving the ability to identify and measure cost reduction opportunities.
- Creating greater automated cross-functional workflow, both internally and with key service providers.
- Instituting straight-through-processing related to the extraction and transformation of data.
- Designing automated environments for routine and repeatable processes.
- Identifying and segregating high-volume, low-risk processes, in order to outsource or move to lower cost locations.
- Reassessing the organisational design across key areas to ensure there is the right balance of vertical (fund/entity) vs. horizontal (functional) orientation.
- Bifurcating roles where operational demands and unique skill sets highlight the need to do so. Examples include separating the reporting function from the accounting group and separating investor servicing from investor relations.
- Enhancing management insight into the costs, profitability and capital required to operate, or invest in new business segments, geographies or products.
- Using data analytics tools to identify and understand operational, tax or compliance anomalies and make decisions based on them.
Controlling operational risk
Alternative firms in the 2020s have undertaken systematic reassessments to identify, prioritise and manage their key business and operational risks, and to enhance the effectiveness of their operations.
The results of these risk assessments will provide a clearer picture of operational risks and allow management to focus on issues that really matter.
Improvement initiatives will be targeted first at functions under high operational pressure and consuming a high percentage of fee income. Targeted initiatives will allow firms to identify stress points in their operations, such as immature IT applications, key person dependency, and ad hoc processes supporting the end-to-end lifecycle.
There will be a reduced reliance on spreadsheets, manual processes and individuals with a high degree of institutional knowledge.
[Banking Boulevard]: and finally, how can alternative firms build a more dynamic compliance function?
[PwC]: The main ways alternative firms will build more dynamic compliance activities are:
- Building and enhancing controls and processes around their regulatory reporting as they do for other critical business activities. This requires greater collaboration between those with the subject matter expertise (compliance and legal) and those with reporting and analytical skills and control mindset (fund accounting).
- Investing in broader compliance resources with interdisciplinary skills extending beyond legal and compliance into analytics, reporting and technology.
- Pushing certain routine compliance activities into business units.
- Rationalising and reconciling the myriad reporting requirements.
- Developing a flexible data strategy to allow for centralised data capture either in-house or via outsourced solutions.
- Creating more systematic compliance programmes and checklists including automated record retention and filing, reminders and summary of information for proper review.
- Shifting from a ‘rules-based’ approach to compliance to a ‘principles-based’ approach for more consistent controls on a global basis.
- Investing in local expertise and creating local processes as alternative firms target investors from less saturated markets and adapt to new regulatory requirement
Contact PWC Belgium: Damien Walgrave PwC | Partner Tel : +32 2 7109621
PwC Bedrijfsrevisoren bcvba / PwC Reviseurs d’Entreprises sccrl
(1) PwC. Asset Management 2020 – A brave new world
(2) PwC. Alternative Asset Management 2020 - Fast forward to centre stage