ETFs: The momentum keeps growing
As Fund Forum drew to a conclusion in Copenhagen, there was a visible degree of apprehensiveness among a number of the active asset managers in attendance. The industry is facing stark competition from passive funds such as ETFs (exchange traded funds), which many experts predict will overtake active managers imminently, whereas others think it has already happened. That said, however, speakers at Fund Forum said ETFs are not without their challenges.
With the US ETF market becoming increasingly saturated, one panellist said managers launching conventional index tracking products were finding it much harder to accumulate meaningful assets. As a result, pure ETFs are now making way for more innovative products such as smart beta or active ETFs. Even though the US market is oversubscribed, Europe is a different story altogether as its investors – both retail and institutional – have traditionally been underweight ETFs. As such, ETF managers are likely to begin targeting European investors soon. Elsewhere, the barrier to entry for ETFs is getting higher. A speaker pointed out the ETF market is dominated by only a handful of mega managers, adding firms required at least $100 million to $500 million in AuM if they are to successfully scale their businesses.
Making the way for distributed ledger technology
Furthermore, active managers are facing other serious problems too. Their fee structures are being increasingly challenged by investors, who are becoming ever more impatient with the industry’s lowering returns. In fact, this is one of the biggest reasons why passive funds have amassed such large inflows over the last few years. Regulations such as MiFID II and RDR are also eating into margins. Speaking at Fund Forum, Kate Webber, our Head of Product Development, warned that a reoccurrence of choppy market conditions could further exacerbate the cost imbalances already being faced by active asset managers. If managers are to overcome these impediments, they will need to find ways to rein in their operational costs. It is here where technologies such as DLT can play an integral role.
Fund distribution is an activity laden with inefficiencies, intermediation and duplicative processes, and it all adds non-trivial frictional costs to asset managers’ bottom lines. Edward Glyn, Calastone’s Head of Global Markets, re-iterated during Fund Forum that it is here where our DLT-enabled Distributed Market Infrastructure (DMI) could help eliminate some of those overheads and deliver full operational alpha. By creating a common, digital global marketplace supporting the trading and settlement of funds, Edward said Calastone’s DMI could generate £3.4 billion in savings for the global funds industry each year.
A lot was mentioned at Fund Forum about how DLT could facilitate the tokenisation of listed securities and unquoted illiquid assets, generating widespread market liquidity and new investment opportunities for institutions. However, DLT could also be used to tokenise mutual fund units, something which Edward Glyn said would make the fund investment process more accessible and easier. A paper by Deloitte acknowledged as much too, stating that tokens are highly divisible, which means “investors can purchase tokens that represent incredibly small percentages of the underlying assets.”  As the process by which investors purchase tokens is far more streamlined, Deloitte argues it could result in a reduction of minimum investment amounts.  Through tokenisation, the funds industry will democratise the investment process, making its products available to a wider, less cash rich demographic.
UCITS faces probing questions
Shortcomings in the UCITS’ rules were referenced extensively at Fund Forum. Under the UCITS regulation, a fund is only permitted to have a maximum of 10% of its assets exposed to unquoted or unlisted securities. The premise behind this restriction is simple. UCITS are supposed to offer either daily or weekly liquidity to investors, something which is not possible if the underlying assets are infrequently traded or difficult to value. That a high-profile fund was allowed to breach this 10% limit is likely to raise concerns about governance, and it could lead to further regulatory intervention. UK regulators – in particular – have been vocal about this well-documented incident. The UK FCA is on record as saying EU rules could well be changed or jettisoned post-Brexit as a result of this incident.
ESG: The rush to go green
ESG (environment, social, governance) dominated not one but two entire days at Fund Forum. The reason is fairly self-explanatory, namely that managers, their investors and regulators all think it is important. A number of managers believe that ESG investing will help the industry build up its credibility among more socially conscious millennial investors, a demographic that to date has shown little interest in investment funds. Despite this, our own research indicates that millennials in fact prioritise fees and returns over ethics, so the issue is not quite as black and white as many make it appear.
Regardless, many institutional clients recognise that a failure by their managers to transition into ESG assets is a potential investment risk and are increasingly incorporating ESG questions into RFPs. Simultaneously, regulators – especially those in the EU – are in the process of drafting rules on sustainable investing. The ESG debate shows no sign of dissipating. As such, this is an issue the funds industry needs to keep on top of.
Kate Webber, who is also the founder of the Women in Asset Servicing network, said diversity was essential if the industry is to thrive. She pointed out that women are chronically underrepresented in certain areas of the financial services, most notably fin-tech. She said that progressive, forward-thinking organisations such as Calastone are taking a lead in trying to encourage more women to takes roles in software development. Calastone is helping the cause by working with organisations that encourage schoolgirls to continue studying STEM (science, technology, engineering and mathematics) subjects beyond core GCSE level.
The view ahead
With the funds industry facing so many challenges – whether it be rising operational costs, regulation or increasing competition – a change of tactic is required. Embracing new distribution strategies and new technologies will be key if the funds industry is to stay competitive and attract flows moving forward. If you would like to learn more about our technology and the DMI, please contact me at [email protected]
(1) Deloitte – The Tokenisation of assets is disrupting the financial industry: Are you ready?
(2) Deloitte – The Tokenisation of assets is disrupting the financial industry: Are you ready?