Managers that embrace change, tech most likely to get ahead

The lingering effects of the COVID-19 pandemic likely to extend well into the new year combined with slower asset growth, continued pricing pressure and the urgent need for technology upgrades are creating a challenging environment for money managers.

"All of the macro issues affecting the global investment management industry fall into one bucket — maturation," said Kevin P. Quirk, principal, of Stamford, Conn.-based Casey Quirk, a practice of Deloitte Consulting LLP.

"The money management industry is experiencing classic maturation problems including slower organic growth that is mostly flat when capital market gains are excluded, fee pressure in most investment strategies, and an urgent need for technological advances for their businesses," Mr. Quirk said.

One of the biggest issues facing the industry is an oversupply of money management firms, Mr. Quirk said, noting that his firm believes "the business is massively oversupplied. An uptick in mergers and acquisitions will remove some of that oversupply," he said.

An exacerbating factor for money managers this year is asset owners' newly heightened impatience with problematic investment strategies, said Christopher M. Redmond, global head of manager research, Willis Towers Watson PLC, London.

"The time frame for patience with managers has gotten very short, especially for corporate defined benefit plans approaching buyouts. Tolerance for manager underperformance is very low," he said, adding that manager changes are on the rise.

Despite myriad challenges facing money managers, firms that are making transformative changes to their business models stand a good chance of surviving and thriving, sources said.

"The future is bright for asset managers — demand for investment management has never been higher — but it will be very different," said Michael G. Spellacy, New York-based senior managing director, global capital markets industry leader and global asset and management lead at Accenture PLC.

"The reality is that managers can't be complacent. They must transform themselves by bringing better data, better technology, better operations and the best humans together. Large managers haven't been forced to change for a long time. It's a muscle they haven't exercised lately," Mr. Spellacy said.

There will be winners and losers in the transformation stakes, Mr. Spellacy said. He separated the industry into three categories: Winners including firms that generate above-average returns and more profitability; niche firms in the middle that are "trying to figure out what to do;" and "the walking dead, which likely won't survive."

Other observers agree that 2021 likely will be a strong M&A year in the investment management industry.

New York-based Morgan Stanley & Co. LLC said in an Oct. 25 report that the asset management industry is "highly fragmented" with the 10 largest firms managing 35% of market share, making it appear "ripe for consolidation."

Michael J. Cyprys, a Morgan Stanley senior analyst covering asset managers and brokers and a co-author of the M&A report, agreed, noting "there is a strong case for consolidation. We've seen a pickup in deal activity" as managers seek to add new investment strategies, distribution channels, client segments and geographic coverage.

"It's all about organic growth resulting from the best M&A," Mr. Cyprys said.

Investment strategies likely to do well this year and which likely will be in demand for asset owners include "less liquid, less trafficked and more complex strategies like private credit, real assets, infrastructure and private equity, which may spur interest from asset manager buyers looking to add these capabilities to their investment offerings," Mr. Quirk said.

Despite the challenges, money managers themselves generally are optimistic about the fortunes of their firms in 2021.

The Capital Group Cos., Los Angeles, is very upbeat about its prospects this year, especially for the second half, said Ralph E. Haberli, president of the firm's institutional group.

"We had a busy fourth quarter (regarding investment inflow) and anticipate having a busy start this year," he said, noting that engagement with the firm's clients is up in volume between 25% and 40% and inflows continue from existing and new clients.

"As we head into this year, we've got quite a lot of confidence in our pipeline and we expect that to continue," Mr. Haberli said.

He added that Capital Group's institutional investor base is concerned about the divergence between the stock market economy and the real economy and his staff is working with them to understand the consequences on their portfolios.

"As strong as the markets have been, the reality is that it has not translated through to corporate plan sponsors and the pressures that certain sectors and companies are under. Certainly public plans are under a ton of pressure given where tax revenues are, and that is something we are closely watching. We think that's going to be a real challenge for clients and a headwind for all of us to work through together," Mr. Haberli said.

Capital Group managed $2.1 trillion as of Sept. 30.

All the money management executives interviewed said they continue to invest significantly in technology across all areas of their firms.

The Vanguard Group Inc., Malvern, Pa., for example, describes itself as a "technology-first company," said Matthew C. Brancato, principal and head of institutional investor services.

He said Vanguard is "investing millions of dollars to harness personal data to ramp up our digital capabilities in the context of driving operational effectiveness and efficiencies."

A portion of the millions Vanguard earmarked for technology upgrades went to outsourcing the day-to-day operations of its defined contribution plan record-keeping platform to Infosys Ltd., Bangalore, India, last year to cut costs and improve its technology capabilities. As part of the deal, 1,300 Vanguard employees who worked in the record-keeping unit joined Infosys.

Vanguard will reap the benefits this year of its new cloud-based DC plan platform, which went live in October, "allowing us to ... deliver hyper-personalized services," including more education and individualized advice to help investors meet their investment goals, Mr. Brancato said.

Vanguard has 1,500 defined contribution plan sponsors with almost 5 million participants on the new cloud-based record-keeping platform.

As of Nov. 30, Vanguard managed a total of $6.9 trillion of which $1.5 trillion was managed in DC plans.

Another sign of money manager optimism is a healthy level of recruitment, said David Barrett, managing partner of David Barrett Partners LLC, a New York-based executive recruiting firm.

"I don't want to be cavalier but it's pretty much business as usual now. People were still in shock in the second quarter last year and not much hiring was going on, but pent-up demand took over at the end of the third quarter and through the fourth quarter and likely will continue into this year," Mr. Barrett said.

Among optimistic managers without intentions to either sell themselves or buy other firms is Chicago-based value manager Ariel Investments LLC.

"I think consolidation in the money management industry will continue, but we won't be a part of it," stressed John W. Rogers Jr., Ariel's chairman, co-CEO and CIO.

Like other value-oriented managers, Ariel produced good returns; the firm's $1.9 billion Ariel Fund mutual fund was up 21% in October and November when the market flipped to favor value strategies, Mr. Rogers said.

Ariel, which manages $13 billion in active value equity strategies, has added a lot of new clients over the past several months, Mr. Rogers said, noting "this is a really, really good time for us. We think 2021 will be like 2000 (and) value will come roaring back. It will be a tale of two markets with small- and midcap value stocks leading the charge and large-cap growth stocks will lead the S&P 500 down."

Minority-owned Ariel is among the money managers that are deepening their engagement in diversity and inclusion activities both internally and with the companies they invest in.

Mr. Rogers said the firm has gravitated away from "the old socially responsible investment world to … building out a well-established ESG presence," noting that Ariel itself has a diverse workforce and is pushing the companies it invests in to be more diverse in terms of the composition of their boards as well as within their employee bases.

Regarding where and how their employees work this year, most money managers are employing a hybrid model with most of their employees working remotely all or most of the time, with the balance regularly working in their offices, said industry observers.

Accenture's Mr. Spellacy said many managers will choose a hybrid work model because "working conditions under COVID-19 have been like a time capsule into the future given the forced adoption of better technology and new methods of customer engagement."

But having most employees working remotely may be difficult for many investment management companies, Mr. Quirk warned. "The money management industry is an apprenticeship business. This industry really values being together," he said.