Towards a New Era of Asset Management by KNect365GlobalFinance

TOWARDS A NEW ERA OF ASSET MANAGEMENT A SNAPSHOT OF THE KEY CONVERSATIONS ABOUT ASSET MANAGEMENT THAT TOOK PLACE IN BERLIN AT FUNDFORUM INTERNATIONAL 2016. 1

CONTENTS PAGE Leading the Global Agenda ..........................................................

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Resilience, agility and optionality ....................................

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What will the distribution winners look like in 2020?

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Building the Capital Markets Union ................................

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Investment Strategy ...................................................................... Smart Beta: the inexorable rise of a monster? ..............

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To outsource or not to outsource currency risk management ............................................................................

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Key investment takeaways from #FundForum ..........

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The Future of Finance ..................................................................

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Innovations on the digitalisation of the investment value chain ................................................................................

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How will the industry be disrupted by robo-advice, analytics, robotics and blockchain? ..................................

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Responding to disruption ....................................................

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Predictive analytics and machine learning in finance

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WELCOME For the first time in its 26 year history, 2016 saw FundForum International move to Berlin. And along with a shift in location, came significant shift in many of the discussions. Hubris was on the back-burner and a new honesty surrounding the future of asset management dominated the three days of packed-out, standing-in-the-aisles sessions at the world’s largest and most influential event in global asset management. So what were the top conversations debated most urgently between the leaders, innovators and decision makers managing over 13.71 trillion euros of assets?

1. HOW TO REMAIN COMPETITIVE & RESPOND TO DISRUPTION From low-cost passive funds to disintermediation by cheap XO only robo-advisors and engaging P2P disruptive finance models, the question was how, what and with whom to collaborate, partner or buy to create sustainable competitive advantage? Will it impact your ROI anyway? Audience’s Top Pick Session: Samantha Ghiotti, ANTHEMIS and Martin Gilbert ABERDEEN For more, scroll through to page 23, Innovations on Disruption

2. WHERE TO PLAY NOW IF YOU ARE AN ACTIVE MANAGER? With the ETF as your benchmark performance there are only three options for positioning your firm for the future: “Either be supermarket, or create new partnerships with other asset managers or distributors with products and values you cannot provide, or focus on something very special” Audience’s Top Pick Session: Rob Fairbairn, BLACKROCK

3. HOW TO ADJUST TO THE REALITIES OF NEXT GENERATION FUND DISTRIBUTION? Without closing the large implementation gap between customer promises & the real outcome,

successful fund distribution is doomed. How to effect the tricky transformation of the industry from product-push to demand-driven is on everyone’s lips. As regulators get to grips with this issue, the digitalisation of the value chain is underway, dissecting the front to back office process-by- process. How can new technology and big data help cut costs, end-user fees, aid transparency, improve investment outcomes and ensure decision making in the customer’s interest? Audience’s Top Pick Sessions: Ben Phillips, CASEY QUIRK and JB Beckett, GEMINI For more scroll through to page 10, What will Distribution Winners Look like in 2020?

4. IN A LOW GROWTH, HIGH VOLATILITY ECONOMY, WHAT ARE THE VIABLE, STABLE INVESTMENT STRATEGIES OF THE FUTURE? What does an asset management industry focussed on longer-term investing in the real economy look like? From partnering private equity and venture capital with new credit funds to longterm investment in infrastructure, energy and renewables what will the advance of the longer term investment horizon as the one of the only routes to growth and higher returns look like? Audience’s Top Pick Sessions: EC DG Olivier Guersend on CMU; CEOs on ESG & Governance; New Credit Funds; Mohammed El Erian, ALLIANZ For more scroll through to page 13, Building the Capital Markets Union and page 7, Resilience,

Agility and Optionality: Golden Nuggets of Wisdom from Mohamed El-Erian.

5. WHAT ARE THE NEW FUTURE ASSETS & NEW SOCIAL CAPITAL MODELS TO DRIVE DEMAND? With many assets used inefficiently, people will increasingly want control of own financial destiny that fits with their values and decisions. How could a whole new set of values-based assets be created and traded that would drive demand and deliver outcomes?

Audience’s Top Pick Sessions: Andreas Weigend, Former Chief Science Officer, AMAZON, founder SOCIAL DATA LAB; Big Data and Investment; Dr Anthony Ledford, Chief Scientist, OXFORD MAN AHL CENTRE FOR QUANTITIVE FINANCE; FundForum Experiential Lab: MUTO LABS For more scroll through to page 30, Predictive Analytics and Machine Learning.

In this eBook, we have captured a snapshot of some of these discussions that took place on the ground in June 2016 in Berlin. Split into three chapters – Leading the Global Agenda, Investment Strategy and, The Future of Finance – this eBook includes video interviews with key experts and session summaries and analyses. As always, I would like to encourage you to let us know what you think of these discussions on Twitter via #FundForum or via the FundForum LinkedIn Group. We look forward to seeing you again in Berlin in 2017 to continue these important conversations.

JENNY ADAMS EDITOR-IN-CHIEF FUNDFORUM INTERNATIONAL

LEADING THE GLOBAL AGENDA 6

RESILIENCE, AGILITY AND OPTIONALITY

GOLDEN NUGGETS FROM MOHAMED EL-ERIAN Written by Alex Grey

Mohamed El-Erian needed little introduction at the start of Tuesday afternoon’s keynote session at FundForum 2016 in Berlin. It seemed as if the entire conference had piled into Potsdam 1 to hear the views of this global thinker and Obama Global Development Council Chairman. Picking up on the one constant theme of the conference he told the audience that his talk would be about change: “Not just change, but the accelerating pace of change. We as an industry have to think differently.” The message of the last 12 months, he said, was the fact that “improbables” – 30% of government debt trading in negative yields; ECB and Bank of Japan venturing into negative policy; Donald Trump having a real chance of becoming becoming President – had become reality. “The common element throughout all these things,” he explained, “is that the advanced world has lost the ability to grow in a high and inclusive manner, and when that ability is lost and people lose confidence, things start going wrong; things start to break.

The advanced world has lost the ability to grow in a high and inclusive manner, and when that ability is lost and people lose confidence, things start going wrong; things start to break.

“If you understand this basic issue it gives you a framework to understand the future.”

GOOD NEWS, BAD NEWS That said, there had been an evolution in the thinking of the advanced world, he explained: “Finally, there is an understanding that we live in a world where we have cyclical, structural and secular issues, but it’s taken us a long time. “The problem is, because it took so long to understand – we continually overestimated growth and potential, we continuously underestimated the impact of inequality – politics has turned really nasty,” he said, referencing the emergence of antiestablishment movements.

“It’s about a loss of trust. When you don’t grow enough, and the fruits of that growth go to the few, people get angry.” And this complicates the solution, he said. The only response on the policy side so far has been through the central banks. The good news was that the central banks did indeed respond, but the bad news was there wasn’t much they could do: “While central banks have stepped up, and have done so in a manner very few people expected in terms of their willingness to take risk, they simply don’t have the tools – they can’t do structural reforms, change infrastructure etc. The result of that is enormous fluidity on the macro side.” “We have to think collectively about not just what does it mean to run sophisticated democracies at low growth, but also what does it mean that central banks have used the wrong medicine for a very long time – not because they’re stupid but because they had no choice.”

DISRUPTION FROM ABOVE AND BELOW Our world was being shaken by things from above and below, explained Mohamed. “From above, with the loss of low but stable growth, and the loss of central banks’ ablility and willingness to suppress financial volatility; and from below by anytime/anywhere disrupters,” he said.

Some won’t see it because they have a blind spot; some will be “like a married couple: they will hear one thing but internalise it differently”; some will have active inertia – the most dangerous of the four. “The active part is great: you recognise things are different. But then you don’t end up doing anything about it”. And the remainder will “do the right thing”.

WHAT IS THE “RIGHT THING?” “You have to have a much more open mindset – be willing to use scenario analysis and ask difficult questions,” explained Mohamed. “If you don’t have cognitive diversity you will have difficulty getting it right. “You have to work hard at identifying your blind spots and overcoming them – and brand becomes very important.” He told us that there were three things that we needed to do to satisfy our clients: “You have to get the expected return right,” he said. “You have to get the variance of volatility right and the covariance right.

FinTech, he argued, was nothing compared to what was coming: “We’re now living in a world where you can disrupt an industry from another world,” he said, using AirBnB and Uber as examples.

“If you believe in my world, which is that the world we have been living in is coming to an end, then suddenly a lot of conventional wisdom gets questioned:

Because of these two things, he explained, “improbables” were going to become more common:

1. Long term beta will no longer do it for most people; most people, if they want to generate the sorts of returns they expect, will have to consider being a lot more tactical in their investing.

“We are all anchored to think in terms of bellshaped distributions. We know how to live in that world, but that is not the world we’re living in any more. “We’re now living in a world where the road we’re on is being undermined by growing tensions – political, economic, financial – and we can flip one way or another in the next three years.

“This is not a reassuring world. Behavioural science tells you that we are likely to make bad decisions when facing bimodal distributions,” he warned, before going on to list four types of common reactions to such environments.

2. We have to understand that markets will become more volatile, they will naturally overshoot and we need to understand that there will be undue contagion – ask yourself if you will be able to take advantage of that.

3. Diversification is no longer sufficient for risk mitigation; the only risk mitigator is if cash becomes part of your strategic asset allocation. 4. Finally, understand that central banks are pushing you to take more risk. If you want to really derive proper returns you have to go to places where central bank liquidity doesn’t come easy.”

“So they did two things. They changed his training programme – he got pounded in the ring every day in order to increase his resilience, and during the fight, he waited for Foreman to get tired by using the ropes to diffuse Foreman’s blows, thus inventing the now well-known boxing style “ropea-dope”.

FLOAT LIKE A BUTTERFLY, STING LIKE A BEE No one could be unaware that we lost the world’s most famous boxer at the weekend. Mohamed used 1974’s Rumble in the Jungle between Muhammad Ali and George Foreman to illustrate his concluding point on how to deal with this bimodal world: “All the experts assumed Ali would lose. The only question on the table was how badly would he be injured.

wasn’t a normal distribution, it was a bimodal distribution – a very high probability of Ali being knocked out quickly, very low probability that he could win, but no probability that he could last 15 rounds.

“At the beginning of the 8th round Foreman was visibly tired, Ali saw an opening and he knocked Foreman out. “Resilence, agility and optionality,” concluded Mohamed, “is what is required to deal with a bimodal world.”

“The Ali camp immediately recognised that this

WATCH INTERVIEW WITH:

MOHAMED EL-ERIAN - CHIEF ECONOMIC ADVISOR, ALLIANZ & & CHAIR OF PRESIDENT OBAMA’S GLOBAL DEVELOPMENT COUNCIL

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WHAT WILL THE DISTRIBUTION WINNERS LOOK LIKE IN 2020? Written by Alex Grey

According to Christian Staub from Blackrock, who chaired Monday’s Business Leaders’ Forum at Fund Forum 2016 in Berlin, those sitting in Potsdam 1 were definitely in the right place. “This is the room where we will be discussing the crucial elements of how distribution will be going forward,” he explained. So who better to start us off than Ben Philips from Casey Quirk, who has spent his entire career looking at the Asset Management sector. Creating a context for the remainder of the day’s discussions, Ben outlined what the business of asset management looks like today. “Over the last six months, the types of projects we’ve been asked to undertake have changed dramatically,” he began. “They’ve been more transformative, more strategic than we have ever seen,” he said, going on to outline the reasons why. THE NEW NORMAL

Increasingly, this is a winner-take-all industry, where most new growth will come from clawing market share from your competitors. 10

“This is an industry that regards itself as manufacturing at its core, when its customers are increasingly asking for a service industry mindset. That disconnect is something the industry is grappling with. “Most of what is creating that change is the rise of advice. Not just in asset management, but throughout financial services globally, consumer advice is becoming a core driver of how financial service firms compete and grow. “It’s changing into a business model we haven’t used yet in the asset management industry.” Ben showed us how during the decade 2000-2010, organic growth – new money coming into the industry – ran at about 6% per year. His firm predicts

that organic growth in the global asset management industry will shrink below 2% by 2020, something that is already starting to happen. “Most of this has to do with the fact that institutional investors as a whole are starting to shrink” he explained. “Sovereign funds are starting to put money back into policy; retirement funds are starting to pay their money out to participants – and as a result there’s a big shift in the asset management industry, from institutions to individuals,” he explained. “So, fewer and fewer fund managers are benefitting from that organic growth. Nearly half the industry had negative flows in 2015. “It is an oversupplied industry, the opportunity of the asset management sector cannot be spread among as many firms as it did in the past. Increasingly, this is a winner-take-all industry, where most new growth will come from clawing market share from your competitors.” WHAT WAS PURCHASED GLOBALLY BY INVESTORS IN 2015? This can be summarised in three words, said Ben: “passive; allocation; alternatives. “A lot of it is pooling in two places,” explained Ben. “In allocation models where someone else does the allocation and uses passive componentry underneath to fuel the portfolio; and in embedded allocation products and multi asset products.” Ben and his team have spent the last two years focussing on the question: If individuals drive 100% of allocation growth in the asset management industry, what does that mean? “Investors want outcomes,” he said. “It sounds trite but it’s true. It’s less about beating a benchmark and more about generating cash flow. Outcomes are customised – the outcome that I want is not the same as the one you want. As a result, the industry increasingly has to think more like a service provider to meet these client demands.”

“Wealth managers are directly allocating across ETFs and individual securities; insurers increasingly are looking at their product set; other financial services firms are starting to measure the unmet need for advice globally among individuals – they want to play too. That means asset managers who have been used to competing amongst themselves, now also have people coming in from outside the industry to compete with them. “The result is that when you look at the overall fee budget towards providing advice to intermediaries in the US, the product component – asset management component – has been under significant pressure.” Direct distribution has become a much greater discussion point among Casey Quirk’s asset management clients in the last six months. He noted: “Asset managers are asking themselves: if consumer service is really important, how do we compete differently? How do we become better allocators? How do we look like advisors? How do we touch the end user more? “Intermediaries are asking the same questions: How tough is it to allocate, can’t we do that too and only use asset management for the things we can’t do ourselves? They also want to get to end-users themselves.” HOW WILL ADVICE BE DELIVERED? Open architecture and automation will be the future for advice delivery, argued Ben. “The second wave of disruption is starting to happen both in US and Europe in terms of automated advice delivery,” said Ben. “The disruption is going to come from two fronts: robo advisors will begin to compete on not just delivering cheaper outcome but a better outcome. The second is that we believe the big robo advisors in five years will not be independent players but will be extensions of asset managers and existing intermediaries. They have the investment skillsets, they have the missing component, what they need to do is extend technology and user experience.”

INCREASING COMPETITION Illustrating that other financial service companies are getting in on the act, Ben showed us how, of all the wealth created in the world between 2012 and 2014, asset management only secured about a quarter of it.

HOW DO YOU WIN IN THIS NEW NORMAL?

“The key takeaway that you’ll get from the information presented today is that there’s a lot of opportunity for the firms that are able to get the changing operation environment right, realising that the way they’ve done business is no longer going to be sufficient to win going forward.”

“By creating holistic advice for a client, whether institutional or wealthy individual,” concluded Ben, also admitting that while this was easy with a US$50m client, it’s not so easy for a US$500,000 client. “How asset managers compete going forward is going to be about differentiation. The product offer has to be very unique, the advice being offered has to stand apart, the customer engagement and service has to be highly differentiated.

WATCH INTERVIEW WITH:

BEN PHILIPS - PARTNER AT CASEY QUIRK

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BUILDING THE CAPITAL MARKETS UNION Written by Alex Grey

Olivier Guersent, Director General of Financial Stability, Financial Services and the Capital Markets Union at the European Commission, offered his sincere apologies for not being present in person at FundForum 2016 in Berlin. However, thanks to the wonders of technology, he was still able to give us a video conference update on the work of the EC on the Capital Markets Union (CMU). Of the 33 measures announced last year, 26 were currently ongoing, he said, highlighting a few key measures: reviving securitisation, which will first benefit mortgages but would then spread into the SME loans space; measures within the field of infrastructure to allow more investment; and work on the strengthening of the single market for consumer financial services. In the world of pensions, Oliver explained how the EC were keen to have a pan-European personal pension product, where the locations of the company selling the product, the underlying assets and the consumer were all irrelevant.

We want to have a product that serves the needs of someone who initially works in Italy, then goes to work in France, wants to take the product to a UK company, and then retire in Greece.

“We want to have a product that serves the needs of someone who initially works in Italy, then goes to work in France, wants to take the product to a UK company, and then retire in Greece.” Olivier conceded that FinTech was a hugely important topic that the Commission was taking very seriously, assembling a task force to tackle questions such as: whether there is a need for regulation? And if so, what type – and when? “I’m not to keen to regulate everything at every moment – regulations very often have straightjacket effects,” he said. “But FinTech people themselves ask us for regulations sometimes, what we call enabling regulation, things that allow to them to grow outside of the border of the member states in which they

were born. This type of regulation that opens the single market to FinTechs is probably something we should consider.”

We think it’s a great opportunity for the industry in general. If we are able to increase the share of investment towards pensions it also means we are increasing share of investments with a longer horizon, and that would be very helpful from the point of view of market stabilisation. It will be a chance for the industry to show people what we do, and how we contribute to the economy.

the opportunity to distribute through Europe was a positive one: “While there are still obstacles as we all know, when it comes to distribution of funds and the provision of financial services, I think the approach by the present Commission is really interesting,” he said. “From the industry’s point of view we are seriously taking up this baton to have a dialogue with the Commission. It’s important that they do not make this a one-off exercise.” Andrea Beltratti from Eurizon Capital was asked what his thoughts were on the opportunities inherent in a pan-European personal pension. “We think it’s a great opportunity for the industry in general. If we are able to increase the share of investment towards pensions it also means we are increasing share of investments with a longer horizon, and that would be very helpful from the point of view of market stabilisation. It will be a chance for the industry to show people what we do, and how we contribute to the economy.”

The true issues involved were not so much around financial technology, but rather of an operational, custodial, and position-keeping nature. “We will have to think hard about those,” he warned.

THE PANEL’S RESPONSE A distinguished panel then set about discussing the information that the Director General had imparted. Pier Luigi Gilibert, from the European Investment Fund was the first to comment, specifically regarding Oliver’s comments on securitisation: “We see this market coming back gradually,” he said. “It’s coming back with the support of the Commission, particularly with the concept of a simple, transparent and standardised securitisation, which is meant to support the market by providing investors with products that are more understandable.”

Roderick Munsters, as newly appointed Global CEO of Asset Management at the Edmond de Rothschild Group was asked how much attention he was giving to the developments in Europe: “I’m signing up for a portable private pension,” he laughed, by way of conceding that yes, they were spending quite some time on these issues. “It’s de rigeur to bash Brussels,” he said. “But we should applaud what they are doing. It’s very well designed and it’s going to help us and our successors five or ten years from now who will also receive the benefit.”

The sector that Pier saw growing very fast was peer-to-peer SME lending, and consequently this was something they were keeping an eye on with increasing interest.

Indeed, the Director General had issued an open invitation for those present to continue providing feedback to the Commission, something which was reiterated in the moderator’s closing speech:

“So the CMU is coming to life with practical solutions,” summed up moderator Michael ColeFontayn, Chairman of EMEA at BNY Mellon. Urban Funered from Fidelity International felt that

“Let’s do what we promised to do. Flood the mailbox, get the meetings, make the change and build the CMU.”

WATCH DISCUSSION WITH:

OLIVIER GUERSENT - DIRECTOR GENERAL, DG FINANCIAL STABILITY, FINANCIAL SERVICES AND CAPITAL MARKETS UNION AT EUROPEAN COMMISSION

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INVESTMENT STRATEGY 16

Day one at FundForum dived straight into the heavy topics on Monday, as the Investment Strategy Forum grappled with the slippery subject that is Smart Beta. The topic was introduced by moderator JB Beckett from Gemini Investment Management, who compared it to the Creature from the Black Lagoon:

SMART BETA: THE INEXORABLE RISE OF A MONSTER? Written by Alex Grey

“Smart beta has been the inexorable monster that has risen from the depths to be a dominant factor in our industry, in a very short period of time,” he said, before asking the panel for their view of smart beta. “You’re not going to put the genie back in the bottle,” stated Chris Brightman, Chief Investment Officer at Research Affiliates. “Very simply, smart beta is using well-researched, well-understood sources of persistent excess return and modern technology to create simple, transparent, low cost products – that deliver more of that excess return to the end investor.” Marco Corsi, Head of the iShares Product Research and Innovation team in EMEA at Blackrock put things into context: “There are US$282bn assets under management in exchange-traded product doing smart beta,” he stated. “A 40% increase in the European space, a 20% increase in the US over the last year. There is a big trend going on here and we think it will continue,” he said, citing regulatory and fee pressure, and the need for more transparency as reasons why. “I seem to be the lone voice for active management,” bemoaned Clive Hale, MD at Albermarle Street Partners. “There are some smart beta strategies that are worthy of consideration but many who are doing smart beta are doing so arguably because they are lazy – because they can’t find active managers who are delivering the goods,” he said. IS THIS THE BEGINNING OF THE END FOR TRADITIONAL ACTIVE MANAGEMENT? “No,” said Chris. “There are many – and widely varying – interesting investment opportunities across the globe. Some can be very effectively accessed through a smart beta strategy at low fees; other strategies are not conducive to smart beta strategy. “In diversified, liquid, public equities, I think smart beta is challenging the traditional higher cost active management for most investors.”

Clive agreed: “For far too long fund managers have overpaid themselves. There will always be a place for active fund management as Chris said; there are areas where factor investing really doesn’t work. Value is the only factor that has a long-term history of actually working. The problem with a lot of smart beta is that to some extent they are flavour of the month – people want performance now, not in 3 or 4 or 5 years’ time. My concern with some smart beta is that those factor events will disappear. Value investing does have a long-term track record, but you do have to wait for it.” Smart beta is not about performance itself, argued Bruno Monnier from OSSIAM: “You have a strategy; a clearly defined objective, and once you’re educated and you know what the objective is, you are buying this objective. This is something that can be delivered, sometimes long-term like value, sometimes something totally unrelated to performance like low volatility investing. But that is something that can be delivered and measured and not just some promise of performance.” INCREASING COMPLEXITY As the panel delved into the subject of ETFs, Chris argued that more and more complex strategies would enter the market place: “Almost anything can be expressed as an algorithm, and I think we will see increasingly complex smart beta strategies come into the market place, which may or may not be such a good thing for investors.” This is something that worries Clive: “The whole rationale behind smart beta is that it needs to be simple. If it’s complex then the end user is not going to be able to understand it, with all that issue brings. The end user will be disappointed; the regulators will be disappointed. It should be kept simple – we as fund selectors need to understand how something works and explain it to our clients.”

difficult task. The dispersion of returns is much smaller, so the potential to generate any sort of outperformance is much lower.” Chris agreed: “It’s much more difficult to replicate a fixed income index than an equity index. That said, you can create a smart beta of a sort, I think of this as a cookbook of how to beat the bond market. I’ll share it with you: don’t do stupid things like sell a bond after it’s been downgraded; don’t create an artificial boundary between investment grade and below investment grade; don’t sell a security because it gets to one year to maturity. You follow those cookbook rules, you’ll have an easy time beating Barcap Agg Index.” Bruno agreed: “We cannot expect to have the same ease of trading that we have in equity,” he argued. “But the market will develop.” “The problem,” argued Marco, “is that it is very difficult to design a strategy that beats the Barclays Agg Index, otherwise we would see a proliferation of smart beta fixed income products out there. Even if you don’t do stupid things you’re not going to find any compelling performance with respect to that product. Even if you try to be smart and clever it’s very hard to generate anything which is compelling unless you focus on some anomalies like fallen angels – in which case you really capture a segment of the market, and you can see that this actually generates very interesting returns.” THE FUTURE FOR SMART BETA “I’m in the active camp, but I firmly believe that there is a place for some smart beta – selectively,” said Clive. Marco agreed that smart beta was not a solution for everything and had to be well understood and properly used, but added: “It has the potential to deeply influence the way the industry evolves over the next few years.”

SMART BETA IN FIXED INCOME MARKETS With the general feeling that bonds are expensive, investors are looking for alternatives. But running smart beta in the fixed income market is no easy task, as Marco explained: “If we believe that smart beta is an index implementation of factor investing, and it needs to control the risk, and be transparent and simple, running smart beta in fixed income is a

However, as Clive had put it earlier in the session, smart beta is all about science. “I would argue that there is still a lot of art in this business as well, and you can’t write an algorithm for that.”

TO OUTSOURCE OR NOT TO OUTSOURCE CURRENCY RISK MANAGEMENT?

CURRENCY MANAGEMENT SHOULD RAISE FOUR QUESTIONS:

1. The exposure and management element i.e. do I (need to) know what my currency exposure is on a particular date? 2. What kind of strategy do I apply to my exposure? 3. How do I execute? 4. How do I fulfil the governance and regulatory duties?

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Investment managers expose themselves to currency risk either through international assets or demand from global investors. These risks need to be quantified and managed through a transparent, independent currency risk management process. Marc Tuehl, Global Head of FX Overlay at HSBC, explains the considerations and benefits of outsourcing currency risk management. WHAT FACTORS AND COSTS SHOULD YOU BE AWARE OF? Currency has often been left unmanaged as part of a portfolio’s natural exposure. The perceived divergence in central banks’ monetary policy has seen the volatility in currency creep up again, which can have a significant impact on overall performance.

Clients should also consider the cost aspect. Costs such as system infrastructure, Front/ Back-office, transactional, execution venue, as well as operational risk, all need to be understood and managed.

From an operational perspective, asset managers need to invest in robust systems, capable of processing exposure data from different sources and executing these efficiently. Solid controls must be in place and underlying investors are more than ever demanding transparency of the full end-to-end process. “Clients should also consider the cost aspect. Costs such as system infrastructure, Front/Backoffice, transactional, execution venue, as well as operational risk, all need to be understood and managed.”

WHEN SHOULD YOU CONSIDER PASSIVE HEDGING STRATEGIES? The strategy an asset manager implements depends on their objective. Traditionally, to attract foreign investors, managers launch ‘hedged share classes’ in locally denominated currencies. They can implement a passive hedging strategy, enabling the investor to invest in their own local currency whilst mitigating FX fluctuations relative to the fund’s base currency. Investing in international assets can also result in foreign currency exposure. Whilst this can be part of a portfolio manager’s strategic view, reducing exposure to specific currencies can drastically improve a portfolio’s performance. This can again be done with a passive portfolio hedge, reducing the exposure to a benchmark, say 20% or 50%. The ‘drawback’ some perceive is that by reducing exposure to a currency, one reduces not only the associated risk of it depreciating, but the potential profit if it increases in value. WHEN SHOULD YOU CONSIDER DYNAMIC STRATEGIES? These strategies adjust the hedge dynamically with the objective of achieving a predefined result. Unlike a passive strategy, which rebalances the hedge to a predefined benchmark (say 50% or 100%), here the hedge ratio will be a variable one, often governed by a set of rules. Often an Asset Manager will be responsible for implementing the equity or fixed income strategy, whilst FX management is outsourced to an FX Overlay provider. The provider will aim to hedge the currency exposures when the market moves against the underlying position, whilst participating when the market moves in favour. The trigger which dictates when to hedge and when to participate is strategy-specific and each produces different results in terms of volatility, return, cash-flow etc. This is why it is important to understand objectives and risk metrics prior to choosing a strategy.

“If managed consistently, FX can be a source of additional performance. There is a trend of clients looking to explore more alpha sources; currency markets expose investors not only to risk, but can also open doors to new opportunities. Using these opportunities could improve total returns.” concludes Tuehl.

ARTICLE BY:

MARC TUEHL GLOBAL HEAD OF FX OVERLAY, HSBC

KEY INVESTMENT TAKEAWAYS FROM #FUNDFORUM

Markets have been hugely turbulent of late. Buoyed by the on-going uncertainty over Brexit, record low interest rates, falling commodity prices, and volatility in China. But what are the key things market participants should watch out for, and what opportunities are available to fund managers? Panellists at Fund Forum International 2016 in Berlin acknowledge that on-going negative or zero interest rates are unsustainable. Likewise, Central Banks cannot keep spending their way out of trouble, as the long-term consequences will be unpleasant. As such, experts feel that major structural issues could arise at sovereigns if this path central bank profligacy continues. Whether or not it results in a Lehman Brothers moment is yet to be seen. China may have dominated the headlines due to its market volatility and government imposed share trading suspensions but fears of a hard landing are overdone. Many analysts remain bearish on China yet the economy is growing fast, albeit not at a pace as years gone by. Advocates of a China resurgence feel the country has sometimes not engaged correctly with market participants, with some citing a lack of transparency, which can further increase volatility. Nonetheless, investors are looking towards China while fund managers sense an enormous opportunity in the country’s emerging middle class investor base. Others feel the possible extension of Stock Connect – the exchange link – between Hong Kong and Shanghai is a cause for excitement. Market participants acknowledged in 2015 at NEMA Shanghai that the Stock Connect extension to Shenzhen would occur at some point in 2016 although precise timings were unavailable. At FundForum Berlin, many believe it will occur at some point before the year-end. The development would be exciting as Shenzhen’s stock exchange lists a number of small to mid-sized corporates. Whether Stock Connect is extended further afield is up for debate. The time-zone differences could pose practical problems for linkages with the UK, although there is nothing to prevent more regional linkages coming to the fray. Emerging markets have had a setback over the last few years amid falling commodity prices, and fears that the Federal Reserve would increase interest rates. Commodities are recovering and the rate rise has yet to materialise. Some believe that an emerging market recovery is underway, citing major infrastructure investments that are currently happening in markets such as Thailand and Indonesia. These emerging markets could provide fund managers with potentially lucrative investment returns.

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THE FUTURE OF FINANCE 22

INNOVATIONS ON THE DIGITALISATION

Day three at Fund Forum in Berlin and a pre-lunch panel in the Future Finance Forum produced dire warnings that the current crop of robo-advisors would herald a repeat of the 2008 financial crisis and investors in FinTech startups would do better to if they “threw their money out the window.”

Written by Elizabeth Lumley

“FinTech seems to equal robo-advice in this industry, but that is not the right way to look at it,” said Patrick Murphy, founder, Puregroup. “Technology and data have always had a place in investment management and how we manage those products.”

OF THE INVESTMENT VALUE CHAIN

However, while there were some on the panel who held no confidence in the current crop of roboadvisors, there were others who strived (with the support of murmurings in the audience) to bring the conversation around to the benefits of FinTech innovation outside of the narrow confines of roboadvice.

Technology’s purpose is to support business decisions and remove downside risk, allowing the investment management industry to “constantly question the products we are creating,” Murphy adds. However, it was Gina Miller, founding partner, SCM Direct and Paul Resnik, co-founder and director, Finametrica who were the most vocal in their opposition to FinTech, which both almost exclusively defined as robo-advice. Resnik, in a tone meant to provoke, lamented what he describes as “leveraged hubris” where “pontificating arseholes” who are “unwilling to look at science” are leading the industry down a path that would result in a repeat of the 2008 financial crisis. In 2008 the industry was at fault for “mismatching advice”, says Resnik, which is what the robo-advisors are doing now.

We used to only give rich people bad advice, now we give it to everyone - it will blow up in our faces.

“We used to only give rich people bad advice, now we give it to everyone – it will blow up in our faces,” he adds. Miller was more measured and considered in her arguments, but no less passionate. She argues that the current crop of robo-advisors – firms like Betterment and Nutmeg – are online investment solutions and not robo-advice. “FinTech is an enabler and could produce better outcomes with better algorithms,” she adds. “But we are a long way from robo-advice today.”

Miller went on to question the sustainability of the current crop of ‘online investment advisors’ arguing that their basic business models were flawed. The costs of marketing, on-boarding, and maintaining a customer on these platforms, over three years, outweighs the amount being earned in fees by these ‘low cost’ advisors, she outlines. Miller also questions the continued emphasis on marketing to millennials. “Millennials are not joining up to these platforms. We do research on this. Investment management is not their priority – paying for rent or paying off student loans are,” she adds.

“Many of these companies [by companies she means robo-advisors] will not be around in three years’ time,” says Miller. However, Murphy stresses that the industry need not fear failure when it comes to FinTech innovation and startups. “We need tech to fail – because that is how we find new business models,” he argues. “Even if Nutmeg fails, we have learned a lot about this market.”

The hype around startup investment is mostly to blame, according to Miller. Most investors are “hoping” they will back the winning FinTech startup, but Miller jokes that investors would be better off “throwing their money out the window” if that was their strategy.

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GINA MILLER - FOUNDING PARTNER AT SCM DIRECT

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Alternately, it may come from existing players adopting the new technology to enhance their operating model by combining it with their brand, client relationships and investment experience.

It has often been written that the asset management industry is about to experience significant change. The triggers for these comments have typically come from macroeconomic events, significant market volatility or regulation. We saw this most recently following in the aftermath of the 2008 credit crisis. But on reflection, the industry often continues fundamentally unchanged or at best having evolved around the edges. Comments about significant change are increasing in frequency and volume once again. Interestingly, however, this time these comments are based on the disruption new technology and digital (some call it fintech) could bring. This so-called disruption may result from new entrants in the industry raising the bar on customer experience and efficiency by leveraging a different technologybased operating model. Alternately, it may come from existing players adopting the new technology to enhance their operating model by combining it with their brand, client relationships and investment experience. Either way, many believe that this time significant change could really be on its way and, some argue, not a moment too soon. Innovation occurs as a result of unmet or changing market needs; therefore, the current market context is important. Despite the market volatility in the first quarter of 2016 the industry continues to perform well for its shareholders, with operating margins returning to pre-crisis levels, and is the envy of other financial services sectors. However, much of this improved performance is a reflection of the rise in financial markets over that period rather than through significant improvements in operating efficiency. The industry is also facing head winds with the shifting distribution landscape across Europe, an increased focus on fee transparency and the unbundling of costs adding further downward pressure on margins and both regulators and end investors questioning the â&#x20AC;&#x153;value for moneyâ&#x20AC;? provided by active management. Furthermore, the digital transformation occurring in other sectors is raising the bar on the level of customer experience expected to be provided by the asset management industry, particularly for organizations looking to have a direct relationship with end investors.

The industry’s ability to address some of these challenges may be found in the emergence of a number of recent technology based innovations: robo-advice, big data analytics, robotics and blockchain. Not all of these will be appropriate for every organization, but those that can embrace these developments may be able to expand into new client segments and services while improving efficiency.

analytics to structured and unstructured data to provide new insights and understanding on market sentiment around issuers and assets. Taking unstructured data via news gathering from press wires, news websites and social media postings can help identify shifts in sentiment on each underlying investment. The ability to gather this data and to filter and analyze it in a way that enables an investment decision could help to provide a winning edge.

ROBO-ADVICE ROBOTICS The term robo-advisor is often used to describe a broad spectrum of organizations and services. On one hand, it refers to the automation or partial automation of investment advice and allocation of assets into predefined, often passive, funds including exchange-traded funds. On the other hand, it is used to describe organizations, typically new entrants that have built an entire business based on this model. Their differentiators are focused on providing an enhanced customer experience, being digitally enabled and having a lower price point. The underlying investment product is typically relatively simple. The lowercost business model allows these organizations to reach customer segments previously considered unprofitable by traditional players, although recent research shows [The experience factor: the new growth engine in wealth management] that wealthier individuals are more likely to embrace these new services. Given the advisory nature of these services, wealth managers are more likely to be disrupted by these new entrants. However, robo-advice presents an opportunity for existing asset managers to embark upon a “direct-to-consumer” (D2C) distribution strategy with a lower level of investment. Several wealth and asset managers are considering roboadvice as a complement to their existing advisors or sales force, making them more efficient and allowing them to focus on the more value-adding activities.

As the industry turns its attention to managing the cost base and increasing efficiency to protect operating margins, legacy systems architecture is often the limiting factor in re-engineering processes and increasing automation. Could robotics or robotic process automation (RPA) be an effective solution for this problem? Robotics is a software automation solution that enables organizations to automate existing high volume and complex data-handling actions as if the business users were doing the work. This has the potential to significantly remove costs across the value chain, but in particular in middle and back-office processes. Robots have the added benefits of being repurposed in off-peak hours, costing a fraction of an offshore resource and not taking sick leave. The asset management industry has been relatively slow to embrace this technology. However, we are now seeing some exciting use cases emerging. One example is using robotics to assist in gathering analytics — using robots to scrape data from news sites into one single source and in client onboarding — a highly manual, time-consuming, repetitive process for most. Applying robotics to this process removes manual effort and increases speed of completion in a more cost-effective and potentially more accurate way. Asset servicers have been the first in our industry to explore the opportunity that robotics provides but there should be plenty of scope for asset managers to get involved.

BIG DATA ANALYTICS BLOCKCHAIN As well as the use of algorithms around investor preferences to formulate robo-advice, a number of forward-thinking managers are now leveraging the power of analytics to support their investment decision-making. In search of a new information edge, portfolio managers are applying big data

A more radical approach to improving the existing systems architecture is to replace it entirely. Distributed ledger technology (DLT) may provide the opportunity to do this, increasing transparency and reducing costs. The most well-known of the DLTs

is blockchain, a technology that allows multiple parties to share data in a trusted environment, creating a single source of truth. If blockchain were used in financial services to record ownership and trading of assets, it could eventually become a single source of truth for all financial transactions. Instead of each party keeping their own record of events, blockchain allows all parties to access the same definitive record. In this respect, blockchain could revolutionize the operational processes in financial services, which are heavy in data reconciliations and data error handling. Payments and post-trade settlement are just one area of use cases for blockchain, but there are many more that are only just starting to be explored, e.g., sharing of Know Your Client data, fund transfer agency and trade finance.

CONCLUSION The asset management industry is naturally cautious and historically hasnâ&#x20AC;&#x2122;t been quick to adopt new innovations or technology. The industry wonâ&#x20AC;&#x2122;t change overnight. Not everything in roboadvice, big data analytics, robotics or blockchain is appropriate for everyone. However, these new technologies are revolutionizing other financial services sectors, and it would be a missed opportunity if we donâ&#x20AC;&#x2122;t try to embrace some of them to address the challenges ahead.

ARTICLE BY:

ALEX BIRKIN GLOBAL ADVISORY LEADER AT EY

RESPONDING TO DISRUPTION Written by Elizabeth Lumley

“No one has doubts in the room that our industry needs to change,” commented one speaker from the audience. “But when you talk about innovation it is not easy to quantify.” This was in response to a weak showing by the attendees after Samantha Ghiotti, a partner at Anthemis Group, polled the audience to see what percentage of their P&L they anticipated would be dedicated to digital change. Instead of a show of hands voting on numbers as varied as 1% to 80% – the shirt sleeves remained lowered amid comments that the ‘question was too big’. Not being able to put a number or a metric against the response to transformational change and disruption is one that is common to all areas of financial services dealing with waves of FinTech innovation – not just the fund management industry. However, the discussion by the panel – spearheaded by a keynote by Ghiotti looking at how success related to disruption – was not conducted by thought leaders who had their heads in the sand when it came to FinTech and innovation.

Customers now go to many different places to vet and verify their investment decisions. Robos are part of that. 28

Panel moderator, Sven Korschinowski, partner at KPMG Germany asked the speakers if the fund management industry was “ready to be agile” in response to FinTech disruption. Lorna Martyn, vice president, technology management, Fidelity Investments commented that “in terms of technology, this industry has been agile for a very long time.” However, advances in FinTech innovation and the rise of startups has make significant changes in how a firm can take a product to market. However, Matthias Niklowitz, senior analyst, banking e-foresight, Swisscom responded with what is now a well-worn phrase in many industries facing digital transformation – ‘Can you afford to do nothing?’ “You can’t wait until Amazon or Google decide to enter

this market,” he said. “We are also watching China and Alibaba – their entrants to this market could be a showstopper for these businesses.” Of course, no panel about FinTech and the asset management world could be complete without the mention of robo-advisors. Many on the panel felt that most robo-advisors were “too simple” to pose a direct threat to the current financial advisor market. Although Martyn agreed with that conclusion, she did warn that the traditional financial advisor or old is no longer held up on a pedestal dispensing advice. “The world is much more customer-centric,” she said. “Customers now go to many different places to vet and verify their investment decisions. Robos are part of that.”

Although robo-advisors are seen by some as a disruptive force in the financial advisory space, Ghiotti started the discussion with her keynote warning that success and disruption don’t always go hand and hand. She argued that many disruptive ideas, such as the music file sharing service Napster, never see commercial success. Other developments, such as the latest ‘better, cheaper, faster’ iPhone, are successful without being disruptive. It is the the startup or idea that “addressing the previously unaddressable in a sustainable way” where disruption in any industry will equal success.

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SAMANTHA GHIOTTI - PARTNER AT ANTHEMIS GROUP

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PREDICTIVE ANALYTICS AND MACHINE LEARNING IN FINANCE Written by Elizabeth Lumley

As the Future Finance Forum continued into the afternoon of Day 2 at FundForum in Berlin the audience could be lured into thinking they were about to sit through a sober discussion about big data and analytics cutting through the noise of multiple and disparate data points. However, when Luke Ellis, president of one of the world’s largest hedge funds, the Man Group, starts the talks saying he is frightened almost every time he gets in a cab in a major city and he can’t wait until “every car in every city is a driverless car” it is hard to pay attention to sober Oxford-based researchers showing the audience a better way to read charts and graphs. “I would be much happier having a car driving me,” says Ellis. However, taxis aren’t the only old world occupation on Ellis’ hit list. He went on to say that the Man Group’s greatest expense are the “expensive fund managers” inside the building. And he was looking forward to the day when they will be replaced by computers. “Believing that tech can only do the simple and boring is getting the wrong end of the stick,” says Ellis. “Tech can do the really interesting stuff.

Pity the poor fund managers at Man Group for there are those who are counting the days until the robots take your job 30

Panels before this at FundForum tended to repeat the party line that so-called robo-advisors were merely ‘a part’ of an overall financial management package – being too simple to compete with the fair superior advice and management led by humans. Pity the poor fund managers at Man Group for there are those who are counting the days until the robots take your job. Strategies around using data to make better and more informed decisions have been in the works in the financial services industry for some time. However, the tipping point, says Lars Hamberg, head of big data analytics & fund selection, AFAM says

that the breakthrough happened “when computers started learning how to read.” Hamberg points to earlier experiments with using social media sentient analysis – so-called Twitter hedge funds – which had little success causing many in the industry to “give up” on taking advantage of this data. Hamberg laments why the “big media companies” like Google are the front runners in behavioural analytics and big data when “banks know everything about us”. Banks have been “filing away data on us for years and they do nothing with it,” he complains. However, the notion of big data analytics and machine learning only existing in a black box may have something to do with the resistance felt by many big financial firms. Dr. Anthony Ledford, chief scientist, Man AHL Research Laboratory, Oxford University thinks the answer is to “open up the black box” and to show how much more robust and comprehensive analytics using machine learning can be compared to traditional modelling. Ledford illustrated these comparisons with various slides during his talk.

But the core to buying into the new robot future may not be headlining grabbing statements about the desire for driverless cars (or manager-less funds) but in showing how it works in a business context. Valter Trevisiani, group chief insurance officer, Generali Group took the audience on a customer journey through car insurance, smart home environments and health. As an insurer, gathering the right type of customer data, whether that be how safe someone drives a car or takes care of their body, is the key to providing tailored insurance products to customers. According to Trevisiano, “Behavioural-based insurance products are the future.”

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DR. ANTHONY LEDFORD - CHIEF SCIENTIST, MAN AHL RESEARCH LABORATORY, OXFORD UNIVERSITY

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