Since the onset of the financial crisis in 2007, the convergence between traditional and alternative products has been widely discussed, with ramifications expected to affect the industry in a significant fashion.
On the operational front, the dynamics driving these changes are multi-faceted:
* An onerous regulatory environment that continues to move at a furious pace
* A product and security mix that is increasingly more comple
x* An environment where market volatility is the norm, altering all standard conventions
* An institutional client base demanding greater transparency and risk mitigation
According to McKinsey & Company, this is only expected to get more complicated, fueled by increasing institutional investor allocations across all alternative classes, and the increased use of alternatives by the retail channel. In fact, by the end of 2013, they report that institutional investors expect to increase their allocations in alternatives to 25 percent of portfolio assets. Likewise, by 2015, retail alternatives are expected to account for one-quarter of retail revenues.
As a result, the changes driven by this convergence are expected to be one of the top challenges that asset managers and third party providers face. No aspect of the servicing platform is immune, as people, processes and technologies are all scrutinized. Obviously the downstream effects that these changes entail will result in an increased expense base, which will hopefully be offset by increased efficiencies. The areas where these convergence dynamics are currently playing out are where our clients, both managers and TPAs, cite their largest challenges.
Multi-product/service capabilities As more managers execute multi-product strategies that include traditional, hedge, ETF, private equity and global product lines, the panacea of getting to a singular platform that can handle all products has been recognized as impractical. The inherent differences across products, along with the associated regulatory and tax hurdles, have rendered this approach moot. At SunGard, given our unique product set that includes core engines across all the major investor products and services, we see most of our clients' strategies tackling two areas. The first involves enhancing data aggregation and management tools allowing for consistent enterprise-wide reporting to both internal and external constituencies. The second entails using common surround technologies across utility functions, allowing for efficiencies across products, as well as consistency and risk mitigation.
Cross-jurisdiction platforms As more managers roll out offshore product, the ability to have consistent processing schemes across jurisdictions is a huge differentiator. For our Transfer Agency clients, incorporating multi-currency and multi-lingual shareholder capabilities that facilitate distribution support across Europe and Asia, as well as industry standards like NSCC are imperative. In addition, earlier this year we launched a solution for international fund trading, expanding the capabilities of our SGN global fund trading solution, allowing asset managers to broaden and streamline the processing and distribution of their funds. This solution allows fund companies and transfer agents around the world to automate their trade processing and access fund processing platforms such as NSCC and Fund/SERV.
Institutional investor requirements A major factor driving higher allocations to alternatives is the shift to an absolute return type of investment objective by institutional investors, who have redefined how they measure performance to better align potential outcomes with objectives. This increased allocation by institutional investors is forcing alternative managers to adopt traditional fund characteristics, particularly around regulatory and transparency requirements, as well as implement the audited control environment that institutional investors are accustomed to. Conversely, alternative managers seeking a broader investor base are targeting a retail distribution approach, rolling out more regulated product. Similarly, traditional asset managers looking to attract institutional assets are seeking higher performance returns, increasing investments into complex instruments across geographies.
Product development According to McKinsey, the expectations for strong growth and attractive revenues have prompted traditional asset managers to respond, with two-thirds making alternatives a top-three priority. The primary focus is on product development, with over 90 percent of asset managers planning to launch some form of alternative product over the next three years. For example, as sub-second trading and portfolio maneuvering has become commonplace, real time data access capabilities are seen as true differentiators, particularly as it pertains to product development. One real life example we are currently working on with a few of our clients is true intra-day priced funds. Seen as a potential alternative to actively managed ETFs, this solution would let active managers bypass the daily portfolio disclosure and high cost of trading drawbacks associated with actively managed ETFs, while still allowing for multiple NAVs throughout the day.
In summary, these portfolio shifts are evidence that traditional managers see value and opportunity in the mainstreaming of alternative products. However, from an operational perspective, the convergence between traditional and alternative products can be seen as both a challenge and an opportunity. Over the next few years, convergence solutions will most likely be one of the highest priorities for asset managers and their service providers. Already we're starting to see aggregated reporting at both the executive management and investor levels. In addition, some of our administrator clients have begun to align teams into an enterprise services model across utility functions (pricing, recon, corporate actions, trading, etc.), agnostic of product type.
However, for the most part, the core servicing platforms encompassing technology and operations have remained siloed. This is specifically problematic for our top tier clients, the large asset managers and global custodian banks, all of which are facing severe headwinds from a margin perspective, and whose value proposition is based on scale and efficiencies. At the same time, this is also the segment where we have seen the most activity and investment, and where we have been engaged the most. The good news is that all of these players seem well aware of the barriers they need to overcome, and have already started developing and implementing solutions for the combined model.