Buy-side firms will face mounting pressure to shift their focus to competitive alpha generation alongside cost reduction as difficult economic conditions continue to bite into next year, according to a new report by technology consultancy firm Ovum.
Volatility and regulation will be the two dominant forces shaping the financial markets in 2011, argue the report's authors, adding that regulatory change would be “intense, pervasive, and will fuel uncertainty as new policies create structural change and new business practices”.
The report cites poor economic conditions, low client confidence and high market volatility in 2011 to support its suggestion that investment managers will no longer be able to rely on market upswings or new client investment to increase their assets. Instead, lacking alternative sources of revenue, they will be forced to outperform the market, meaning that instead of preserving capital, improving performance and efficiency will become more important.
“There have been significant asset outflows out of the industry,” said Daniel Mayo, an analyst at Ovum. “There's a realisation now that the only way to be successful is through improving performance. This means stronger front-office and risk management systems. The execution management system is key.”
Based on data gathered from 66 buy-side institutions globally, the report suggests that key investment priorities for 2011 include front-office trading systems, while back-office operations and infrastructure spending will be kept under control. According to the study, 39% of investment institutions planned to increase spending on risk management systems, 38% on compliance, 36% front-office trading systems, while only 10% planned to splash out on back-office support systems.
In terms of technology, both buy- and sell-side firms will need to invest in enabling the front office and automating the back office, while investment institutions will also need to dedicate significant spending for compliance and reporting systems. Meanwhile among other consequences of the economically strained environment, risk appetites are expected to increase, leading to the resurrection of the hedge fund sector, while investment managers will place greater emphasis on multi-asset strategies to allow them to manage risk.
“The equity markets have been very volatile,” said Mayo. “Managing long-term positions has become harder – you need to understand where your positions are in the short term now. Investors are seeking much greater transparency. People are no longer happy with an annual report. They want more information, more frequently.”
Investment firms' front-office priorities will focus on trading connectivity, execution management systems, market data distribution and investment support systems to enhance the effectiveness of investment managers. Meanwhile as income growth remains flat, further savings will be necessary, forcing cost-cutting at the back-office level to go beyond management and into wholesale transformation. Investments will be made, said the report, but these will be especially targeted at achieving long-term cost savings.
“Things are going to remain very tough for the investment management side,” said Mayo, adding that cost structures were coming under increasingly intense scrutiny. “Reducing the easily accessible costs is no longer enough. Compliance and reporting costs are going to go up. This is no longer a temporary blip – you need a permanent reduction in cost base, and the only way you can do that is transforming your model,” he added.
“Investment managers who can show high performance are seeing most of the business and people are taking money out of others. I suspect there's going to be a lot of consolidation over the next year or so.”