RBS International’s head of Institutional Banking in London, Neil Walker, and head of Institutional Banking in Luxembourg, Ian Harcourt, share their views on how the funds management industry will evolve in the year – and decade – ahead.
This year, 2020, marks the beginning of a new decade, one that is likely to feature an intensification of many of the economic and social trends of recent years. From tech-driven disruption and major demographic shifts to growing scrutiny over corporate governance and significant changes in consumer behaviour, the 2020s will present the funds industry with both familiar and new challenges.
Growth of alternatives
There’s no doubt that volatile equity markets and low bond yields have led to institutional investors looking beyond traditional areas in which to invest. That in turn has led to the creation of a ‘wall of money’ that some estimates put at around $700bn.
One of the principle effects of this huge build-up of capital seeking deployment is the growth of the alternative asset space. A look at recent Preqin data shows a total of $10.7trn in assets under management (AUM) across all alternative asset managers globally (as of March 2019) – a threefold increase on 2008 levels. Preqin estimates it will reach $14trn by 2023.
With over 15,000 institutional investors active in alternatives, that trend is gathering pace, with some estimates suggesting the alternatives space will see double-digit annual growth over the next five years.
Beware the bubble
This activity will likely fuel the growing interest in renewables and infrastructure, renewed investment in private equity and commercial real estate, as well as private debt and natural resources. It is also likely to lead to a continuation of larger fund managers raising ever-larger funds, which in turn may make it harder for smaller funds to compete across sectors.
Not surprisingly, fears are growing that the wall of dry powder will create a bubble of overpriced assets. No bubble stays inflated forever, so the timing, scale and intensity of the eventual correction is a concern for everyone in the investment industry. This explains the element of caution in investment activity as many investment managers seek to balance the need to deploy funds with buying at the top of the market as the cycle turns.
Infrastructure and renewables make more waves
As urbanisation gathers pace across the world, investment in infrastructure is set to grow. With the widening scope of the category to include everything from telecoms and fibre to renewables, once again infrastructure is the focus of increased interest from funds across the world.
Renewables in particular will continue to thrive as investors increase allocations to asset classes driving more of a direct, positive impact to social and environmental factors, in turn fuelled by well-documented government-led CO2 reduction initiatives. Aurora Energy Research estimates that by 2030, there will be a pipeline of 60 gigawatts of renewables across north-west Europe, “much of which will be subsidy-free”.
Demographics count
The continuing shift towards an older population in developed countries, especially Europe, presents the asset management industry with a huge opportunity, and it will need to play an active role in the design of solutions to meet this challenge.
From common payment systems to faster and more secure information exchanges, the next few years could potentially see some radical efficiencies emerge in the funds landscape
A rise in the over-50s will be coupled with low birth rates in some countries, putting pressure on the working age population to carry on working, saving and investing. This will have several effects: firstly, the greying of the population will inevitably drive more capital towards investment in care industries and related sectors.
Secondly, the behavior of millennials and Generation Z will become the driving forces behind seismic shifts in how businesses not only design products and services but also how they attract and retain customers.
As sustainability and environmental concerns become embedded in the mainstream, the emphasis is increasingly on experiences and ‘access’ rather than ownership. That in turn means younger generations are less likely to stay with one provider when a better deal comes along. Already the automotive, technology, retail and leisure sectors are all waking up to this and adapting accordingly. Asset managers will need to do the same.
The rise of ESG
As climate change’s effects grow more visible each day, business behaviour, ethics and contribution to social good is under even more scrutiny, and we can expect that to filter into how the funds industry devises strategy, allocates capital and manages investments. With the EU expected to adopt new regulations for index providers to make sure that their environmental, social and governance (ESG) benchmarking is appropriate and not simply enabling greenwashing, 2020 marks the point where we stop talking about this as a new phenomenon and just becomes part of our subconscious culture within the alternative funds space.
Most pension funds now demand clearer and more transparent adherence to rigorous ESG principles and there’s little doubt the direction of travel is towards far greater adherence to this ethos. Perhaps the most telling development in this area will be the end of ESG as a discrete category and section in the annual report; it is on its way to becoming a baked-in part of the investment landscape, with no need for separate mandates and reporting.
Regulators remain active
We can expect to see a number of trends emerging in the regulatory space as governments and NGOs work together with greater urgency to ensure there is no repeat of the 2008 crisis.
To that end, 2020 will see more activity in the offices of regulators across the world. In Europe, the EU is fast approaching the implementation of its new prudential proposals covering prudential requirements for MiFID investment firms as contained in the Investment Firms Regulation (IFR) and Investment Firms Directive (IFD); meanwhile the Financial Conduct Authority (FCA) will be consulting on its paper on assessing adequate financial resources.
Drives for transparency will continue
This year could be marked as the turning point for how governments address the issue of tax arbitrage and avoidance.
Luxembourg will be the focus for many to see how its adoption of tax reforms plays out. By adopting the EU Anti-Tax Avoidance Directive (ATAD), funds in Luxembourg will be subject to stringent rules around interest limitation, controlled foreign companies and rollover relief, among others.
Although it may not directly impact fund managers, 2020 will also mark the end of the London Interbank Offered Rate (LIBOR) as we know it. What replaces this venerable standard is still unclear, but it’s fair to suggest we will be dealing with a lot of additional reference rates – each one constructed slightly differently. And that in turn will create some basis risk between different currencies, making things more complicated in the future (see article below for more on LIBOR).
Rise of the machines
Technology will, of course, be one of the central enablers of many of these trends.
We are already seeing the growth of ‘platformisation’, whereby participants in the industry can increasingly share common infrastructure with which to reach, interact and retain customers. From common payment systems to faster and more secure information exchanges, the next few years could potentially see some radical efficiencies emerge in the funds landscape. It will also, of course, raise the issue of transparency over fees.
We believe that by using technology to improve the flows of capital and information across the globe – and potentially tying in compliance and assurance at source – we can help the investment industry stay at the cutting edge.