Financial Services

The financial services industry has been transformed since Lehman Brothers filed for bankruptcy in mid September 2008. Established business models have gone and new ownership structures have been created – voluntarily and involuntarily – overnight. Asset managers can take some comfort that their core role of delivering investment performance remains the same. But the manner in which it is delivered is being fundamentally challenged. What are leaders doing to position themselves for the future? Egon Zehnder International has been talking to managers throughout the crisis. Below are some emerging perspectives.

1. Asset managers are under severe stress

The market crisis confronts asset managers with challenges on multiple fronts. Clients are questioning the stability and strength of their asset managers, forcing them to upgrade their risk management and operational capabilities and increasing associated costs. At the same time, managers are looking for ways to reduce costs and improve operating efficiency in the face of sharply lower equity and credit markets and continuing volatility. Across the board, firms are experiencing record redemptions.

2. Client trust has been damaged

Performance has been challenging across all asset classes. Data from Morningstar, an investment research firm, indicates that an investor who saved $100 a month for the past 10 years into an average American equity fund would have saved $10,932 - $1,068 less than was invested. Even some ‘safe haven’ money market funds and down-side protected structured products have been found wanting. The industry’s ability to deliver sustained investment performance is once again under question.

3. Product landscape is shifting

Across both traditional and alternative sectors, clients are demanding products that are more transparent, simpler to understand and that perform in line with their expectations. We see a continued shift towards the separation of alpha and beta generation. We expect more demand for cost-effective ways of accessing beta (with a continuing move into passively managed exchange-traded funds). Active managers will be expected to provide true alpha returns and diversification. Wrap structures that promote client loyalty will also be in demand. Asset managers that have been able to withstand the challenging environment are set to reap market share gains as weaker performers fail.

4. Focusing on the core will be key

Top players are ruthlessly reassessing their competitive position and exiting areas where they lack clear leadership or defensible advantage. This requires a candid sense of self-awareness combined with the courage to take tough decisions. Managers are focusing on their key strengths, ensuring strongholds are well defended and only building beyond them selectively. Strategic insight will be at a premium to guide organisations through this challenging period.

5. M&A set to accelerate

Merger and acquisition activity levels in the sector are widely expected to increase. Some diversified groups will dispose of asset management arms to free up capital. At the same time, pure-play managers will build out their product offerings to exploit their customer franchises when markets turn. Acquirers will need to be aware of the importance of cultural fit in reviewing potential targets. Successful integration then requires a fair and transparent approach to identifying and integrating key individuals and teams rapidly. Without a structured approach, acquirers run the risk of losing key staff and destroying value.

6. Clients are demanding better reporting, risk and compliance management

Many institutional investors are undertaking a fundamental review of their risk parameters and compliance requirements. They are demanding more accurate, timely and consolidated reporting. Many are selling first and asking questions later if managers are unable to answer questions clearly and quickly. Meeting clients raised expectations will be key to re-establishing their trust.

7. Sales and marketing teams are under the microscope

Sales and marketing strategies and team structures are under review, with staff reductions already under way. Top managers are taking this opportunity to reassess whether they have the right structures and staff in place to succeed in a tougher environment. Some will restructure teams to better represent more focused portfolio management offerings. Clients will increasingly focus on relative fund performance and staff will need to respond to more probing and challenging questions going forward.

8. Effective leadership will require a more thoughtful approach

Proven leadership skills will be at a premium, given the need to reassure and motivate teams in the face of volatile market conditions. The days of achieving strong results through light touch management are gone. A much more involved, hands-on approach will be needed. Teams will look to their business leaders for a sense of purpose and direction. Providing this, though, is going to be more difficult as the outlook remains uncertain.

9. Compensation renegotiations need care

Managers now have an opportunity to restructure contracts and long-term incentive plans that were struck when markets were at higher levels. Taking this opportunity is likely to make sense for some - but not all - staff members. Strong teams have come under unprecedented stress as a rush to cash and fears of negative future returns have left many strategies ‘under water’. With weakened ties to their current employers, some are looking to cut loose and start-up afresh. We have seen an up-tick in interest from both teams and providers of financing looking to establish new ventures. Managers that take a ‘one-size-fits-all approach’ to compensation negotiations may inadvertently accelerate this trend.

10. Lay the foundations now for future success

Leadership and strategic skills will be needed to navigate challenging markets. Commercial capabilities will be at a premium to identify and close on new sources of funds. Boards and senior management will be tested in new ways and will need to restructure and reshape operations. Those that do so now will put themselves ahead of the pack, building platforms for future success and profiting from the next wave of growth as markets rebound.

Yogi Berra, the American baseball player, is widely quoted as having said: “it's tough to make predictions, especially about the future.” One prediction looks safe enough today, though: for a long while to come, change is going to be a constant feature of the asset management industry. In terms of specific areas, we make the following predictions:

• Boards: expect more appointments of financially literate non-executives on asset management boards to strengthen business oversight, enhance risk awareness and challenge incumbent management
• Senior leadership: turnover will increase as boards call time on leaders that lack the grit and determination to deliver as emphasis shifts from growth to efficiency and cost management
• Portfolio management: we expect strong demand for asset allocation and credit skills, particularly in distressed security investing. We also see growth in team moves
• Sales and marketing: traditional managers will re-scale and re-tool teams, attracting talent that has previously been out of reach from alternative managers and investment banks
• Risk management: talent will shift from investment banking to asset managers across major areas of risk management (operational, market and investment)
• Human resource management: talent management will become more critical to target, attract, evaluate and integrate new staff as needs evolve and new talent becomes available
• Compensation: new packages will have a longer term dimension aligning staff and shareholder interests more closely

The Chinese word for crisis - wei-ji or 危機 – combines the characters for danger and opportunity. Capturing new and emerging opportunities in difficult markets will require leaders to remain flexible while taking tough decisions. The value of making great people decisions to ensure that the right people are on the team has never been more critical.