Asset management & the main trends shaping the sector

Asset management & the main trends shaping the sector

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New resources are being discovered and advances in digital technology are happening every year. This leads to an increase in assets directly and indirectly. Despite the COVID 19 pandemic crisis, the aggregate global wealth increased by $28.7 trillion during 2020 financial year to reach $ 418.3 trillion (Credit Suisse, 2021). Global institutional pension funds total assets increased by 11% ending 2020 financial year to reach $52.5 million (Willis Towers Watson, 2021). There is abundance of wealth and some of it needs to be managed. That is where asset management comes in.

Asset management is the professional management of assets by a financial service institution to meet the investment goals of the investor. The assets include financial assets such as equities, bonds, cash or non-financial assets such as real estate and valuable physical artwork. Investors are generally categories into three groups. They are institutional investors, retail investors and high net worth individuals (HNWI). The investors give mandate to the financial institutions to manage their assets. The mandate may be discretionary where the investor delegate the management of their assets including investment decisions to the financial institution who work according to an agreed investment strategy. The mandate could equally be non-discretionary where the financial institution role is limited to analyzing and monitoring portfolios, together with tailoring proposals to support investment decisions. In such a mandate, the investor will take the final decision with regards to whether to buy or sell an asset. The last type mandate is execution-only mandate where no analyses or advice is given by the financial institution and instead, they act as an intermediary in the buying and selling of assets on the investor’s behalf. The focus of this thought leadership article will be on asset management. The following sections will be looked at in this article:

  • Different asset class available for investors
  • Financial markets related to asset management
  • Financial market authorities of big 5 economies
  • Trends shaping the asset management sector

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Investors make capital available to asset management financial institution. The institution will in turn allocate the capital to assets for it to increase in value through a process called asset allocation. Asset allocation is an investment strategy which aims to balance risk and reward by apportioning a portfolio's assets according to an investor's objectives, risk tolerance and investment horizon (Chen, 2020). Asset allocation is very important as it will be the main factor which will guide the investment portfolio results. There are two way of allocating assets. The first is strategic asset allocation which refer to the long-term apportionment of an investment portfolio to different asset classes base on the investor’s objectives and risk appetite. The second method of allocating assets is tactical asset allocation which exploits short term movements in asset prices anomalies by making temporary adjustment to the investment portfolio in order to increase the value of the investment portfolio. The main building block in the asset allocation process is the type of asset to invest in. Those assets are grouped into asset class.

Asset class is a group of financial and non-financial assets which exhibit similar characteristics, behave similar in terms of risk & return and are usually subject to the same law and regulations (Shajani, 2020). There are different type of asset classes and each have different cash flow stream with a corresponding different risk. The various types of asset class are explained in detail in the following section.

i. Equity: Also known as stocks, is a share of ownership issued by companies. Equity has the potential for wealth creation in the long term. The market value of an equity share of a company takes time to grow and it is subject to market risk which will impact the share price of the share equity. Equity asset class usually outperform other asset classes over the long term (Kothari, 2020). However, equity asset class are very volatile in the short term. Example of equity asset class include purchasing shares in company like Amazon or owing shares in the start-up.

ii. Fixed Income: They are financial instruments which pay a rate of return in the form of an interest every year. At the maturity date for many fixed income assets, investors are repaid the full principal amount they had initially invested together with the interest charged on the fixed income asset. It is one of the oldest forms of investment. Fixed income asset class is usually safer than equity as investors are guaranteed a return every year and in an event of bankruptcy of the investee, fixed income investors are often paid before equity asset class investors. Example of fixed income asset include US Treasury Note and Corporate Bonds.

iii. Cash and Cash Equivalence: This is the most know asset class worldwide as it is used on daily basis to pay for goods and services. Cash equivalents are highly liquid instrument with a maturity of less than one year. Cash and cash equivalents are suited for short-term investing. The primary advantage of such investments is their liquidity. Investments made in cash and cash equivalents assets are easily accessible. Example of cash equivalent asset is treasury bill issued by the US government and commercial papers issued by corporations.

iv. Real Estate and Other Tangible Assets: They are asset which offers protection against inflation. The tangibility of real estate and other tangible asset investments is a crucial characteristic and makes it different from securities that exist only in virtual or dematerialized forms. The market value of this asset class tends to rise and fall more slowly than other types of asset class. Example of real estate assets include real estate investment trusts (REIT) which are companies that own commercial real estate. Examples of other tangible assets is a valuable original painting.

v. Commodities: They are a specific asset class which have risk and returns that are largely independent of other asset class such as equity and fixed income. Commodity asset usually run parallel to inflation and that help protect future purchasing power. Having commodities asset class in an investor's portfolio is highly recommended by many experts as it is seen as an asset which enable an effective diversification of an investor’s portfolio. Example of commodities include gold, crude oil, copper and wheat. Commodities are extracted products such as natural resources or agricultural goods which are often used as inputs into other processes.

vi. Financial Derivatives: Derivatives are an important asset class. They offer risk and returns that are specific to them as they derive their value from the underlying assets which it is linked to. Derivatives equally enable asset management firms in the diversification of their risk and limiting their potential losses. Derivatives are usually leveraged financial instruments, which possess huge potential for returns and risk. Example of financial derivatives includes forward contract, future contracts, options and swaps.

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The asset classes listed above are just a few. There are other types of asset class such as foreign exchange currencies, venture capital and other alternative assets. The asset management firm buy and sell the various asset classes on the financial market. Financial Market refers to the marketplace where the activities related to the creation and trading of the different financial assets such as bonds, shares, commodities, currencies or derivatives takes place and it provides the platform to sellers and buyers of the financial assets to meet and trade with each other at a price as determined by market forces (Thakur, 2021). From the asset management investor’s point of view, the financial instrument and products are the asset classes described above. There different types of financial markets. The main types of financial markets are discussed below.

i. Money Market: It is a type of financial market where short term loans with a maturity of less than one year are purchased and sold. Money market has a high degree of safety and relatively low rates of return. Most of the transactions which occur in the money market are transactions which take place between financial institution and companies. Cash equivalent assets and fixed income assets which have short term maturity of less than one year are usually traded in the money market.

ii. Capital Market: It is a type of financial market where equity asset class & long term fixed income asset class are bought and sold by investors and investees. The market is used for borrowing & lending funds in the long term. The capital markets comprises of the primary capital market and secondary capital market. Primary markets handles transactions related to new issues of share & other securities directly by a company such as initial public offering, whereas secondary market deals with the exchange of existing or previously-issued securities. Equity asset class & long term in nature fixed income asset class are usually traded in the capital market.

iii. Commodity Market: It is a financial market which facilitates the trading of commodities. Commodities are usually split into hard commodity and soft commodity. Hard commodities include natural resources which are usually extracted from land such as crude oil, silver and diamond. Soft commodities are usually agricultural products and livestock such as wheat, sugar and meat. Commodities market enable producers and consumers of the commodity asset to gain access to the financial market. Asset management companies can invest in commodities directly through futures contract. Commodity asset class are traded in the commodity market.

iv. Derivatives Market: Derivative markets is a type of secondary financial market which deals with the trading of financial derivatives either through a formal exchange or over the counter market. The derivative market is often estimated to be value at over $1 quadrillion due to the existence of various types of derivatives which have virtually linkage to every type of underlying asset (Fry, 2020). Financial derivatives asset class are usually traded in the derivative markets.

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Financial markets have rules and regulation which are to be followed by the participants in the market. The rules and regulation are mandatory reporting and compliance standards which are usually issued by independent regulatory bodies. Violation or noncompliance of the rules and regulation by the participants in the financial market could lead to huge fines and in extreme cases expulsion of the participant from the financial market trading activities. For example, on 2012, the British pharmaceutical company GlaxoSmithKline agreed to pay $3 Billion in fine due to violation of the Security Exchange Commission rules and regulation (Thomas and Schmidt, 2012). We will discuss about the various types of financial market regulatory and their corresponding responsibilities for the financial markets located in the five biggest economies in the world. 

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In the United States, there are three main regulators who in charge of regulating the financial market. The Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) and Financial Industry Regulatory Authority (FINRA).

Securities and Exchange Commission (SEC): The US Securities and Exchange Commission (SEC) is an independent agency of the federal government which was created after the Wall Street crash of 1929. The mission of SEC is to protect investors, maintain fair & efficient markets and lastly, to facilitate capital formation (US SEC, n.d.). SEC has five functional divisions, which are responsible for helping to ensure that they fulfills their responsibilities. The division of corporate finance oversees disclosure made by corporations in order to ensure that investors have the right information they need to make informed investment decision. The division of trading & markets is responsible for developing and maintaining standards for fair, orderly and efficient market by overseeing key participants. The division of investments management regulates investment companies, asset management companies and registered investment advisors. The division of enforcement is in charge of investigating cases related to securities law violation and for prosecuting civil suits and administrative proceedings. Lastly, the division of economic and risk analysis is in charge of integrating data analytics and financial economics into the SEC’s core mission. The commission ensure that the financial market participants follow the law and regulation which govern the industry. Some of those law include Dodd-Frank Act of 2010 and Sarbanes-Oxley Act of 2002.

Commodity Futures Trading Commission (CFTC): It is an independent agency of the US government created in 1974 that regulates the derivatives financial markets in the US. Their mission is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation (CFTC, n.d.). CFTC has four divisions who have the main goal of overseeing the markets and enforcing regulations. The division of clearing and risk is in charge of overseeing participants in the clearing process and ensuring derivatives clearing organizations comply with the relevant regulations. The division of market oversight is in charge of ensuring that derivatives markets in the US are open, transparent, fair, competitive, and secure. They are equally in charge of creating regulations related to the security and great functioning of the derivative financial market. The division of swap dealer and intermediary oversight is in charge of overseeing derivatives markets intermediaries and ensuring that they comply with the relevant regulations. The fourth is division of enforcement who in charge of enforcing the rules and regulations which govern the derivatives financial market and investigating & prosecuting those who are not in compliance with the relevant rules and regulations.

Financial Industry Regulatory Authority (FINRA): It is a private self-regulatory organization which regulates member brokerage firms and exchange markets. It is the largest independent regulator for all securities firms doing business in the United States. FINRA's mission is to protect investors by making sure the securities industry operates fairly and honestly.

In China, the main regulatory body who regulated the Chinese financial market is the China Securities Regulatory Commission.

The China Securities Regulatory Commission (CSRC): They are a public institution in charge of regulating China’s securities and futures market with the aim of ensuring efficient and fair market. It is under the direct control of the state council. It is the functional equivalent of the US Securities and Exchange Commission. It supervises the securities & futures firms, securities & futures exchanges, securities depository & clearing corporations, securities & futures investment consulting institutions and securities credit rating institutions. It is equally in charge of developing laws and regulations related to the securities and futures market.

In Japan, there are three main regulatory body which oversees the financial market. They are Securities and Exchange Surveillance Commission, Japan Securities Dealers Association and Financial Futures Association.

Securities and Exchange Surveillance Commission (SESC): They are the main regulators who regulate the securities market in Japan. It is in charge of ensuring that the transactions trading which occur in both the securities financial market and financial futures financial market are efficient and fair. Its mission is to ensure the integrity of capital markets and to protect investors, thereby contributing to the sound development of Japan's economy (SESC, n.d.). SESC has six divisions which enable them to work towards their mission. The market surveillance division is in charge of the daily market oversight and investigate any suspected violation of market rules by market participant and if violations are identified, civil penalties or criminal charges may arise. Inspection division evaluates if the financial market participants are in compliance with the laws and regulations of the market. The disclosure statements inspection division reviews the notes to disclosure of the audited financial statements of listed companies to ensure they are not falsified. The administrative monetary penalty division and investigations division carries out investigations into non-compliance by participants in the financial market. The coordination division is responsible for the overall coordination of the Executive Bureau.

Japan Securities Dealers Association: It is a self-regulatory organization who regulates intermediaries in the financial market. Its functions include rule-making among intermediaries, accreditation of sales representatives and represent the intermediaries in exchanges with the government and other parties. Their goal is to contribute to the protection of investors by ensuring fair and efficient trading and promoting the sound development of the Japanese financial instruments sector.

Financial Futures Association: It was established in 1989 with the main goal of ensuring the protection of investors and the sound growth of the financial futures industry in Japan through proper business management of financial futures firms. They provides guidance on industry-wide self-regulation, settlement of claims and grievances.

Germany has one main financial regulatory authority and they are called The Federal Financial Supervisory Authority.

The Federal Financial Supervisory Authority: Also known as BaFin, is an independent federal organization who is governed by Germany's Federal Ministry of Finance. It was created in 2002 with the goal of being the primary regulator of Germany’s financial markets and institutions. The organization was formed by the merger of three former regulatory who include Federal Banking Supervisory Office, Federal Supervisory Office for the Securities Trading and Federal Insurance Supervisory Office. This lead to BaFin having many functions. They have authority over Germany’s banks, financial services companies, insurance companies, stock exchanges, & other obligated institutions. BaFin ensures the smooth functioning of Germany's market for securities and derivatives in accordance with the Securities Trading Act. Other responsibility include supervision and regulation of financial institutions in Germany in order to maintain the stability and safety of the wider financial system.

In the United Kingdom, the main regulators in charge of regulating the financial market is Financial Conduct Authority.

Financial Conduct Authority: It is a financial regulator who regulates financial market participants in the UK and maintain the integrity of the financial market. The goal of the organization is to ensure honest and fair markets for the financial market participants and the UK’s economy as a whole (Kenton, 2020). It ensures investors rights are protected, enhance the integrity of the UK financial market and ensure that there is a healthy competition among the financial services providers in the financial market. It equally have power delegated to them which include rule-making, investigating and enforcement power. It has the authority to charge and raise fees to market participants as it is an independent body who don't receive any government funding. Instead, they charge fees to members of the financial services industry in the financial market in order to raise income in order to finance their operations. The organization works together with the Prudential Regulation Authority and the Financial Policy Committee to set regulatory requirements for the financial sector.

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Asset management sector is going through transformation and is no longer the same as asset management sector in the past. The sector is going to change in the future. The question is no longer whether asset management needs to change, but what that transformation should look like. Asset management industry is going through a transformation especially with the event of the COVID 19 pandemic. The sector is experiencing very low growth which is causing profitability to reduce, client expectations are changing rapidly due to demand in personalized products which meet the specific investments need of the client, tougher competition from new digital participants, rougher & increase in regulations and a need for digital transformation (Birkin et al, 2021). These events requires asset management firms to proactive assemble the right strategy and business model in order to adapt to the transformation taking, place including reinventing the customers experience and integrating digitalization into investment decision-making.

Despite the transformation which is taking place, the asset management industry has an opportunity to strategies appropriately and elevate its purpose to create and protect their long-term value. The following factors listed below are transforming the asset management industry and the participants need to integrate them into their business model in order to succeed in the future.

i. Digital Technology: Technological disruption is transforming the customer experience by creation of user-friendly digital platform that advice customers when it comes to the decision making process as well as giving them direct access to signing up for products. Artificial intelligence and data handling are revolutionizing the investment process. Artificial intelligence help construct portfolios based on more accurate risk & return forecasts and more complex constraints by increasing efficiency, accuracy, and compliance (Bartam, Branke and Motahari, 2020). The digital technology will allow manager to have real-time overview of the market situation and enable them to take decisions faster. Digitalization will accelerate the asset management firms push to new products which will create new revenue streams.

ii. Personalization investor’s preference: Investors today want to be actively involved in the investing decision process and not only play a passive role. Giving clients the freedom to pursue their very specific objectives in a highly customized manner will continue to drive innovation in the asset management sector. Clients nowadays expect to be at the center of the decision making as well as to have the choice of how and when to invest or divest. Meetings those expectation and moving from product-centric to a client-centric business model lies in the future of asset management industry.

iii. Actively advising clients: Vital advice is usually needed by investors especially as demonstrated during the COVID 19 pandemic crisis. During the pandemic, thousands of actively managed funds outperformed their passive alternatives across asset classes and portfolios. Desire for personalization goes beyond products only. Research carried out by Accenture found that three-fourth of asset management firms are considering expanding their product and service and move to advisory and consultative role not only to investors, but also to advisors and distribution partners which will result in the asset management firm building stronger relationship with investors in the long term (Kerrigan et al, 2021). This will lead to the creation of long term value for the asset management firm.

iv. Talent and Culture: In order to compete in the future successfully, asset management firms will need to innovate frequently and respond with agility to technological change. When one has a top class talent workforce, one will produce a top class performance (Kerrigan et al, 2021). A workforce with a blend of functional and technological skills will be very vital. Furthermore, a hybrid of physical and virtual workforce will become the way asset management employees work. The leadership of an asset management firms will have to embrace inclusiveness instead of command and control leadership approach. This is very vital due to the new expectation of the younger workforce who are expecting to feel that they are involve in finding the solution and to be included in the decision making process.

Reference List

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Metuk Edwin Sube

Accountant / Tax Specialist at Febe Associates, Felix & Co Chartered Certified Accountants Ltd, Beecountants Ltd

3y

Thanks for sharing, very enlightening

Joel FEUPOSSI

Blockchain | DeFi | Global Shapers

3y

Great job. Yusuf Madi, ACCA, CPA, CGA, CFE. Good content. What about digital assets in your classification. Any data..

Bisong Belmond, ACCA

Internal Auditor @ Access Bank Cameroon

3y

"A workforce with a blend of functional and technological skills will be very vital...." Great job putting this all together. 👍

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