The asset management industry stands at a critical juncture at the start of 2019. Unprecedented geopolitical and macroeconomic uncertainties, the return of volatility and industry-specific challenges throw up a host of dangers for the sector. Asset managers will compete in a survival of the fittest contest played out in a hostile investment ecosystem. The winners will be those that can overcome — and exploit — the most pressing challenges. Here are our five top challenges for the industry in 2019.

Volatility  

Volatility returned with a vengeance in 2018 and is set to notch up a few levels this year. The “V” word is clearly at the forefront of investor minds. Recent research we have conducted shows institutional investors across the globe are bracing for greater volatility and uncertainty in 2019 amid increased geopolitical instability. 

A multitude of macroeconomic menaces loom large including trade wars, interest rate hikes and signs of a global economic slowdown. Brexit, political risks in the eurozone and currency moves add to a toxic investment cauldron.  

This volatile and uncertain backdrop will see risk management climb to the top of investor priorities in 2019. The ability of asset managers to provide effective protection from downside risks will be all-important.

This environment will favour active managers and we could see the active camp — which has been impacted by fund outflows and fee compression — make something of a comeback in 2019.

Volatility presents active portfolio managers struggling against the relentless rise of passives with attractive entry points and the opportunity to take advantage of short-term market movements. Tactical asset allocation will be key to weathering — and taking advantage of — heightened volatility in 2019. Actively managed multi-asset funds offering broad diversification will also hold appeal.

But the increasing correlation between equities and bonds will render the task of achieving diversification that much harder. This could see alternatives prove increasingly popular this year as investors look to recession-proof portfolios. One alternative sector that may benefit from the heightened volatility is infrastructure. Investing in the likes of airports, toll roads, renewable energy projects and healthcare infrastructure offer the benefits of diversification, steady income streams and attractive risk-adjusted returns.

Asset managers face a stern challenge in 2019: that of generating attractive returns in choppy markets and providing effective downside protection through robust risk management systems. But this two-fold challenge also provides an opportunity for the active sector to reassert itself after a prolonged period of passive outperformance and for skilled managers to stand out and shine.

However, portfolio managers will need to do more than merely seize the investment opportunities on offer. Against a backdrop of increasing macroeconomic dangers, they will need to assuage investor fears over market volatility and provide a degree of reassurance to jittery clients through effective communication and insightful thought leadership.  

Cyber Risks

Recent high profile cyberattacks not only demonstrate the reputational and financial damage inflicted on organisations by breaches but underline the fact that such attacks are now part of everyday life.

The sheer scale of the threat was highlighted by some bespoke research we carried out at the end of 2017 that showed a majority of SMEs had suffered some form of cyberattack over the past year.

With billions of people impacted by breaches in 2018, cyberattacks pose real dangers to the financial services sector and the wider global economy.

A recent study by UK regulator the FCA study spelled out in stark terms the need for asset managers to develop more robust cyber defences to safeguard investors. In a review of the asset management and wholesale banking sectors released in December, the FCA ominously warned that failure to manage cybersecurity could cause “serious harm” to both clients and wider markets. Among several damning findings, the regulator said boards and management committees lack familiarity with cyber risks.

As asset management companies increasingly turn to technology to drive down costs, streamline operations and launch new digital propositions, they will need to allocate increasing resources to cybersecurity risk management.

Indeed, cybersecurity must be put at the top of to-do lists in 2019. Organisations need to develop comprehensive cybersecurity programmes that ensure systems and processes are safe, secure and robust. Technology upgrades, information sharing and staff training should be focal points. Ultimately, cybersecurity must be elevated from an IT issue to a corporate priority that is embedded into a firm’s cultural fabric.

The increasing sophistication of attacks, coupled with the asset management sector’s growing use of technology, make it imperative for companies to take this threat very seriously.

There is also an important regulatory incentive to beef up cyber defences — under GDPR rules, firms could face fines of up to €20m, or 4% of global annual turnover, for cybersecurity infringements.

Strengthening cybersecurity defences makes sound commercial sense too. According to a report from Comparitech.com, companies hit by cyberattacks will likely underperform the market by 40% in the following three years.

Regulation  

With RDR, MiFID II, GDPR, PRIIPs and SMCR, asset managers have been hit by a tidal wave of acronym-infused regulation over the last few years. And that’s not forgetting the FCA’s Asset Management Review of course.

As asset managers brace for the incoming SMCR and continue to ride the challenge of MiFID II, the torrent shows no sign of letting up with regulatory fatigue threatening to become regulatory exhaustion.

The increasingly large burden of rules will see asset managers devote additional time, resources and money on regulatory compliance this year – something that will impact smaller firms disproportionately. This, in turn, could drive more industry consolidation.

Of all regulations, MiFID II perhaps represents a real watershed moment for the industry. With new rules on research and inducements and new product governance and transparency requirements, asset managers were heavily impacted by the regulation which came into effect in January 2018. As were all financial market participants. Research we undertook last year found UK financial advisers considered MiFID II the second-biggest challenge for their business in 2018, behind volatile markets.

The vast and complex MiFID II rulebook remains something of a work in progress as some sections of the asset management industry struggle to get to terms with it. Ambiguities over how the rules should be interpreted and applied present the biggest headache for organisations. The regulation has also resulted in unintended consequences such as confusion over research pricing.    

With Brexit adding another layer of ambiguity to the regulation, the task of decoding MiFID II presents a significant challenge for the asset management industry in 2019.

But just as asset managers wrestle with the mammoth that is MiFID II, another key regulation looms on the horizon. The extended Senior Managers and Certification Regime (SMCR) comes into effect on December 9, 2019. While that may seem a long way away, those firms not yet up to speed face a race against time.

Established in response to the 2008 banking crisis, the SMCR aims to improve individual accountability within firms and strengthen consumer protections. The regulation is broad in scope and will be especially onerous for asset management businesses with cross-border operations who will need to ensure both their UK and international staff are on board with the rules.

The concern is that firms already burdened by Brexit preparations, MiFID II, GDPR and the like might take their eye off the ball when it comes to SMCR. But with the clock ticking, this is simply not an option. Early planning, preparation and engagement with senior management staff will be key. 

The increasingly complex web of regulation perhaps poses the biggest challenge to the industry both in 2019 and the foreseeable future. While the big beasts will be better able to weather the storm, we will see increasing numbers of smaller firms outsource compliance functions to manage regulatory risk and reduce costs. 

Consolidation

The last couple of years have seen a number of big name deals in the asset management space, including the Janus-Henderson, Standard-Aberdeen and Amundi-Pioneer mergers.  

With the industry facing further disruption, it is poised for a new round of consolidation. The rise of passive funds, margin pressures, digital disruption, increased competition and ever-increasing regulation continue to make it harder for asset managers to achieve scale. And the uncertainties of Brexit may add additional fuel to the M&A fire in 2019 as further declines in the pound make UK asset managers more attractive to overseas buyers.

While these industry dynamics present opportunities for the acquisition-hungry industry giants, they pose a considerable threat to those smaller players looking to stay afloat and remain independent.  Indeed, we predict that in less than five years’ time a third of smaller asset managers will disappear from the market.  

The concentration of assets among those at the top of the food chain will continue to grow this year as large vertically-integrated firms add further strings to their bow in a bid to offer one stop shop solutions. These large players will increasingly look to snap up robo-advice, fintech and platform propositions to create new distribution channels and target wider audiences.

All of which means those smaller outfits looking to achieve scale will need to adapt and innovate. The ability to add new technologies and efficiencies and develop digital-first business models incorporating artificial intelligence, big data, blockchain and machine learning will help determine who survives and thrives.   

Passives

While pure index trackers will struggle in 2019 if the current stock market rout persists, the inexorable rise of passive products will continue to pose a threat to active fund managers in 2019 and beyond.

This is chiefly because the name of the game has changed. Passive products may have risen to prominence on the back of the advance of global equity markets, but the emergence of a new breed of passives mean they are no longer confined to index tracking funds.    

Indeed, a new generation of thematic ETFs and smart beta funds allow investors to gain exposure to innovative market themes and trends such as artificial intelligence, cryptocurrencies, ESG mandates and complex derivative strategies.

Moreover, the rapid growth of actively-managed ETFs and active funds in ETF wrappers mean passive investments are increasingly taking on the characteristics of their active counterparts. So while the return of volatility might offer a lifeline for beleaguered active managers, new forms of  ETFs offering downside protection and tactical tweaks mean investors no longer have a binary choice between active and passive.

But while all this poses a challenge to traditional active fund managers, the new playing field also provides them with an opportunity to evolve their propositions. The latest instruments to roll off the passive conveyor belt offer the ability to generate alpha in a low-yield, volatile environment and at a low cost. Active managers will respond accordingly and add these vehicles to their product range in order to capture new business from cost-conscious investors.

With the proliferation of low cost passive products fuelling recent mutual fund closures, the active camp has little choice other than to respond to the new economic realities and embrace elements of the passive universe. As the saying goes, if you can’t beat them, join them. But choice and diversity will remain key and those organisations able to offer both traditional actively-managed investments and a passive range will be best positioned for growth.