Digitization's Second Wave Finds Buy Side Seeking Wisdom From Within

Chapter IV of Confucius’ Analects contains a simple instruction; as the Scottish Sinologist John Legge translated it, “When we see men of worth, we should think of equaling them; when we see men of a contrary character, we should turn inwards and examine ourselves.”

In other words, allow room to be both aspirational and introspective.

Scholars believe the Analects were written and widely known by 206 BC, but this particular chapter likewise applies just as easily today — and in contexts well beyond matters of personal virtue.

Indeed, many large firms on the buy side—from asset management giants to insurers and private wealth managers—have begun to take their own steps to “turn inwards” with digital initiatives, following a sustained period of extensive, often prolonged transformational projects that were mostly outwardly facing.

As digitization veterans tell Waters, this new second mode of self-improvement has proven the more difficult. But the growing sentiment among these firms is that it must be done, even if their tech teams are now reinventing the way they think and plan in order to get there.

With a multi-boutique, you strive to keep the unique characteristics of each fund manager, but when it comes to distribution, relationship management and compliance, we leverage a shared function. So it’s a hybrid approach and striking the right balance. - Brian Ness, Principal Global Investors

Tough Sledding

Many of the more impressive digitization projects Waters has seen in recent years have revolved around user interfaces and client portals capable of providing deep transparency to investors.

These will sometimes take several years from start to finish; they’re elegant, highly strategic and when done successfully, the end product explains itself. After all, the centerpiece—the front-end—is geared toward the visual and intuitive, and the key focus on clients is music to any chief executive’s ear.

Despite being both time and resource-intensive, though, in many ways these initiatives are actually easier to pull off than the less-visible digital projects focused on operations within the enterprise, itself.

In fact, this latter variety, Stanford University professor Behnam Tabrizi tells Waters, accounts for most of the estimated (and surprising) 70 percent fail rate that digitization projects still suffer, particularly in financial services.

“The main reason why is they’re just too slow,” he says. “They underestimate the amount of change required to digitize, and think technology can solve things by itself. In finance, we’re used to getting things perfect, pushing it over the wall, and calling it done without introducing a culture of digitization and really authoring the change, front to back. Part of the problem is that finance tends to retain a top-down leadership model rather than the flatter structure you’ll find elsewhere and in Silicon Valley, and that doesn’t mesh with the rapid transformation, holistic involvement, and constant feedback that internal digitization demands.”

Josh Sutton, a managing director at Sapient, adds that it’s often a misunderstood delineation between one category of project and another, even at C-level.

“Firms tend to clearly understand the challenges with regard to the direct customer interaction—that’s been well defined during the past five to ten years—but they’re surprised that it reaches beyond customer engagement,” he says. “I sat down with the COO of a large asset manager a few months ago, and midway into the conversation, he realized that 'this isn’t just about technology.' It is a very different paradigm than most people think about digital work because the real upside is on that back-end: employee enablement, optimizing processes, and eventually, creating new business lines overall.”

Myriad Drivers

So, how to get it right? Brian Ness, chief investment officer for information technology at $330 billion Principal Global Investors (PGI), says it’s first about pushing the implementation envelope.

“How you accomplish this is to make digital core to the execution of the business strategy itself,” he says. “Prototyping and smaller trials help us gain agility on a quicker basis to test what works in different parts of the world, whereas historically we worked in a model where they would give us a three-to-five year road map, and we’d deliver on that. It’s a much more dynamic model, whether through agile development practices or a series of quick proofs-of-concept. You do this on a much more rapid basis because the business is shifting underneath. Today, it’s hard to anticipate where your priorities will be a few years out.”

This change is evident up and down the investment management chain—with myriad drivers to explain why. Asset managers are consolidating. Many now operate using novel approaches, as PGI does with its multi-boutique model, by acquiring a set of smaller hedge funds that operate somewhat autonomously.

Pension funds and other institutions, meanwhile, have woken up to the fact that managing more money internally saves them cost—to the tune of 38 basis points, according to a recent study by CEM Benchmarking.

“Traditionally, institutional investors have relied heavily on external service providers—such as consultants and fund-of-funds managers—to evaluate portfolio performance and analyze risks, but technologies that facilitate data accessibility and aggregation are disrupting this model,” explains Tyler Kim, chief technology officer at fund administrator MaplesFS.

“With these tools, institutional investors are able to pursue ‘do it yourself’ models, whereby their internal teams play a more active role in the investment process, thereby disintermediating some of the players in that process and significantly reducing costs. What we’re definitely seeing is the increased prevalence of providers—like Innocap’s managed accounts platform for emerging managers, and Société Générale Securities Services’ Gateway—that are providing infrastructure for smaller managers through a central platform.”

Multi-Boutique

Just how buy-side firms are digitizing depends on their size and dispersion, but two areas of focus—relationship management and costs —stand out beyond the front-line risk and portfolio functions, reflecting the nature of the industry’s changes.

The first piece, explains Ness, is reflective of PGI’s centralized services hub.

“With a multi-boutique, you strive to keep the unique characteristics of each fund manager, but when it comes to distribution, relationship management and compliance, we leverage a shared function. So it’s a hybrid approach and striking the right balance,” the CIO says.

“Expectations vary by region: you cannot assume a Japanese client will have the same expectation for collaboration, reporting and analytics that a German client will have; therefore we have to understand how we’re interacting, how the relationship manager can work with them in a way that adds value. Sometimes that’s empowering a relationship manager to use technology, while other times that’s going direct to the customer to really comparatively understand that dynamic in each part of the world. To engrain that into the culture takes quite a lot of work and fine-tuning as you’re going along. We have a pretty good cadence around annually reviewing our boutique operating model now, talking to them about adjustments they see as necessary, as well as our own, and then using that to constantly improve. But it's taken years to do.”

Sapient’s Sutton also notes better fidelity for internal communication as a common target, moving from a traditional content methodology to one that is more interactive.

“That starts with qualitative information, and there’s a very strong need in most organizations to have an improved strategy around this, given that 80 to 90 percent is garbage—either dated, no longer accurate, or otherwise,” he says. “So first, you’re creating an ongoing catalogue that’s aligned with go-to-market strategies that is current and directed to the right audiences. And then on top, it’s about customizing that to specific classes of customers—with portfolio data, NAV calculations, what-if scenarios and modeling—and to a certain extent, building a sandbox where they can walk through concepts before potentially building them into a client portal.”

New View of Cost

Digitizing revenue and product tracking is a bit of a different beast, and demands computational power usually reserved for the more intensive analysis a firm will use to manage its books.

As one illustration, SAP recently released a cost allocation tracking and control tool for insurers that use the provider’s new HANA in-memory computing platform to allow firms to tightly integrate once-separate actuarial measures and to parameterize data as much as possible for different stakeholders. The German software provider says a wide range of buy-side firms could soon benefit.

Revenue and cost allocation are surprisingly algorithmically intensive, according to SAP senior industry principal Mike Russo. Many institutions have taken a fairly simplistic approach to this on volume metrics, but in 2015 they want to employ methodologies with more sophisticated activities-based cost measurement, which accounts for the ways cross-product and cross-customer relationships produce potential subsidies for each cost object (and large firms will have hundreds of these to track).

In the end, he says, it’s down to being as precise as possible, with a system landscape to match.

“There’s a move toward being more proactive and understanding what the impact on the next transaction is going to be,” Russo explains. “How much capital is consumed, what is the relative profitability of a new contract prior to doing it? It’s a real-time ability to get those insights before the transaction occurs, and to be predictive, where tech should make inferences from those activities. That’s the advantage that comes with using this type of architecture.”

Authorship Crucial

Of course, as more firms of different stripes look into digitization projects—constantly dabbling as much as they are transforming—sources agree that there are a few common pitfalls that can turn promise into quagmire.

One, says Sutton, is insufficiently assuaging personnel.

“Concern will always come from those who have been guardians of information,” he says. “They’ll often have trepidation and there are mixed emotions and a thought of, ‘I don’t want to become irrelevant and replaced by technology.’ But in most buy-side functions, there’s always going to be a certain human element to it. And done effectively, what digital does is provide a multiplier effect around greater assets under management or customer numbers, but with a higher level of service.”

This is especially the case for those chasing a younger but increasingly important generation of high-net-worth investors. As Sutton continues: “How do you make your services easy, accessible, and value added in a short time frame? It used to be about building up a stellar reputation over a multi-year period; now, it’s about how to provide value immediately, and build the relationship with a broad set of ‘initial touch points’—simple tools to solve simple problems like what-if calculators and very targeted offers—rather than a long, drawn-out courtship.”

PGI’s Ness broadly agrees, citing the concept of authorship as crucial. “As we look at digitization, we see push back in negotiations around these things as an opportunity to improve,” he says.

“A big part of the proposition of the multi-boutique model is having that ability to move quickly as customer expectations change. That’s a distinct advantage, and we’re able to have those discussions and do internal disruption in a way that helps us be more responsive to customers and market demands. It’s an active dialogue with each boutique around what the things they need provided by IT, and we value that. If you had a culture where that was not valued as a benefit, this process certainly could become a detriment—you need to value that to be successful.”

Beyond ‘Perfection’

Indeed, those resisting internal digitization might find that the train has already left the station … with clients aboard. Few would say the process is straightforward—especially at firms with thousands of staff—but fewer still believe it can be ignored.

Technology-based disintermediation of the traditional asset management operating model is “well underway,” as Kim at MaplesFS argues. At Stanford, Tabrizi has an even stronger take: Much like the major banks, buy-side firms should take seriously the possibility of being outmaneuvered.

“To survive in the past, these firms just needed to perfect the product and wait on the huge margins; the digital economy means you have to be much more competitive,” he says. “They have their work cut out for them; whether many truly get it, I’m not so sure yet. Among startups these days, social media is pretty much done, but along with healthcare, there is growing excitement around finance. Put smart people in this space, with a lot of money behind them, and five years from now I think we’ll be seeing some significant disruption.”

The prospect only becomes more “terrifying” for a large firm looking around—even with the achievement of a beautiful front-end for clients in hand—and figuring out what’s next, says Sutton.

“They’re all asking: what do I need to do to avoid becoming the next Borders?” as he puts it. The answer increasingly lies within.

Salient points

• Various types of institutions on the buy side are turning to internal digitization projects after a recent period of focusing on outward-facing client-reporting portals and interfaces.
• This is particularly true for large asset management firms that have undergone organizational transformation, acquiring smaller hedge fund outfits and introducing hub-and-spoke shared services models. It is also true for institutional investors that are looking to handle more of the investment process in-house.
• Many of these projects are focused on two areas: one is internal communications and closer attention to relationship management, while another is to cost allocation and revenue as they relate to new product development and tracking.
• In-memory computing and other enterprise-grade technologies traditionally associated with risk management and data aggregation are being introduced to these areas as firms’ requirements change.