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MARKET NOTE

Larry Tabb, Research Chairman and Founder


February 2019

The Multi-Asset Buy Side: Overkill, or Table Stakes?


Introduction First, active managers need to hone their product, pricing,
Trading success historically has revolved around focus. The and marketing to tie into investor demand. They need their
more intense the focus, the more successful the trading investment strategies to perform, be fee-sensitive, and
strategy. In banks and brokerage firms, this has influenced manage downside risk without giving up too much
their organizational and technological alignment. The world, performance. That is a tall order.
however, is changing, as new technologies such as
algorithms, data science, cloud infrastructure, and open- Second, active managers need to rethink their alpha
source software are enabling firms to analyze information implementation ideas, moving away from traditional
more quickly and reduce tick-to-trade times and investment rich/cheap value analysis and toward more complex
turnaround. Technology not only is redefining the job; it’s strategy implementation ideas that cut across traditional
reshaping the business. Many trading decisions are asset class barriers. They need to think seriously about how
executed, if not driven by, machine. to more adequately implement an investment thesis. The
answer may not be just buying equities but in augmenting
Technology is changing the nature of investing. equity strategies with financial products that gain precise
exposures without adding unwanted risks.
Today, computers pore over financial information, reading
and determining the sentiment of news and social media; Third, as firms move away from siloed investment
satellites look down from the cosmos and measure crop implementations, they need to rethink their infrastructure
yields, mining production, and car and parking lot densities; (read: technology), so that portfolio managers can run their
and billboards measure rush-hour traffic and, combined with investments across asset classes. They should see their
cell signals, help determine the demographics of passersby. positions aggregated across the strategies, and implement
So, with all this new alternative information, why are them in either multi-asset solutions or very tightly integrated
traditional active equity managers still struggling? Why solutions, so equities, debt, options, futures, swaps,
aren’t active investors’ jobs getting easier? financings, and other products can be analyzed, traded,
settled and viewed as part of an integrated strategy.
It is precisely because new technology, data science, and
investment structures are increasing competition, culling the Let’s discuss the infrastructure side of the challenge. Any
wheat from the chaff. This makes money management money management firm today not only needs scale, but
more difficult, especially at the institutional level, as efficiency as well. Anyone charging a management fee of
investment timeframes compress. Real-time tradable ETFs zero cannot make up for lost margins with additional
also increase competition by commoditizing many volume. As fee pressure mounts on managers, they no
benchmark investment strategies. And, finally, firms such as longer have the leisure to worry about asset collection and
Fidelity are increasing competition by adding fulcrum and infrastructure rationalization. Many money managers are
zero-fee products, driving traditional management fees into the aggregate of smaller managers. Unless these
the ground. unconsolidated organizations have found the proverbial
goose and can hatch golden eggs, they need to harvest
Is this the end of active management? Absolutely not. corporate synergies by quickly consolidating operations,
technology, and infrastructure.
A New Strategy Imperative
This means rationalizing multiple processing infrastructures
There are three major focal points that active managers into fewer and maybe even one; from single-product
must have at the forefront of their minds in this age of platforms per management silo to multi-product platforms
compressed timeframes: product, implementation, and that can process across currencies and regions. Order and
process. execution management platforms that are aligned by a
single asset class already are a reality. The next horizon is
©2019 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 1
The Multi-Asset Buy Side: Overkill, or Table Stakes? | February 2019

a unified processing infrastructure that can process bonds, Exhibit 2: Trading Desk Initiatives
swaps, mortgages, derivatives, Treasuries and Bunds as
easily as it can trade an equity. 61%

This is directly aligned with institutional equity firms’


strategic initiatives, as 47% of the 100 buy-side head U.S.
equity traders we interviewed in 2018 mentioned that
automating their non-critical functions and improving their
technology infrastructure was their most significant
25%
business initiative. In addition, if you add the 20% of firms
that discussed upgrading their EMS/OMS platforms, that
13%
bumps up the percentage of firms that are pushing
automation to almost 70% of funds (see Exhibit 1).

Exhibit 1: Major Buy-side Technology Initiatives Technology Execution Relationships


Quality
Automate Non-Critical/
47% Source: TABB Group
Improve Technology

OMS/EMS Upgrades 20%


Fees and return pressures are polarizing the market into
two categories of asset managers: pure beta (passive) and
exceptional alpha generators. As investors vote with their
Incorporate Advanced Data
14%
flow away from the lower-quality and more expensive active
& Analytics
managers toward passive strategies (see Exhibit 3), the
flow concentrates in benchmark securities (those within
We are automated enough 12% indices). This trend further pressures sub-standard
managers and swings flow either to the truly exceptional
alpha generators or the increasingly bland index-style
Post trade Improvements 7% offerings.

Source: TABB Group


Exhibit 3: Net Fund Flows from Active to Passive ($Billions)

$2,000

Even rationalizing each firm to a single priority, improving $1,573


internal technology was the overwhelming strategic initiative $1,500

in which institutional investors were investing, above


execution quality and improving their broker relationships $1,000

(see Exhibit 2). $1,005


Billions

$500

While rationalizing a firm’s infrastructure is critical and


provides efficiency, what a firm can do once it has a unified $0

processing infrastructure is probably more important than


just shaving off a few basis points in management fees. A -$500
-$568
consolidated platform opens up the fund to an array of new
capabilities. -$1,000

Net Difference Cumulative Active Equity Cumulative ETF

Increased competition Source: TABB Group

Fee pressure isn’t impacting only managers’ expense


ratios; it’s applying pressure on investment returns as well. Firms will need to understand, and take advantage of,
As investment fees come under scrutiny, any adverse differing ways to find alpha, through asset selection and
slippage and style drift by traditional managers creates implementation of investment ideas. While managers have
awkward performance discussions with their investors. typically gained corporate exposure through buying equity,
increasingly, firms will need to analyze how equity exposure
©2019 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 2
The Multi-Asset Buy Side: Overkill, or Table Stakes? | February 2019

aligns with corporate debt, equity options, credit default Exhibit 4: Percentage of Firms Reacting to Passive Influences
swaps, whole loans, and even sovereign debt, since an 57%
equity exposure has a risk-free rate (sovereign debt) as well
as a corporate balance sheet component. They must learn
how to capture the upside (or downside) of an investment
while limiting risk. This could be captured through options,
debt, or traded through a total return or equity swap. To be
one of the truly exceptional, firms will need to adopt different
investment strategies.
19%

While machines are good at repetitive tasks, it takes insight 12%


to fully understand the full paragon of investment 7%
5%
implementation strategies. Machines will be able to tell you
the value of Apple stock, not only based on last quarter’s
Do Nothing/Staying Introducing New Adding New Expansion into New New Fee Structures
earnings, but, increasingly, through the sentiment of the Course Passive Strategies Strategies Asset
managements’ last quarterly earnings call, news and Classes/Regions

tweets, card swipes at Apple stores, and purchases at Source: TABB Group
apple.com. They will leverage satellites to track parking lot
images and sensors for foot traffic. Any number of complex investment strategies. This requires moving from
alternative data sources can note on a moment’s notice best-of-breed-type investment platforms to ones that
changes in purchase demand and sentiment. provide a more comprehensive service and compliance
offering.
While machines will be able to hone their value analysis of
Apple to a gnat’s eyelash, what if it isn’t the equity that Getting to Technology Nirvana
should be in play? Maybe it’s an option or a bond? Maybe Creating this level of integration is not easy. The first level
the stock is rich and should be shorted, but the bond is of integration is just enabling the platforms to process
cheap? But what if we really don’t want an interest rate different asset classes or transcend geographic boundaries.
play? A U.S. Treasury or fixed income future could be This is no mean feat. While equities are fairly vanilla,
shorted to insulate the strategy from Federal Reserve rate equities processing is more defined by its multi-currency
policy. Increasingly, commodities, energy, and metals will processing, clearing, connectivity, geographic regulatory
also be used to analyze value, as valuation models in the regimes, and corporate actions nuances.
soft commodities will have implications for farm equipment
providers as well as the supply chain partners or their Once you start trying to integrate fixed income products, a
partners’ partners. whole host of issues appears, not the least of which are
calculation methodologies. Different instruments have
The implementation of these strategies is not particularly different calculation routines, as traditional notes and bonds
easy. In fact, most of the 100 head U.S. equity traders we pay semi-annual interest, discount notes don’t pay interest
interviewed were doing nothing but going with the flow as at all, and many mortgage-type products pay monthly
the investment world pushes toward passive strategies: principle and interest payments. In addition, the actual
57% of the firms we interviewed were staying the course, calculation routines can differ by country and product, such
19% were implementing new passive strategies, 12% were as a 360- vs. 365-day count. Futures and foreign exchange
implementing additional active strategies, and only 7% were also create challenges, as products trade at various
expanding into new asset classes (see Exhibit 4). exchanges and have different clearing mechanisms. All that
doesn’t even take into account the market data, valuation,
The problem is that most investment managers do not have and corporate actions that are needed.
the leeway to invest in these complex investment
implementations, nor the automated compliance However, calculation and processing are just table stakes.
infrastructure to ensure that managers investments and Once firms start creating synthetic exposures, they need to
allocations fit within their mandates. Their technology be able to link these products together and provide
infrastructures, bought as best-of-breed, do not bring the integrated compliance. While it would be great to process
integration needed to analyze these opportunities, nor bonds, futures, and equities in a single platform, if they can’t
insure compliance, trade them, capture the data in a single be displayed together on the same screens, then it
location, nor value them in a way to harvest these types of becomes difficult ensuring compliance, tracking the various

©2019 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 3
The Multi-Asset Buy Side: Overkill, or Table Stakes? | February 2019

component parts versus the individual pieces, or just New Architectures


obtaining a comprehensive view of the portfolio. Just The platforms that can handle the challenge will be a
looking at using U.S. Treasury Notes to hedge two different consolidation of portfolio and order and execution
deals; what if one deal required a long position while the management, with a consolidated and integrated overlay of
other deal required a short position? While the net position portfolio accounting and compliance. These platforms will
may be net flat, if the platform flattens out the long and short, be multi-asset class, multi-geo and multi-utility, as the
the hedges, the U.S. Treasury aspects of those two deals demands of a hedge fund are not the same as those of a
go away, and the economics may be compromised. mutual fund and certainly are not what either an insurance
company or pension fund require.
In addition, the market structure employed to trade these
products can also differ. Equities not only are predominantly The only way this will be fulfilled is through new ways of
traded on an agency basis in exchange-based limit order thinking through the problem set. While cloud and ASP-
books, but also some are traded in dark pools, and others based solutions will most likely be core—and open source
on the balance sheet of banks and dealers over the counter technology will most certainly be a part—software firms
(OTC). Bonds are almost the exact opposite with the moving into the next decade will need to rethink how they
majority being traded OTC, through phone, RFQ platforms, develop, service, and charge for software. On the latter, the
and to a smaller extent, electronic central limit order books. ability to charge multi-million-dollar licensing and
maintenance fees will certainly drive scrutiny. These key
As efficiency becomes more critical, integrating all of these drivers are reshaping the competitive technology landscape
trading styles into a single technology stack, will not be just today and will drive the industry into the future.
a nice to have but a central core of a firms’ processing
facilities. Not only is developing an integrated trading
Conclusion
technology stack into the core processing facilities of a firm,
difficult, but the ability to visualize, trade, process, link and Firms and funds need to start thinking of their investment
account for a world of heterogenous products is very difficult horizon differently. As the juices get squeezed from
and should not be discounted. traditional asset management strategies by low-cost funds
and packaged products, the managers that will remain will
either have the scale to compete with the Vanguards and
Tech Stack Consolidation
BlackRocks, or have the flexibility, agility and streamlined
Major organizations are making billion-dollar investments to infrastructure to analyze the market from a different
facilitate this transition and are consolidating the technology perspective and rethink the investment process. This only
stack to service clients in just this fashion. This has been can be accomplished by a firm with the capabilities to
the defining factor surrounding two major financial analyze, position, trade, and account for a more varied and
technology acquisitions made during the last few months. complex investment strategy that will increase yields,
reduce risk, and allow managers to crush, not just beat, their
First, Eze Software was acquired by SS&C, one of the benchmarks. This, however, only can be done through a
largest hedge fund accounting platforms. Eze Software, the more highly functional and streamlined technology
leading provider of hedge fund order management platform—one that not only handles the traditional, but the
technology, now has the potential to be more tightly linked complex and difficult strategies with ease.
to SS&C’s GlobeOp hedge fund accounting platform. This
combination of technologies enables SS&C to provide As the industry continues to wrestle with investors’ fixation
greater service and support to a wider array of hedge funds on passive investing, traditional asset and hedge fund
and investment strategies. managers need to do more with less. They need to develop
undiscovered and under-monetized alpha sources more
The second example of how the technology stack is efficiently and effectively than ever before. This will push the
consolidating is State Street Bank’s acquisition of Charles buy side to increasingly consolidate trading to professionals
River Development. The combination of these two (and technologies) that can effectively locate and harvest
businesses, not unlike Eze Software and GlobeOp, links the alpha opportunities that are presented no matter the asset
front end of the investment process of one of leading class, product type, or geography. Firms that do this right
traditional money manager order management systems will be rewarded, while those that don’t will increasingly be
with the custody and services businesses of State Street, relegated to oblivion – or, if they are lucky, consolidated into
one of the top global custodians. the menagerie of amalgamated platforms the winners call
scale.

©2019 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 4