Client needs, asset manager appetite focus of financial innovation study

The ongoing interest among asset managers in financial innovation needs to be put in context of client needs and expectations as the record of industry innovations remains decidedly mixed, a study covering $29trn of assets suggests.

Investment Innovations, published by CREATE-Research, and commissioned by Citi’s Global Transaction Services and Principal Global Investors, surveyed over 500 respondents from 30 countries.

It asked respondents which financial innovations they believe have worked, which have not, what should be the main thrust of innovations over the next three years and what specific improvements and actions they want to see related to these innovations.

Asset management

The report says that investment innovations since 1980 have been clustered as new asset classes, new asset allocation techniques, new risk and returns enhancing tools, new theme funds or new business models.

From these there were, according to the research, five areas of innovations that delivered most value in the past decade: emerging market equities, emerging market bonds, high yield bonds, liability-driven investing, and exchange traded funds (ETFs).

Those that delivered least value were leverage, structured products, portable alpha, and currency funds.

Overall, there were four ‘rules’ around innovation identified by the research: innovations work as long as we know their limits; asset managers should improve the old before creating the new; the innovation boat is unlikely to be pushed out too far; there needs to be a clear line of sight between innovations and client needs

Other key findings of the report include:

   – Some 35 innovations saw significant adoption in the last decade. 57% of respondents said that emerging markets equities delivered most value while leverage recorded the worst performance, according to 40% of respondents

    – 50% of pension plans believe a switch from products to solutions will be a key driver of innovation over the next 3 years

    – A mismatch exists between asset managers’ and clients’ expectations

    – 39% of the clients think further product innovation will deliver genuine value over the next three years versus 64% of the asset managers

    – Lack of client engagement is viewed as a major cause of failed innovation: 73% of pension funds surveyed are only rarely/occasionally engaged when asset managers innovate their financial products

    – 88% of asset managers foresee further product innovations over the next three years, although of these, 52% believe they will be incremental, improving existing innovations, rather than creating new ones

Client needs

The study also found that tailored solutions are an important part of responding to client needs.

This is because the findings show that a lack of client engagement is viewed by the industry as a major factor behind failed innovation.

Nick Lyster, chief executive of Principal Global Investors Europe, called for a direct link between innovation and client need. This means, he said, “building tailored investment solutions that are relevant and additive to clients’ business objectives, rather than creating copy-cat products or those which rely on financial engineering. We believe that the multi‐boutique model provides a strong platform to execute this strategy, enabling a deep knowledge of products combined with an ideas-centric, client driven approach.”

The headline findings cite 2008 as a watershed for financial innovation with many of the new products, asset classes, return enhancing tools and asset allocation techniques developed in preceding decades viewed as becoming increasingly fallible, as the financial crisis developed.

The report says this prompted a dangerous mismatch in expectations between asset managers, advisers and their clients. Now, client engagement is rising again and the report presents a call to action for asset managers and owners to work more closely together to add value in the innovation process, better aligning their interests and expectations for mutual benefit.

Amin Rajan, chief executive of CREATE-Research and the study’s author, said: “The global economy is still in a state of uncertainty and strong headwinds in the shape of financial regulation, scarcity of talent and revised client expectations are buffeting the industry. Against this backdrop, there has to be a clear line of sight between innovations and client needs. Asset owners will demand creative solutions which deliver tangible value. New products developed without such fundamentals and without clear client engagement will struggle to gain traction.”

The report finds that pension plans increasingly want to see an overlay of human insight, foresight and empathy in the investment process, as quant models can only deal with historical data.

This is highlighted by the failure of existing risk models during the last two vicious bear markets.

The report also highlights that product quality, better alignment and operational excellence will dictate the thrust of innovation in the near term. Asset managers intend to adopt more robust processes for promoting new ideas and stress-testing the resulting products. They also expect to rely more on their administrators in order to focus on their own core capabilities and continue an upward advance in the investment value chain. 

Click here for a copy of Investment Innovations

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