This article originally appeared in GARP. Sebastian Ceria, PhD, is founder and chief executive officer of Axioma.
The business of investment management has a technology crisis on its hands – a crisis that not only undercuts the ability of institutions to compete, but costs firms huge sums of money.
Unlike the global financial crisis, which dropped like a bomb, the tech crisis has taken 20 years to materialize. In fact, it has seeped into the industry so slowly that few saw it coming, and even fewer grasp the dimensions of its impact.
The crisis has been caused by the failure of institutions to modernize their technology infrastructures over the last two decades. As a result, institutions today, rather than benefiting from the latest technology, continue to rely on patchwork legacy systems that are literally on life-support.
And keeping such systems alive doesn't come cheap. According to a recent Deloitte study, the banking and securities sector comfortably outspends all others, with IT budgets representing 7.2% of total revenue. Yet tech budgets tell only part of the expense side of this story. How much is also spent on manual data reconciliation, cleansing of market and proprietary data, and custom integration of legacy applications? How much is spent paying highly compensated staff for things that can and should be done by technology? When the total cost of ownership is considered, the price of failing to modernize is staggering.
So, how did we get here and what needs to happen next?
First, some context. The financial industry's first big push into technology came in the late 1990s, when many firms invested heavily in proprietary systems. While those systems served their purpose, just as it was about time to modernize, the Global Financial Crisis hit. And in the difficult years that followed, modernization was at the top of no one's to-do list.
Yet, while technology planning stood still in the wake of the GFC, the evolution of investment management did not. Competition has exploded: active vs. passive, passive vs. passive, passive vs. robots. Margins are shrinking. Asset owners have become more sophisticated and demanding. Operational needs and regulatory requirements now necessitate transparency and consistency across the enterprise.
Should we have seen this coming? Probably. But with the near-death experience of the GFC, and the afterlife of the longest bull market in history, most firms just kept kicking the technology-modernization can down the road. In fact, compared with many other industries, financial firms are laggards in terms of their application and modernization of technology.
While the incentives to change may not have been so urgent before, they are now. As reported by the Financial Times, “The U.S. stock market faced its worst December since 1931, leaving fund managers with a 26% share-value loss for 2018 – the deepest annual dip since the financial crisis.” The result? Extensive belt tightening and layoffs across the industry.
Granted, results in January improved, but an inflection point has been reached. With increased competition and slimmer margins, success requires creating better products, attracting more clients and scaling up. And to accomplish that, more powerful and more cost-efficient technology and best-of-breed solutions are necessary. Firms must up their game by enhancing their unique investment processes and their ability to discover alpha, while reducing costs. It's time to modernize.
The question is, how? Consider the options.
Option #1 is obviously a nonstarter. The landscape has changed. To compete in today's environment, firms must leverage modern technology. Period. That said, for many firms, modernization is a Catch 22 situation: “Yes, we need to invest in technology, but how can we possibly afford it, given current circumstances?” Ultimately, that boils down to a choice between short-term savings and long-term success – if not survival.
Much the same can be said for Option #2 – the “all-in-one, front-to-back” outsourced third-party solutions offered as an exit strategy by some institutions. Do those solutions reduce the pain of managing legacy systems? Yes . . . and no.
CEOs tend to like the attractive value propositions of such solutions. But there's almost invariably a disconnect between those value propositions and the realities of day-to-day operational requirements, which ultimately force firms to build parallel infrastructures, such as research capabilities and the ecosystems required to generate more IP. As CutterResearch recently noted, that only 6% of surveyed firms “use all-in-one, front-to-back solutions exclusively.” CutterResearch once favored “all-in-one” solutions, but no more.
Beyond that, the “all-in-one” solutions are essentially legacy systems themselves – systems that, in the best case, have simply been migrated to the cloud. Most of them are still deployed systems or running in proprietary data centers, instead of modern cloud-native infrastructures built to fully capitalize on, and evolve with, cloud technology.
Which leaves Option #3: partnering with fintechs to create a tailored approach to modernization. The challenge here is that while most agree this is the way to go, almost no one agrees on precisely how to do it. And having a clearly defined path forward is critical, both for planning purposes and because none of it is easy.
True modernization isn't about making a fix here and putting a patch there. Think about it. How many asset managers now leverage the cloud? How many have CTOs – meaning technology strategists and planners, not just heads of IT – on staff? Modernization is a comprehensive overhaul that involves changing the way firms think about, deploy and spend on technology. And that requires a collaborative effort – with a lot of smart people with specific areas of expertise in the room – focused on the unique challenges facing each individual firm. For firms determined to modernize, we believe the concept of collaborative partnering is essential.
It also takes experience, and that often only comes the hard way. In 2013, for example, our firm launched an enterprise-wide multi-asset class risk-management solution for the front, middle and back offices – a solution aimed at the weaknesses exposed in the GFC. To fully realize the strengths of that solution, we turned to the cloud for its scalability, on-demand computing power and lower cost of ownership. This necessitated a complete modernization of Axioma's architecture and infrastructure. We had to start from scratch, and natively build our solution in the cloud. In other words, to create this new risk solution, we had to modernize our organization and infrastructure in much the same way that institutions must now modernize theirs.
Open, Adaptable, Interoperable
So, what exactly is needed? A modern infrastructure for financial institutions requires three critical features: it must be open and adaptable, interoperable and consistent.
An open and adaptable system allows the client to customize it to their specific needs, i.e., to select the best-of-breed solutions, applications, data, tools, etc. that work best for them and their investment process.
The system must be interoperable so that the various components selected by the client all play nicely together.
Finally, the system must be consistent, because consistency provides transparency across the enterprise—in terms of data, accessibility and analytics—thus reducing the need for costly and time-consuming data reconciliation, custom integration, etc.
And who needs to be in the room to make this happen for a client? What's needed is what we call a “tripartite collaborative partnership,” consisting of the client, a fintech and a technology expert. Because a truly effective modernization process for investment managers requires expertise on multiple levels.
The client defines the unique needs of their investment process. The fintech brings expertise and experience in consistent, enterprise risk and portfolio-management solutions, analytics and data. And the technology partner provides expertise in interoperability, scalability and cloud computing. Axioma, with its technology partner Microsoft, along with some of our most forward-looking clients, is one example of this tripartite approach.
By the way, a collaborative partnership approach has another major advantage for firms: it enables them to modernize incrementally and at their own pace, depending on the magnitude of the challenges and the resources at hand. Because far from being turnkey, modernization is an evolutionary process.
Modernization is about to transform the investment management business in much the same way that technology has dramatically transformed manufacturing and other industries. We believe that over the next 10 years, modernization will enable firms to halve their total cost of tech ownership, while substantially enhancing both the efficacy of their investment processes and their operational efficiency.