Asset Managers: Digitize or Die? (Part 1)

An article from GemCap UK Executive Chairman and Blockchain Limited CEO Jonny Fry, on the growing pressure to digitize funds. Look out for part two next week, on who is already moving forward and why.

According to PwC, the asset management industry will be managing $145trillion globally by 2025 as governments worldwide offer tax incentives and continue to encourage their citizens to take responsibility for their pension arrangements rather than rely on the state. Subsequently, the fund management industry is shaping up to expand even further. Looking back in history, the managing of investments in a fund is reported to have been started in 1774 in Holland by Abraham van Ketwich, who set up a fund called ‘Eendragt Maakt Magt’ (‘unity makes strength’). Possibly, the real innovation was not that it merely offered investors a means to have their capital managed in a diversified manner, but also enabled smaller investors as well as the rich to invest. In very simplistic terms, there are nowadays two types of collective investment schemes, aka funds:

Open

The size of the fund can expand or contract depending how much money is invested (ignoring the performance of the underlying investments) e.g. a mutual fund in the US, also known as OCICs in EU/the UK. According to MutualFunds.com: “The roaring ’20s saw the introduction of the first official open-ended mutual fund. On March 21st, 1924, the Massachusetts Investors Trust (MITTX) was created. The key distinction of this fund was that open-ended mutual funds must buy back their shares from their investors at the end of every business day. The creation of MITTX essentially gave birth to the mutual fund industry as we know it today.”

Closed

An initial amount of capital is raised and then invested. The oldest remains the Foreign and Colonial Government Trust, dating back to 1868 and still traded on the London Stock Exchange today. As a Cambridge University paper reminds us: “From its beginnings as a portfolio of “well-selected Government Stocks” it added 4 colonial government securities and then US railroad stocks. After 1890 the fund moved to a 90% exposure to the New World outside Europe.”

The fund management industry has always evolved and adapted to investor demand, in part due to regulatory pressure – as can be seen by the invention of hedge funds, private equity funds, sovereign wealth funds, index funds and exchange traded funds (ETFs). The types of funds that have attracted the most money are open end mutual funds, of which there are over 137,000 with $56trillion worth of assets. In essence, the manner in which investors access these opened funds has changed very little in over a century. Typically, for as little as £50 per month or a one-off investment of £1,000, retail investors can access these professionally managed and highly regulated funds. The cost to buy a fund could be as much as 5%, with the investors being required to pay 1.5% p.a.to have their capital managed. Compare this to an institutional investor, which would have to commit a minimum of £250,000 (where typically there would be no initial fee to invest) and the annual management charge could be 0.25 to 0.75% p.a.

However, existing mutual funds currently only allow investors to buy and sell a fund once a day, five days a week, and the price of the fund is calculated by the asset management firm that is managing the fund. It is worth bearing in mind that it typically takes three or four days for investors to receive their capital once they have sold the units/shares they have in a fund. Furthermore, if the fund in question generates income, then this would be typically distributed once every six months. Alternatively, once the fund has been digitized then the asset manager could offer a digital share class which could enable investors to buy or sell the fund 24/7 and the price would be calculated not by the fund management company or its administrator, but determined by independent market makers. Furthermore, another advantage of digitizing a fund is that any income the fund generates could be distributed to investors monthly or potentially weekly and, when the investors come to sell the shares/units they own in the fund, proceeds ought to be transferred the same day – not in three or four days’ time.

Given the recent brouhaha concerning a fund administered by Link Group Ltd, which has resulted in a fine by the FCA of £50million and potential compensation of a further £300million, one cannot help but wonder why fund administrators would not wish to have the funds that they look after be priced independently by third party market makers. Interestingly, the UK Investment Association has recently given the go-ahead to tokenizing funds, although some hurdles do exist. Alongside many regulators globally, the FCA seeks more transparency so as to ensure that confidence in financial transactions is maintained and, where possible, strengthened; after all, customers must be treated fairly. Tokenized funds enable both of these regulatory objectives and, as Digital Bytes has been advocating for a while, tokenization will be driven by compliance and regulators, reducing costs and making buying and selling funds more efficient. Furthermore, as the funds become digitized, they are unlikely to pursue the use of cheques and traditional banking rails – hence the need for new digital payment products and services.

Interestingly, there has already been a number of leading asset management firms lending their support when it comes to digitizing funds, including:

  • Marita McGinley, head of digital assets strategy at Schroders, has said: “Tokenization brings forth two fundamental advantages: synchronized data and heightened automation. Moreover, it expands accessibility and enables customization, providing investors with more options. Managed in a responsible way, we think this is good for clients and for the market.”
  • Goldman Sachs digital assets chief, Mathew McDermott, has told CNBC: “Tokenization, remaking the plumbing of financial markets and the “profound” effect that digital currency will have across markets.”
  • Matteo Andreetto, at State Street Global Advisors, states: “The ability to fractionalize and digitize ETFs and private assets through tokenization will be game-changing and something the firm will be looking at”. Speaking at ETF Stream’s ETF Ecosystem Unwrapped 2023, Andreetto announced that “tokenization is the next evolution facilitated by blockchain and the digitalization of assets, with potential applications in ETFs and private assets representing extremely interesting developments”, continuing, “We will be looking at the tokenization of ETFs. And then the tokenization of private assets. That for me will be game-changing.”

Although the direction of travel seems to be clear and the need to digitize funds seems to be logical, there is one further factor worth considering. According to Calastone (a large third party fund administrator), its Global Funds Automation Report states that “62% of UK asset managers are still stuck in the past using fax machines.” There can be no doubt that AI will be increasingly important when it comes to wealth management and selected funds in which to invest. And it is claimed by market intelligence and search platform, Alpha Sense, that “robo-advisors are on the rise, utilising AI algorithms to provide automated and personalized investment advice. Revenue generated by robo-advisors has multiplied by 15X between 2017 and 2023, and it’s expected to continue on this trajectory for the foreseeable future.” But ultimately, how can AI and/or robo-advisors analyse, let alone recommend, buying a fund if the fund’s details are on a fax held in a filing cabinet? Surely AI and regulatory pressure are strong factors in encouraging/forcing asset managers to digitize their funds?

So, it would appear asset managers do indeed need to digitize or die…!

Next week we look at who is already moving forward and why.

Jonny Fry

CEO, Blockchain Limited and

Non-Executive Chairman, GemCap UK

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