In July 2016, I wrote an article that predicted Armageddon for the asset management (AM) community. While it has been no Hollywood blockbuster, the sands have indeed shifted under this industry.
As I prepare to speak at an AM conference in front of hundreds of asset managers, I thought it worth revisiting some of the original thoughts, to see how far the industry has come – or not…
Asset managers are being disintermediated at an alarming rate
It may already be too late to save the industry from the threat of disintermediation. While some asset managers have recognized the opportunity that digitizing assets (new crypto assets) presents, many more remain in ignorant bliss of blockchain and have signaled the final nail in the industry coffin. The Achilles' heel is the basic structure of the AM model.
Many old guards and industry stalwarts believe to this day they are protected from new entrants by a mix of regulatory protection and scale. Believing themselves to be too big to fail, being the 600lbs dominant gorilla in the room, they fail to realize these metrics are now meaningless and underestimate the threat of digital revolution.
T+n days to trade (move) assets between the industry layers can now be done T0 through the digitization of assets using infrastructure like ours, called crypto capital markets. And here is the kicker: Low fees, that would not be able to pay all the parties involved in the diagram below.
ACT I: The opportunity
It is generally accepted that all assets will be digitized or, simply put, written to the blockchain – a move taken for no other reason than it is inherently more efficient, more transparent and above all trusted – thus replacing a self-serving, inefficient industry financed ultimately by the asset owner. However, this is not the main advantage.
The opportunity for asset owners is the efficiency of secondary trading markets and exchanges, and the creation of new asset classes that can help deliver liquidity to asset classes where few selling opportunities exist. In this world, the movement, trading and monitoring happen T0 (immediate marching and settlement), and where transaction fees = micro fees, and where the cost model of the entire AM industry is collapsed.
The so-called crypto assets, digital securities and new hybrids instruments are becoming the new norm, neatly wrapped with regulatory and legal requirements and everything else that delivers transparency and trust – a place where validation of the underlying and the ownership is tightly coupled in automated transactions.
In a blockchain world what does custody actually mean?
Secondary trading exchanges of digital assets will manage their treasury needs, holding minimum assets at any one time in 'hot wallets' connected to the internet, requiring on-demand services from the custodians who manage and transfer assets from cold storage. The passing of information, the recording of ownership, the payments and the physical transfer of assets are directly linked to a new crypto capital markets infrastructure in real time.
ACT II: The problem
The centralization effect, reinforced by legacy IT and business strategies based on greed, sees that the System of Record model is alive and licking in the AM industry: A multi-layered birthday cake that is able to feed everyone that drinks from the industry trough; an industry designed for inefficiency, where fees and charges are uncorrelated to the services or value delivered and received. It is money for old rope, a state that remains unchallenged because until now no other options for the wealthy existed.
The System of Record is considered the work of Satan, making it impossible for any real transformation and business improvement; companies will never place existing revenues at risk. A little bit of lipstick on the pig is all that can be achieved.
The criminal of the piece is the centralized database. At every layer in every company in the AM industry model, every business has a different database containing a different version of the truth – versions that each industry participant does not trust, requiring human interventions to check and re-check because trust has all but disappeared. Organizations are told to not trust their own information by compliance rules (detrimental to performance) and GDPR rules add another layer of excuses and polarizes the participants.
The problem is structural, where 40% or more of back-office processes and functions spend their lives checking, rechecking and trying to match and find data to keep the workflows going. Simply because the layers in the industry distrust the other, we literally have more than 40% of the people working in the industry working against each other, where these costs paranoia trusts costs enforce by compliance are merely passed onto clients as higher fees. It can come as no surprise that net overall performance of AM is quoted net of actual costs/fees, and when inflation and intrinsic value of a declining fiat currency is considered, assets owners lose every time.
There is no single version of the truth in an AM industry that professes to place so much emphasis on getting things right. All that exist are half-truths pending validation by parties that do not trust their own data enough to provide any basic warranty. So the blame game continues as departments' information goes back and forth to resolve issues and personal data is traded without concern for sovereignty and identity.
Blockchain: A zero friction truth model
Why is blockchain seen as the future of so many industries that are re-inventing themselves? The reason is that blockchain is a legitimate transformational technology in its native form – a friction, cost and time out play, delivering a simplification model that is difficult to ignore.
The industry is becoming a place where everyone sees and uses the same information that becomes a validated truth of existence of fact, about an asset, its ownership and status – a single version of a decentralized truth, where everyone is invented to play nicely in the playground or be exiled as a fat, unfit bully.
Imagine an industry with 40% less staff at all levels. Where intermediary functions are collapsed removing another 50% of people that stand with their hands out waiting to get paid, expecting fees, and for doing what exactly? For checking someone else's work, amending the process, trying to keep the workflow moving, hiding behind regulations and legislation.
GDPR, rather than improving efficiency, is another useful piece of legislation for inefficient functions to mask their performance, along with other compliance laws so often used to drive up margins, harbor costs and allow the front office to price this inefficiency to the client.
Until now AM was a dark art of complexity managed behind closed doors, delivering safety for wealth and asset owners at a cost. All of this was reluctantly accepted by clients because there were no other options. In other words, AM survived as a protectionist industry because they can get away with it.
Since writing the original article on the AM Armageddon in July 2016, I have developed close working relationships with the family office and UHNW community, as we deliver both deal flow and offer diversified investment opportunities.
As wealth is looking for best value, they are also taking things into their own hands and prefer to have flexibility than being locked into traditional fund models and structures. As global recession approaches, traditional assets remain illiquid (e.g., land, real estate) and digitizing them has the potential to improve liquidity as overcharging through inefficiency and T+n goes away.
Wealth is learning fast, with the dawning realization that the digitization of traditional financial instruments, services and assets is the only way forward. It is heading on a path to flexibility, to immediacy, to transparency and to lower fees. And yes, they can trade their own positions through new markets without the need for traditional third parties, balancing their portfolios and hedging their positions in real time.
In an ideal scenario, digitization could offer simple brokerage accounts with access new digital securities, where commercial rules are automated, where the market sets the price on volume and efficiency with no hidden back office costs hidden as part of the service and where everyone uses the same information as a register of trust. By offering a window to regulators and insurers (and more importantly the clients) the game between old guards and new tech can be played on neutral grounds; without the inefficiencies of the old ways, digital alternatives to traditional AM may have the upper hand.
Your services, asset managers of antiquity, are no longer required.