Changing course: How funds are getting on the front foot

Asset managers are feeling the squeeze, but experts at FundsCo are divided about how the industry will handle market events moving forward.

Sparked by Central Bank monetary policy tightening and ongoing sticky inflation, global Assets Under Management (AUM) suffered a 9.7% contraction in 2022, falling from $127.5 trillion to $115.1 trillion, according to one panel member.

With the Federal Reserve promising it will implement successive interest rate cuts over the course of 2024, experts are confident that asset managers will stage a much needed recovery. One panel member is certainly bullish on the asset management industry’s potential, with PwC projecting in its base case scenario that global AUM will increase by 5% to reach $147.3 trillion by 2027.

Despite this, the impact of geopolitical tensions (i.e. an escalation of the war in the Middle East, the possibility of hostilities breaking out on the Korean peninsula and in the Taiwan Strait, the uncertainty around the US Presidential election in November), the risk of disruption to international supply chains, de-globalisation pressures, and the implementation of de-carbonisation policies, could still prove disruptive - and cannot be ignored.

"There is a stark disconnect between geopolitics and what the market is doing. What is interesting is that markets are pricing things as if we are operating in a very calm environment, and assuming that there will be a soft landing. I think the risk here is that any shock will have a bigger impact on the market, than what it is prepared for" said Ann Prendergast, Head of EMEA, State Street Global Advisors.

Recent market events have also led to significant changes in how retail investors operate, the audience heard.

Whereas the Covid pandemic and meme stock frenzy that followed led to a surge in speculative and short-termist retail investment activity, Yorick Naeff, Co-Founder and CEO at BUX, a neo-broker, stated that changing market dynamics - partly driven by the war in Ukraine - has resulted in investors refining their behaviour.

"Instead of taking a purely speculative approach towards asset allocation, retail investors are increasingly building up diversified portfolios, as they look for ways to achieve their long-term investment goals" said Naeff.

Speakers at FundsCo highlighted that the retailisation of private market strategies is a trend that is expected to accelerate over the next few years.

This comes as private markets focused managers (i.e. private equity, private debt, real estate, infrastructure, venture capital, etc.) increasingly try and target investors outside of their traditional institutional circles.

At the same time, more retail investors (e.g. High Net Worth Investors [HNWIs], mass affluent investors, etc.) are slowly rebalancing their portfolios away from public equities and conventional fixed income by upping their allocations to illiquid asset classes (i.e. private markets), in order to obtain better returns and risk diversification.

By distributing to retail investors, private market managers could benefit from significant AUM growth.

"Of the circa $290 trillion in global wealth, roughly half of that resides with individuals, and a lot of that money is sat on the side-lines. Over the last decade or so, institutional investors have moved into alternatives, and now have around 10% of their overall assets invested in alternatives, rising to 30% across endowments and foundations. Retail investors could be a massive opportunity for private market managers" said a panel member.

Assuming retailisation actually happens, private market managers could see their AUM skyrocket. For instance, Preqin, a data provider, anticipates private equity’s AUM will soar from $4.8 trillion (as of 2022) to $8.5 trillion by the end of 2028, while private debt’s AUM is poised to almost double from $1.5 trillion to $2.8 trillion over the same time-horizon.

However, the industry still has a lot of work to do.

For example, the penetration levels of private market strategies in the retail segment in Asia are strikingly low, at least when benchmarked against the US and Europe.

According to a panel member, only 5% of HNWIs in Asia have private market exposure, compared to 20% in Europe and 35% in the US: "Private assets have about five or six years’ worth of catching up to do in Asia."

Although appetite for alternative products is gradually recovering in Asia, it has taken a long time for the industry to regain investors’ trust, following the 2008 financial crisis, when instances of hedge fund mis-selling and the Lehman minibond episode left a lot of people in the region nursing steep losses.

While retail investors globally remain underweight private markets, the industry is working hard to make itself more attractive.

In the EU, regulators have introduced significant structural improvements to the European Long Term Investment Fund (ELTIF) regime, a fund wrapper designed to channel retail money into unlisted companies or projects requiring long-term investment.

The original ELTIF framework – which was launched nine years ago – faced intense criticism for being too inflexible, meaning launches were far and few between.

At the beginning of 2023, just 84 ELTIFs had been set up in four EU member states.

Whereas the previous ELTIF structure was not especially popular, the revisions – otherwise known as ELTIF 2.0 – have won extensive industry backing. That ELTIF 2.0 allows for the establishment of evergreen (i.e. semi-liquid) fund structures is likely to help drive more mass affluent investment into private assets, highlighted Fabio Osta, Head of the Alternatives Specialists Team in EMEA Wealth, BlackRock.

In order to generate interest in evergreen or other semi-liquid fund structures such as ELTIFs, education will be essential, a point made by Dani Cukierman, Managing Partner, iFunds.

Bridging the education gap cannot be underestimated. "Any approach needs to be calibrated in terms of audience, from financial professional to end client investor with a local language and retail lens in mind. To deliver this, a manager’s scale matters" says Rashmi Madan Senior Managing Director, Head of Private Wealth Solutions, EMEA at Blackstone.

Some experts believe tokenisation could be an option for private market managers hoping to win over retail investors.

By enabling fractional ownership, enhanced secondary market liquidity, and simplified administrative processes, tokenisation could help democratise investors’ access to private market strategies, an asset class which historically has been off limits for many people due to the high minimum subscription thresholds.

Bain & Co suggests tokenisation could result in an additional $12 trillion flowing into alternative investment strategies, thereby generating a further $400 billion in fee income. Read the article on bail.com >

However, another panel member said the industry needs to think carefully about tokenisation. "Fractionalising private market assets does not mean people should forget about suitability. If you are tokenising assets, you need to make sure the underlying assets are suitable for retail clients’ consumption."

If private market managers are to attract wallet share from retail clients, then they will need to think carefully about product innovation and the fund structures they adopt.

Whereas mutual funds suffered outflows totalling $1 trillion in 2023, active ETFs accumulated $166.9 billion, bringing their AUM up to $700.4 billion, an increase from $487.22 billion at the end of 2022. Read more about this on funds-europe.com >

But, why are so many investors buying active ETFs?

"Firstly, active ETFs are becoming more popular because they are easy to trade" noted Prendergast.

This is because active ETFs can be traded by anyone with access to a brokerage account, whereas mutual funds tend to have minimum investment criteria.

Active ETFs are also cheaper than mutual funds, which for many investors is a compelling selling point given the cost challenges many of them are facing today. There are also transparency benefits with active ETFs, as portfolio holdings are disclosed daily, whereas mutual funds will typically report on a monthly or quarterly basis.

"There has been an inflection point within the ETF industry following the emergence of active ETFs, and that is providing plenty of new opportunities, which is giving investors more options and outcomes. However, I do believe there will still be a place for mutual funds and passively managed ETFs, which continue to dominate the market. It is an exciting time for investors" said one of the panel members.

During the FundsCo keynote speech by Helen Sharman, the first British astronaut to go into space, it was pointed out that the safest space programmes were the ones which paid close attention to detail, encouraged dialogue between all stakeholders, and embraced a callout culture, whereby people could voice their concerns openly.

Amid today’s volatility and uncertainty, these are the same values embodied by leading Financial Market Infrastructures (FMIs) such as Euroclear, to help ensure the safety, security and resiliency of financial markets, and the participants operating in them.