Covid-19 and the changing investment management landscape

The global pandemic has resulted in historic human, social and fiscal challenges and economic harm to businesses and investors. The immediate shock in financial markets caused the fastest bear market in history, CBOE’s Volatility Index [VIX] reaching a record closing high, and a staggering oil price crash. Despite a short-term rebound driven by sectors such as technology and healthcare, there is a continued uncertain outlook, with the IMF recently pointing to a disconnect between the optimism of markets and the depressed state of economies (1). Generally, the investment industry has shown resilience during the Covid crisis, with many investors already prepared for some kind of correction following a 10-year bull run (2). Immediately, there are notable changes in fund flows, and longer term, the pandemic will be a catalyst for structural shifts which were already underway.

Immediate flows into active and responsible funds

Retail funds experienced net outflows of £10bn in March 2020 as investors reacted to international lockdowns, but returned £4bn into funds in April. The comeback was fuelled by record inflows to responsible investment funds (£969m) and actively managed funds (£2.7bn). May showed a similar picture, with active funds receiving strong net retail sales (£3.5bn – more than double net passive funds) as well as bond funds (£1.9bn) and responsible investment funds (£911m). For institutional investors, money market and global bonds have topped inflows in April and May respectively.(3)

Quality and value

Before the crisis, the FCA had highlighted concerns over quality, value and a lack of transparency making it hard for investors to choose the right products. Recent volatility will stress test strategies and further spotlight product suitability for investors. Going forward, investment managers will make a case for valuation against cost, performance versus objectives and quality of service in annual value assessment reports. St. James’ Place published their first this month, revealing just 44% of their funds offer investors ‘good value’ and 12% are on its ‘watchlist’. Offering retail investors more transparency can only be positive, but it will add to the existing margin pressure felt by the investment industry since the shift to passive investing. The focus on quality and value will likely accelerate consolidation and integration across the value chain.

ESG goes mainstream

Covid-19 and its global lockdowns have highlighted the need for collective action from investment managers in responding to the next major health crisis: climate change. During the pandemic, ESG investments have remained resilient (4), demonstrating the benefits of investing in companies which marry profit and purpose. Recent public campaigns like Richard Curtis’ Make My Money Matter have launched in aim of raising investor awareness of their power to shape company practices and the transition to zero-carbon through their pensions. Asset managers list ESG investing in their top three priorities for 2020, with 59% seeing an increase in client demand for ESG products (5). Such products will expand beyond environmental into social purpose, and responsinble investing will start to cover more asset classes in more depth. More active managers will highlight research capabilities and strategic expertise in relation to ESG and will introduce more and bigger responsible investment ideas.

Private markets and alternatives

Private capital looks set to continue its growth post-crisis, as investors diversify further in search of returns in a low interest environment. In recent years, private equity and real estate have become mainstream, and fast-growing areas like infrastructure and private credit have emerged. Income investors have been severely impacted by the pandemic, with most major global companies slashing dividends, with the worst-case scenario predicting global dividend payments will be cut by more than a third.(6) This will force investors to seek different sources of income and returns, and investment managers are already making alternative strategies accessible via mutual funds, as well as more illiquid and niche areas through closed-ended investment trusts.

Continued rise of Multi-Asset

Ongoing uncertainty, coupled with limited returns from bonds and cash, and a global search for income will drive investors further afield for returns; while financial advisers are increasingly outsourcing investment decisions to focus on financial planning. Both factors will spur the continued rise of multi-asset investing, offering diversification alongside risk mitigation and a focus on client outcomes. The multi-asset sector was worth £235bn in 2019, with net retail inflows to multi-asset making up 50.4% of the entire retail industry total (7).

AI for risk and innovation

Post-pandemic, the use of artificial intelligence and algorithmic decision-making by investment managers will expand. The use of AI will go beyond risk management, with the development of AI-based systems capable of better detecting and handling market anomalies. Deep learning should capture more complex patterns in asset behaviour, unlock the use of alternative data, and allow algorithms to adapt to changing market conditions in real-time. These systems will produce early warnings and enable more advanced portfolio construction, going beyond a mere look back at historical data. The use of AI should also impact trading speed, enabling firms to identify correlations, back test strategies and develop new customer-centric products.

So, who will emerge the winners?

Investment managers who are already integrating technology and advanced data in their investment and risk processes, coupled with client-centric digital transformation, transparency and personalisation, will likely win out. The impact of fee pressure and changing operating models will continue, leading to more M&A activity as firms bolt on new capabilities or add new markets. As ESG investing becomes standard practice, investment managers will need to integrate metrics at a minimum. Ideally, the focus for investment managers should be on developing a differentiated and considered responsible investment offering, which aligns with client outcomes, and on using their shareholder votes to transform business and society for the better.

Sources

1. https://www.imf.org/en/Publications/WEO/Issues/2020/06/24/WEOUpdateJune2020
2. https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/institutional-investing-in-the-time-of-covid-19
3. https://www.theia.org/industry-data/fund-statistics
4. https://www.ft.com/content/78167e0b-fdc5-461b-9d95-d8e068971364
5. https://www.ftadviser.com/investments/2020/05/26/traditional-assets-shunned-as-managers-eye-esg/
6. https://www.ft.com/content/8ce3382b-a1e7-449f-aa71-68ca4fcf0db5
7. https://www.theia.org/industry-data/fund-statistics/funds-under-management/2