Ian Webster, Axioma
2016 seemed to be the year in which politics overtook economics as the major driver of markets, at least in the second half. The year started with a sharp downturn in equity markets driven by concerns about China and tumbling oil prices, but that decline - and the resulting increase in volatility -- reversed quickly. It was not actually until June that the importance of the political landscape arose: we saw the unexpected outcome of the UK referendum, the looming Italian constitutional crisis, and the US Presidential election. 2017 promises to bring more of the same. With elections in France, Germany, and the Netherlands, 2017 will see the theme of political instability continue to play out, with Europe taking centre stage again.
Key relationships between markets also shifted late in the year. Changes in bond yields became less correlated with equity market returns, currencies, especially the pound and euro, uncoupled from equity markets, and equity markets became somewhat less correlated with each other. As a result, we expect asset managers to step up their utilization of sophisticated risk models to home in on these changing asset class dynamics and portfolio correlation risks, as well as their underlying volatility, in their quest to preserve and improve performance.
Against this backdrop, we foresee five trends which can shape the European asset management landscape in 2017:
1. Active managers turn to quant tools to improve performance. The active asset management industry will continue to face pressures in 2017 as investor flows are impacted by the rising popularity of passive investing strategies. With factor investing dominating the conversation, and managers increasingly realizing that factor exposures can have a major impact on their performance we expect more and more traditional active managers will turn to quant investing tools and analytics to mitigate, or at least understand, risks to their portfolio performance, while at the same time adding more transparency to their investment process and end client reporting.
2. Quants to reclaim smart beta. As our analysis of these popular strategies in 2016 demonstrated, many products marketed as smart beta are often neither smart nor beta. This is because many smart beta manufacturers sacrificed portfolio construction techniques for "simplicity", thereby creating portfolios that sound as if they are targeting the same factor but in fact look very different, complicating the investment decision process. At the same time, portfolios that are meant to target different factors may end up looking too similar, reducing diversification benefits for those investing in different strategies, as well as creating potential crowding issues. We expect that in 2017 quants will reclaim the smart beta strategy, bringing greater discipline and focus to the portfolio-construction process. This should result in better exposures to the underlying factors that lead to better performance, along with better understanding and avoidance of the issues related to crowded trades.
3. MAC investing strategies continue to rise. In times of volatility, and cyclicality, multi-asset class investing will continue to increase as more investors want the flexibility and diversification that MAC portfolios deliver, and recognize that markets do not react in isolation. As a result, we expect to see a growth in top down portfolio construction built to meet specifically-defined factor exposures by selecting assets in different asset classes to ensure true portfolio and risk diversification.
4 .Analytics get smarter. 2017 will see asset managers enter an arms race of analytics - supported by the rise of multi-asset investing - as they seek tools to understand the correlation between asset classes, capitalise on complex market dynamics and improve their performance. At the same time, the proliferation of analytics tools will lead to the need for greater customization and sophistication of analytics, with the introduction of machine learning in the analytics process being a particularly significant trend for asset managers looking to differentiate and ensure that they have the right analytics for the investment process. As a result of this overall trend, we will also see asset managers requiring scalable and elastic cloud computing capabilities to handle greater amounts of data analytics.
5. Regulatory pressure to increase. The theme of transparency, value for money and benchmarking will continue to dominate the regulatory agenda in 2017, as witnessed by the UK's Financial Conduct Authority interim review of the country's £6.9 trillion asset management industry published at the end of 2016, with a similar review expected in other EU jurisdictions. In this regard, some of the trends we see materialising this year, such as greater use of analytics, better benchmarking of performance and better understanding of risk, will work hand-in-hand with the need for managers to increase their regulatory reporting
As we enter 2017, the asset management industry will continue to be challenged from a macroeconomic, geopolitical, technological and regulatory standpoint. How asset managers respond to each of these challenges will be crucial to their performance in 2017, as well as their ability to preserve their long-term business models against disruption and their market share in the investing ecosystem.