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Swipe Right for Innovative Alpha

In this latest article, Anders Kirkeby, Head of Open Innovation at SimCorp discusses the role of innovation in the front office and why it may be the answer to achieving both competitive differentiation and the standardization many investment managers seek. Kirkeby is also joined by Alex Marangoni, Director, Citisoft for a Q&A on the topic.

Foreword by Anders Kirkeby, Head of Open Innovation, SimCorp 

 Anders Kirkeby, SimCorp

Creating the ‘secret sauce’ of investment management is more elusive than alpha itself. Today’s largely homogeneous buy side must navigate squeezed margins and more regulations, while building the scale and expertise needed to keep up with growth in alternatives and ESG. Asset managers are stuck playing catch-up, with innovation on the back burner.

This dynamic is not new, but what has changed is the number of firms that have simplified their systems architecture and consolidated platforms to optimize cost and risk. These largely automated firms are reaching an inflection point, with little low-hanging fruit left to optimize.

A recent SimCorp poll showed that competitive pressure to differentiate and improve investment outcomes has never been greater.

But the question firms sometimes miss is, rather than a competing priority, what if innovation enables differentiation, leading to new clients, reduced costs and better returns?

Breaking through old operating models 

Many firms take the age-old approach of buying or building innovation projects, with the aim of perfecting data and creating insights that provide an edge. This is particularly the case in portfolio construction and optimization, and ESG data and research, which were highlighted in the SimCorp poll as investment areas that would benefit from innovation.

Alas, the pandemic put much of this on hold, as live in-house projects became subject to even longer, arduous procurement processes. As for the ‘buy’ option, our poll indicates three-fifths of you struggle with the sourcing, due diligence, integration and compliance aspects of such projects. Ironically, the sheer abundance of fintech innovation available, has become a victim of its own success, now creating a drag on innovation adoption.

There is, however, a new alternative that stems from a renewed desire to balance core operational efficiencies, with the choice to experiment with tools that can set firms apart.

This shift is driving a desire for optionality and, we believe, will shatter the operating models of the past. It’s not about Buy vs Build, or Best of breed vs Consolidation. It is about achieving the best of both worlds, while retaining choice and full control.

It is time for service providers to step up and solve the innovation conundrum, by delivering fast access to fintech innovation directly from a core, standardized platform.

To pursue value-add strategies, a ‘single source of truth’ needs to be established as the foundation for future innovation. This doesn’t mean pushing innovation to the bottom of the priority list; rather, the availability of new technologies or functionalities should be a key component in the search for a core platform.

Firms should be confident that their provider can demonstrate not just what they can deliver today, but also how they will commit to evolving their services. 

De-risking innovation adoption to increase experimentation 

Driven by client engagement, SimCorp has already taken the leap, from its traditional responsibility as a buy-side service provider, to create long-term partnerships, easily consumable services and open access to innovation. An integral part of this relies on opening up our platform and architecture, to grow and sustain a thriving buy-side ecosystem.

By curating partnerships within the broader financial services industry, we are solving our clients challenges in the investment areas, prioritized by them, such as the portfolio optimization space. But to really help the Buy Side succeed in their outcomes, we need to do more than just deliver access to innovation. It is our role as a service provider, to simplify innovation adoption, with a full-service approach that takes care of many of the headaches around contracts and integration, through to compliance and even maintenance.

There is now no excuse for inaction or complacency. In the end, the firms who are the most agile at experimenting and adopting fintech innovation, will be tomorrow’s winners.

To read the full article click here. If you’d like more information on how front office innovation can deliver competitive edge and boost margins for your firm click here or get in touch with Anders Kirkeby [email protected]

Q&A with Anders Kirkeby, Head of Open Innovation, SimCorp, and Alex Marangoni, Director, Citisoft 

Explain the discord in the buy-side front office between innovation and standardization of operations. How did this evolve?

Anders Kirkeby: In the past we’ve had very rigid operating models: Buy vs Build, or Best of Breed vs Consolidation. These pulled the industry in very different directions. For example, the best of breed model reigned supreme over the past few decades, but as a result of that haphazard approach and subsequent fragmentation, we’re now seeing a wave of firms move toward consolidation.

This move to standardization is a direct response to the tangle of accumulated ‘spaghetti systems’ and their attendant manual processes. Interestingly, the scale at which this is happening, has meant many firms are focusing their efforts on cost savings and efficiency gains, rather than driving innovation.

By taking these very black and white approaches, the opportunity often missed is the ability to combine standardization with innovation, to achieve the same priorities. To date, there has simply been a lack of interest in business cases for innovation, often seen as experimental and risky, compared to ‘no-brainer’ cases for cost reduction or alpha generation.

This means firms have missed out on innovation that can not only address cost and risk efficiencies, but also address the competitive pressure to differentiate and the desire for better investment outcomes.

 Alex Marangoni, Citisoft

Alex Marangoni: The imbalance is rooted in the dynamics the industry is facing, including fee pressures brought on by an explosion of low-cost options, an extended period of near 0% interest rates in the U.S., increased market volatility, and increased regulatory oversight.

The challenges of a low interest rate environment and increased market volatility can be overcome by portfolio construction strategies, but they are more costly to implement. Managers must find new ways of generating returns while also employing instruments to smooth market volatility.

One area managers have found strong returns is direct (and indirect) investments into other asset classes, such as alternatives and private markets. These instruments are far more complex and costly to support than plain vanilla stocks and bonds. On top of that, these markets and instruments are much more opaque than public markets, making it more difficult and costly to fulfill regulatory reporting requirements, monitor exposures, and manage to investment mandates and guidelines. This is particularly true of indirect investments made via hedge funds, pooled funds, or other third party managed funds. Many of those third-party managers are reluctant to disclose data to investors to protect the ‘secret sauce’ behind their returns. This need for data, and the scarcity of it, again adds to operational costs.

To hedge risk brought on both by market volatility as well as the risk inherent in these new asset classes, managers have increased their reliance on derivative instruments. These vehicles can smooth volatility and provide more predictable return streams. This strategy also allows for managers to create synthetic positions that provide returns more like those seen in a more traditional interest rate environment.

Thus far, all the levers I have mentioned that the front office is pulling only increase complexity and costs for the firm. This brings us to the crux of the imbalance we are seeing in the industry, as the only sure-fire way to attract investors is better returns at a lower cost. The most obvious ways to contain costs is via standardization of managers’ operations and technology stack along with simplification of their architecture. However, what we see in practice goes against this, as firms still explore point solutions that need to be integrated with other solutions, which begets further costs and complexity.

How can buy-side firms strike the right balance, i.e. standardize operations while continuing to adopt innovation?

Alex Marangoni: Though challenging, it is possible for sophisticated and innovative strategies to be deployed within a standardized operational framework where costs are reduced, operational risks contained, and regulatory requirements fully met.

Simplification of managers’ technical architecture and deployment of a technology stack that allows easy integration across applications is a necessary foundation for standardization across both the technology and operations groups. Further, applications that can support requirements via configurations (or pre-built integrations that allow for plug-and-play) make it easier to scale assets under management without seeing a proportional increase in operating costs.

Collectively, the above also reduces the reliance that firms will have on-point solutions aimed at solving a narrow sliver of requirements not able to be fulfilled by existing sets of applications. As I mentioned in a recent Citisoft blog, the surge of stop-gap side systems in the early 2000s led to extremely complex architectures that were unstable, costly to support, and difficult to unwind. I think it’s safe to say we all want to avoid being in that situation again!

The vendor and service provider communities can help, via front-to-back solutions that enable expanded functionality via modules that are configured and turned on. Service providers and vendors are forging new partnerships that allow for out-of-the-box integration capabilities, simplifying connectivity and reducing reliance on ETL tools, particularly when it comes to ingestion of external data. This interoperability also extends, in some regards, to firms seeking best-of-breed solutions where some of those applications also come ready to ‘talk’ to other industry-leading applications.

Anders Kirkeby: Typically, many have gone down the Buy Vs Build route to adopting innovation, but the pandemic has put many in-house projects on hold. As for buying, the sheer wealth of fintech start-ups and scale-ups makes it difficult to really home in on those that can add value for you. This has created a significant drag on innovation adoption.

What we are now seeing is consensus around the fact that a trusted service provider can capably enable firms with a core standardized platform and at the same time optimize for competitive differentiation. This is where we believe service providers like SimCorp can step up and solve the innovation conundrum, by delivering fast access to fintech innovation within a core platform.

Going forward, how can technology solutions providers play a role in helping buy-side firms adopt innovation? Will this be a differentiating point for the buy side? What does the future hold?

Anders Kirkeby: As we see it, innovation adoption plays a leading role in the future of the Buy Side. And in response, SimCorp has chosen to democratize access to that innovation, to empower our clients with new functionality and technologies from a growing number of innovative partner vendors, without compromising on operational efficiency.

By carefully curating partnerships across the broader financial services ecosystem, we can deliver the optionality that can solve our clients’ challenges. We’ve chosen to do this by pre-integrating these partnerships into our platform, to simplify that adoption, while continuing to ensure that all-important single ‘source of truth’ across the business.

Our starting focus is the portfolio optimization space, an investment area where we see great potential for innovation. Partnerships here include Intellibonds, an AI-powered fixed income portfolio optimization provider and StarQube, a powerful alternative to maintaining bespoke quant tools. Each fintech offers a different flavor of portfolio construction and optimization functionality, giving clients the optionality that fits their needs, rather than a one-size-fits-all approach.

But to really help firms succeed, we need to do more than just deliver access to innovation. As providers, we need to remove the barriers, by taking away the headache of integration, compliance and maintenance. By delivering a more complete service, we mitigate the vendor selection risk of innovation adoption while minimizing opportunity costs by keeping upfront costs close to zero.

As we see it, the future of innovation for the Buy Side, is not too dissimilar to that of an app store where you can easily plug into multiple tools and solutions, or to a very popular dating app, where you swipe right on multiple options which best fit your profile.

Alex Marangoni: The key for technology solution providers is to give the people what they want. They need to provide buy-side firms a set of tools that will enable the innovation that is sought by the functions and activities along the value chain. Adoption of the solutions will come in various forms, due to the industry’s notorious aversion to change. We also have yet to see truly disruptive technologies force the hand of established firms and as a result, firms will continue to be picky about where and how they adopt new and innovative solutions.

With respect to differentiating factors, achieving operational excellence where (to steal a phase from the late Steve Jobs) “it just works” can absolutely be a differentiating point for the buy side. When things “just work,” costs can be reduced drastically, while productivity and scalability of an operation grows exponentially. When teams are unburdened from a constant barrage of fire drills, they can focus on more value-add activities while trimming away the activities that simply add to operational overhead and/or financial losses from errors.

For the front office, the key is to offer a better risk/return balance than competitors, at a lower price.

With regards to the future, I think the trends we are seeing in the industry will persevere. Retail investors and institutional investors alike will continue demanding more transparency into investments, fees, etc. This will include increased pressures to provide look-through capabilities for fund of funds, private pools, etc. to allow investors to better monitor risk and exposures. The continued shift to alternatives, private markets, and other complex investments will add another layer of complexity. Risk tolerances will also continue to get tighter as the volatility we are seeing in the market have investors on edge more than ever. This means offering investors upside while minimizing downside risk and providing a stable return stream. I believe there will, also, be continued cost pressures, particularly as newer entrants continue to woo younger investors away from traditional channels.

From a software vendor and data provider perspective, I believe the evolution we are seeing will continue with front-to-back offerings further maturing, data services expanding, and continued collaboration between software vendors facilitating platform integration and connectivity.