Diversifying products in asset management through uncertainty

While market indicators may point to a bumpy year ahead, Canada's asset managers have plenty of tools and strategies to steady the course. Insights from KPMG's annual Asset management opportunities and risks survey help identify top product trends that managers are likely to focus on to maintain performance into 2023.

Almost 70% of Canadian asset managers we consulted see launching new products and services as their best opportunity in the year ahead

Canada's asset management firms are nearly unanimous on the importance of products and ranked "launching new products as services" as the top opportunity for the days ahead. That ranking doesn't just concern the firms themselves, but the industry overall.

Asset managers are not only looking to new products for survival and growth, but to help withstand interest rate increases and high inflation. As a result, they're exploring a range of diversification strategies and designing product portfolios to appeal to longer-term investors, pension plans, even different geographies. For Canadian asset managers, diversifying doesn't just mean keeping Canadian products in the suite, but building products that are relevant to international investors.

Managers are exploring new fund strategies most of all, with managed accounts ranking second. Sub-advisory, insurance related products and enhancing yields through new asset strategies were ranked slightly lower. The way they go about launching those products, however, could see some interesting changes.

A lot has changed since the pandemic. That period stimulated beta-type market strategies and higher than usual market valuations which produced extremely high rates of return. Managers earned impressive fees with passive strategies making up a large part of their overall asset mix.

Since then, however, markets have evolved and valuations and returns have fallen dramatically. Today's high interest rate environment, higher than expected inflation, and possible recession are expected to have long-term implications. New product strategies are needed to weather the storm, but managers are now looking at products and services that deliver non-correlated returns to meet client expectations and needs, and help to stay profitable.

Even so, those changes can't happen overnight. Even with the launch of new products and strategies uncorrelated to market conditions, it takes time to see the fruits of those efforts. It's not easy for managers to start offering products that haven't traditionally formed part of their product suites (e.g. real estate or private credit) or in areas they've never performed.

As a result, we may soon see more mid-tier acquisition activity with firms buying other firms to acquire niche capabilities and attract key high talent individuals to deliver new products. This activity will help smaller firms reduce their locked-up capital and gain networking capacity, though the fruits of this opportunity might not be perceptible in the industry for some time.

We can expect a shift to long-term investment in private credit, infrastructure, real estate, and private equity. Those four top-ranked new product types are not traded on a regular (monthly or quarterly) basis and therefore lock up cash in longer cycles (8 to 10 to 12 years). That product mix could create different investor dynamics since more capital is necessary to remain in those funds over the long haul. Some asset managers may place new or sharper focus on institutional investors and high net worth individuals since "stickier" capital is needed to support illiquid assets and products in the alternative space over longer terms.

Retail investors may have more difficulty locking up their cash and taking on limited liquidity for these longer-term products. Still, leading asset managers will find a retail-friendly structure that lets them access or retain that investor base. The resulting products may simply be built a little differently in terms of asset mix.

Approximately half of asset management organizations we spoke with identified product differentiation as an emerging risk for both their own firms and the industry overall. Many have been building out their private and alternatives asset classes to be able to offer a full suite of products to their clients. When markets are going up, however, it's much easier to launch and sell new products. Managers now need to provide returns that are more of an alpha nature rather than coasting by on high beta returns. Due to market conditions, many asset management firms are feeling pressure to address their client portfolio needs and asset mix.

Given the uncertain economic environment, people may start shifting their allocations and pulling money out of certain products. Rather than spending aggressively to develop new products, some firms may decide instead to assume a more defensive posture and brace for a possible recession.

For others, that could mean putting new product initiatives on hold and focusing on core offerings. It could also be a good time to rationalize the product shelf by building a suite of funds that will be well positioned for the next five years and closing those that may not be as profitable to save costs.

Alternative assets can play well in a challenging marketplace, but could be a harder sell to defensive-minded investors. The vast majority of retail investors will revert to what's familiar, so it could be a challenging time for newer alternatives, such as blockchain assets. “Traditional” alternative assets, including private equity and private credit, will most definitely gain market share.

Many smart investors will be ready to pounce on opportunities, despite economic fluctuations, the interest rate environment, and real estate concerns. Many Canadian asset managers are positioned to thrive in this market and alternatives, in particular, can play very well. We expect the next year to be fairly strong for alternative product.

Crypto, for one, is certainly here to stay. Managers will continue to figure out how to play profitably in the crypto market despite facing a lower fee environment and more conservative investor posturing in the months ahead. Asset managers will need to think clearly about how they adopt it – whether that's playing in the crypto market, launching it as part of a product, or engaging with it by way of transactions.

Despite some regulatory uncertainty around ESG products, particularly in the United States, that area will continue to be of keen interest to institutional investors and people placing money with Canadian managers. The large pension funds and institutional players are highly likely to continue to demand ESG products in the months ahead.

The solutions market, too, will continue to grow for large institutional investors and pension plans. They help tailor investment solutions as amalgamations of products that deliver specific, risk adjusted returns necessary to help diversify portfolios. It's a far more sophisticated approach to sales, and meets investor needs for diversification, risk management and performance.

It's a great time for asset managers to focus on their core business. If they're launching products, it's critical to understand how these products will react to higher interest rates and continued high inflation. For asset managers, that's their everyday business, but it's going to be even more important to fully concentrate on this for at least the next 12 months.

Keeping open lines of communication with investors about product portfolios and options is always important, but could be more critical over the coming months.

At the end of the day, performance drives growth in asset management and is the key to survival. KPMG's Asset Management team has keen and informed insights into today's evolving economic environment and its finger on the pulse of product trends. We're ready to help organizations face the future with confidence.