Traditional and alternative investment managers are facing a litany of risks in today’s market environment.
Navigating these challenges will not be straightforward, but asset managers must overcome them if they are to attract investor capital in this competitive fundraising environment. Portfolio BI takes a look at some of the main risks which the asset management is currently tackling and what lies ahead in 2022.
#1: Macro risk: Although most asset managers – according to a Bank of America study – believe inflation risk will be a temporary phenomenon, there are growing concerns about what might happen should the Federal Reserve start scaling back its bond purchasing programme.[1] With the Federal Reserve likely to begin tapering its $120 billion monthly bond purchases in the next few months, asset managers warn that a taper tantrum in the bond market is a tail risk which could cause serious issues.[2] Elsewhere, supply chain disruption caused by COVID-19 (plus Brexit in the UK] is having a notable impact on a number of companies. Should the problems continue, fund portfolios may be adversely affected. In addition, low interest rates are forcing investors to identify returns in riskier, over-valued assets. This is evidenced by investors growing their exposures to instruments – like crypto and SPACs.
#2 : Climate risk: Once considered a longer-term risk, some of the recent extreme weather events across the world suggest climate change is happening at a rate faster than many people assumed. Damage to infrastructure caused by adverse weather/increased incidences of flooding is something which could have an impact on managers’ underlying portfolios. Climate change has already contributed to corporate bankruptcies (PG&E) and it is likely that many more will follow suit. Changes in government regulation [i.e. banning of petrol and diesel automobile sales] and consumer behaviour might also result in certain companies becoming un-investable in the next few years, exposing those holding such assets to potential stranded asset risk. Stranded asset risk has already prompted a number of the leading sovereign wealth funds and pension schemes to divest from polluting industries. Climate change risk is a metric that must be factored into managers’ investment decisions.
#3: Cyber-risk: Already a serious problem for the industry pre-COVID-19, the pandemic has led to an upswell in cyber-attacks. According to Bitfdefender, the number of ransomware attacks surged by 485% in 2020.[3] Financial institutions are especially vulnerable, with Boston Consulting Group estimating they are x300 more at risk than other companies.[4] A study by the Depository Trust & Clearing Corporation [DTCC] found cyber-crime to be a top five risk – according to 54% of financial institutions. [5]An attack on an asset manager could have serious ramifications. A data leakage or manipulation of trading systems might result in serious losses and investor withdrawals. Targeted firms with poor cyber-hygiene measures are also likely to find themselves facing regulatory censure, especially with the introduction of rules such as the EU’s GDPR [General Data Protection Regulation].
#4: Geopolitical risk: While the US Presidential election has been and gone [albeit with a volatile transition], a number of other geopolitical challenges remain a cause for alarm at asset managers. Most significantly, disquiet about Chinese expansionism remain, particularly in regards to its territorial claims over the island of Taiwan. Such a scenario could spark a major confrontation between the US and China. Elsewhere, instability in Afghanistan – fuelled by the US’ decision to withdraw troops – is likely to reverberate throughout the wider Asia region, as are the ongoing disputes in the Middle East.
#5: COVID-19 risk: Vaccination drives have been effective at suppressing COVID-19 across major markets [e.g. US, UK, parts of Europe] but scientific research is now showing that vaccine protection wanes after six months. Israel – a country which led the way in its vaccine rollouts – is now introducing boosters to avert the risk of another de-stabilising and costly lockdown being imposed. Further lockdowns elsewhere cannot be ruled out should new vaccine resistant variants emerge, something which would have a devastating impact on the global economy. BlackRock also warned that the uneven vaccine rollout between developed and emerging markets will exacerbate stress in the latter[6].
#6 Reddit risk: Hedge funds holding short-positions in stocks such as GameStop, AMC and Bed Bath & Beyond have incurred losses of more than $12 billion after being wrongfooted by aggressive day traders sharing tips on messaging sites such as Reddit. According to reports, many hedge funds – who posted impressive returns in 2020 – are re-evaluating their short-selling strategies following the meme trade debacle, with some taking on a greater number of smaller short positions as opposed to larger individual shorts. Other hedge funds are investing in new technologies and algorithmic tools to scroll through online forums to identify whether retail traders are engaging in co-ordinated buying activities.
#7 Operational risk: The pandemic exposed a number of deficiencies at asset managers, both in terms of how they managed their underlying liquidity and counterparty risk. Investors have made clear that weaknesses in business continuity and disaster recovery will no longer be tolerated. While black swan events such as COVID-19 are far and few between, institutional investors already want demonstrable evidence from fund managers that they have high quality business continuity processes firmly in place.
#8 Regulatory risk: The 2008 financial crisis sparked a slew of new regulations across the US, Europe and Asia-Pacific [Dodd-Frank, AIFMD {Alternative Investment Fund Managers Directive}, MiFID II {Markets in Financial Instruments Directive II}, etc. ). The dust is still settling from COVID-19, but it is very likely that regulators will be introducing heightened checks on fund managers’ business continuity and liquidity management over the next few years. Right now, regulators are also beginning to demand asset managers report more information on their ESG (environment, social, governance) practices. These added regulatory costs , together with declining margins , will be tough on managers.
#9 Technology risk: The emergence of new technologies – namely DLT (Distributed ledger technology), AI [artificial intelligence], smart contracts along with digital assets [e.g. crypto-currencies, StableCoins, security tokens, etc] – is an exciting and welcome development, but these innovations carry potential risks, some of which may be unknown or little understood within the financial industry.
#10 Disintermediation risk: In order to succeed and future proof their businesses, fund managers need to evolve and embrace new technologies, particularly if they are to win over sceptical millennial investors. With a handful of technology giants having already launched their own payment platforms, some investment firms wonder whether or not these providers will eventually move into distribution, wealth advisory or even asset management. The lack of legacy systems at these big technology companies will play to their advantage – should they decide to launch asset management businesses.
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This originally appeared in AIMA
[1] CNBC [June 15, 2021) Most professional investors agree with Fed on inflation, Bank of America survey shows
[2] CNBC [June 15, 2021) Most professional investors agree with Fed on inflation, Bank of America survey shows
[3] Fitch Ratings [May 17, 2021) Ransomware attacks a growing global security and financial threat
[4] Markets Insider [June 20, 2019) Cyber-attacks are 300 times as likely to hit financial firms than other companies
[5] DTCC [December 2, 2020) Coronavirus pandemic cited as top 10 risk for financial stability in 2021, according to DTCC survey
[6] BlackRock [June 2021[ Geopolitical risk dashboard
