Only one financial institution worldwide currently makes the cut in Lion Global Investors’ Disruption Innovation Fund.
S.K. Selvan, senior portfolio manager for multi-asset strategies at the Singapore-based fund house, says the fund captures listed companies that are rewriting the rules, challenging incumbents and bucking industry norms across industries.
Although that includes finance, he says banks and insurance companies are all going to be among the disrupted, especially as regulators continue to promote fintech and other innovation.
The single exception included in the fund’s portfolio is…
But hang on a moment.
First let’s understand how the portfolio has been conceived, and the team’s view on financial services.
Selvan, who joined Lion in 2014 after running portfolios for the asset-management arms of Nomura and Nippon Life, among others, says the idea behind the fund is twofold: to develop a methodology to capture disruptors, and to advance innovative ways of selling the product.
Asset allocation is quant-driven, but Selvan and his colleagues scour sell-side research and other sources to determine what companies should be included in the eligibility universe. They ignore common benchmarks like the MSCI World Index and instead bracket the world into 15 categories, such as autonomous vehicles or blockchain, and seek companies that are sustainable, have proven business models, and commercialized tech, which usually comes down to their use of data.
“I’m more like a project leader than a portfolio manager,” Selvan said.
The team now has about 500 listed companies in its universe, and continues to add new ones, particularly as new companies list. The team is developing its own “disruptors benchmark” of stocks.
It does so based on several factors, including:
- Fundamentals – this includes market cap, as the team wants companies that scale;
- Earnings per share (EPS) and sales growth – the team pulls data from Bloomberg and Reuters terminals, and tracks earnings momentum;
- Price volatility – Selvan says true disruptors, such as Amazon and Apple, are not volatile stocks, and when a company hits a rocky stretch, it’s appeal, and therefore the portfolio’s allocation, declines;
- Price-to-sales – Although most listed companies can be valued traditionally through price-to-earnings ratios, Selvan says many innovative companies are more interested in gaining traction through revenues than in profitability. But price-to-sales multiples show where the momentum lies. Amazon is the poster child for this approach.
Once the team has curated the eligible companies in what it views as big-theme disruptive plays, it lets algorithms based on the above factors determine weightings. The algo decided to cut its exposure to Facebook; the team decided Tesla was no longer a disruptor.
Fintech’s long play
Selvan says banks and insurers will be disrupted, but there are few good investment ideas to leverage that belief. Many of the more intriguing companies are still private. The fund has resorted to proxies to capture the blockchain movement, including Amazon and Baidu, as well as consumer tech companies like GoJek and Lazada for payments.
Selvan says payments remains the hottest area for disrupting finance. “The world is going cashless,” he said, noting how digital payment companies in China have bypassed credit cards. For now credit-card companies are, overall, huge beneficiaries of trends in payments, as many fintech solutions continue to use their networks. But in the retail world, as the likes of Alibaba and Amazon open cashless stores, they will look to put shoppers on their internal payment rails.
Artificial intelligence is another theme reshaping finance, Selvan says, noting the potential for “digital assistants” like Amazon’s Alexa and GoogleHome to supplant interactions with banks. RegTech for KYC, account opening and fraud detection are going to remain hot areas.
Other parts of the fintech world have lost pace: Selvan’s team this year removed Lending Club and CreditEase, as they decided peer-to-peer marketplaces for loans weren’t sufficiently disruptive, or not commercially attractive.
Disrupting fund disruption?
The second aspect of the Innovation Fund – to run the business along innovative lines – has been harder to realize. Since its launch in early 2017, it has gathered only S$40 million (US$29 million) of assets.
Initially the fund was sold through Singaporean online distributors such as Fundsupermart and Dollar Dex, in part because they don’t charge the high front-end loads that bank distributors require. More recently, OCBC (the parent bank of Lion Global Investors) and RHB have added the fund to their shelves.
“It’s frustrating,” Selvan admits, saying distributors have a hard time categorizing the fund. “Distributors still hold that power, because funds are still sold, not bought.”
He says the mission of the fund is to give ordinary people a chance to benefit from the innovation of the world’s biggest disruptive companies. The fund’s minimum investment size is a miniscule S$100, and Selvan says Lion is trying to attract first-time investors with a clear story. “This is the story of the fourth industrial revolution, and that’s something that resonates with young people.”
Lion is launching the product in Malaysia later this year, also beginning with online distributors, with Indonesia next.
Overall, Selvan and his team are skeptical that banks and insurance companies will win from the erosion of fees that digital and data will continue to force.
So far they’re not convinced by crypto stories either, as companies launching tokens don’t look viable or able to attract the mass use they need for their coins to sustain value. Although many top-flight investment banks like to say they are tech companies with a bank license, Selvan doesn’t think that makes them disruptive.
The exception is Ping An Insurance. “They’re a traditional Chinese insurance company, but they’re on top of Internet 3.0,” Selvan said “They acquired 200 million digital customers in just three years.” And Ping An will continue to spin off attractive fintech businesses like digital wealth-management platform Lufax.
The team is also keen to see the likes of Ant Financial go public so it can also be added to the eligibility universe.
AllianceBernstein looks to add value to digital channels
Ajai Kaul, regional head, says the buy-side battleground is moving to banks’ evolving digital distribution.
This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. We will also provide strategies from Invesco and BEA Union Investments. Go here for more insights into digital asset and wealth management.
Asset managers need to be ready to work with banks’ digital capabilities to reach retail investors.
Ajai Kaul, the Asia ex-Japan CEO at AllianceBernstein, a $580 billion investment firm, says digital distribution remains a puzzle for the industry. Although new channels are emerging, particularly in China, asset managers will likely adapt to what their existing distributors do online.
“Banks have the capital and the captive client base,” he said. “As asset managers, we deliver a product and service the client, including their digital engagement. So we need to understand how we’re going to plug into what banks are doing.”
Over the past two decades, banks in Asia have transitioned away from supermarket approaches involving dozens of manufacturers to a core set of perhaps 20 asset managers on the shelf.
Banks represent the vast majority of sales to retail investors in the region, so asset managers remain dependent keeping these relationships. Although buy-side firms recognize the importance of “digital transformation”, in Asia at least they are waiting to see which way their distributors move.
Follow the banks
“Banks are already responding with their own digital strategies and we need to continue to engage them and plug into their platforms,” Kaul said, adding this is likely to be more around operations, education and reporting than marketing or front-office activities. “We’re having conversations now about what this might look like…I do not believe banks are about to cede customers to the digital and online service providers.”
One aspect is likely to change how asset managers support distributors with things like marketing material. This will increasingly be less about papers and statements, and more about real-time online communication. And it will change the way asset managers arm financial advisors, bank salespeople and other intermediaries with information about their products, and about investing.
“People want convenience,” Kaul said. “They’re used to instant transactions. But we need to ensure that they understand what they’re buying.”
That principle sounds simple but it’s not clear how it will materialize. Does that information get communicated at point of sale, or via a continuous stream of back-and-forth with investors? Who is responsible for education – and who finances it?
The prize for getting this right is data-driven insights that enable fund mangers to build better products, with more tailored, suitable features, be it about liquidity, or asset classes, or risk. “You can scale faster if you get a real insight,” Kaul said. “And there’s a lot of data – if you ask the right questions.”
What about direct?
Is there a point at which asset managers will also go direct to consumers?
Kaul says this could emerge as a complementary strategy, but: “We’ll always be working with banks. Wealth management and financial advice are just tools for banks, along with loans, credit cards and foreign exchange.”
In other words, banks will retain the overall customer relationship, at least as far as asset managers are concerned – although banks themselves are now eager to cement their customer relationships in the face of being themselves swallowed up into “ecosystems” dominated by consumer-facing tech platforms.
Kaul is also looking at more direct digital channels, notably in China, where AB, as the firm is known, is licensed as a private fund manager, which can raise money from professional investors but not retail.
This makes PFMs unappealing to domestic banks, which can’t sell their products to their retail clients. Most sales are institutional in nature, but digital channels are becoming relevant.
This is still however more theoretical than real for firms like AB. But Kaul and his colleagues are putting time into studying the market.
“We need to understand mobile platforms and how we engage with them, in general,” he said. “In mobile environments, we can’t just be a product on a shelf.”
The China experience
So far the majority of funds sold in China through such channels are money market funds. But platforms such as Ant Financial, EastMoney and WeChat are beginning to develop more advice-based services that will help users with financial planning.
“How does a fund manager add value?” Kaul said. “If a transaction is on a mobile phone, that’s a very small piece of visual real-estate to work with, or become prominent on.” Fund products are usually three, four or five clicks away from where users spend their time on these platforms. Foreign fund managers do not enjoy brand recognition in China. “Just being a product isn’t sufficient to win traffic,” Kaul said. “You have to present something of value that creates interaction between the user and AB.”
He says China offers a good place to begin this learning process, given the popularity of these channels for everyday use. And within the Chinese context, these digital platforms are similar – if a fund house can master one, it can adapt a similar method to the others.
What’s special about mainland China isn’t the platform so much as it’s the investor culture, which ever since the stock markets appeared in 1990, have been habituated to short-term trading.
“How we build and deliver product may not match the local wealth market, which has developed its own biases toward duration, time horizons and the purpose of investment,” Kaul said. “But the population there has fully embraced mobile platforms, as we can see by the sheer volume of transactions now taking place. China is the front line of innovation.”
BNY Mellon pursuing “open architecture” in custody
The bank is forming alliances to connect data to front offices – and affirm the custody business model.
BNY Mellon recently announced a partnership with Bloomberg, which comes on the heels of another with BlackRock.
The aim, says Singapore-based Mathew Kathayanat, head of product and strategy for Asia Pacific, is to provide value by bringing critical data and insights into the front office, allowing clients using both BNY Mellon and its partners to improve the investment-decision process. “We’re open architecture because we know our clients want flexibility and choice,” he said.
Custody represents the primary revenue generator for the world’s biggest banks. Custodians act as the vault for institutional and corporate accounts, safeguarding assets, collecting and reporting on related information (such as corporate actions), providing accounting, maintaining funds’ registrars, handling foreign exchange, and providing a range of legal, tax and compliance services related to those funds.
Although fees on core custody are ultra low, the volumes that top banks generate still makes custody valuable. Despite low interest rates, custodians still earn a spread on holding customer deposits, and lending out client assets (splitting the gains with the client) is lucrative. During the global financial crisis, custody provided steady revenues at a time when other banking activities were in peril.
But this bulwark is under threat from fintech. Many of the services banks provide are now available from tech companies as modular, plug’n’play software-as-a-service.
Some custody functions may resist being displaced: robots aren’t trusted to cut a fund’s NAV (net asset value) or to handle all middle-office functions such as risk management and compliance. On the other hand, fund accounting and middle-office outsourcing are usually loss leaders for custodians, as these activities do not generate revenues. The lucrative bits, such as core custody, forex and securities lending, are the most at risk.
That’s the background to BNY Mellon’s teaming up with partners, most recently Bloomberg. BNY Mellon will integrate its data, analytics and servicing capabilities with AIM, Bloomberg’s portfolio management system. Buy sides using AIM for trading can now access BNY Mellon’s data tools directly.
This follows a deal announced in April to give similar access to BNY Mellon data to users of Aladdin, the investment and operating management platform offered by BlackRock solutions and used by many buy sides (including by BlackRock itself, which manages nearly $6 trillion in assets).
Alliances versus acquisitions
The partnership approach is different than rival State Street, which has opted to acquire platforms used by clients instead. The capstone of its M&A was last year’s $2.6 billion purchase of Charles River Development, a front-office platform for asset managers – in effect, taking on Aladdin directly. (BNY Mellon has $35.5 trillion of assets under custody or administration; State Street has $32.6 trillion.)
In both cases, the first reaction by the biggest standalone custodians has been to get bigger by adding front-office facing platforms, either through acquisition or partnership. The idea is to make their custody solutions easy and attractive to CRD, Bloomberg or BlackRock customers, either to win their existing clients, or to prevent the banks’ own users from leaving. Winning clients new to any existing players is a third goal.
Data has huge value, but does that mean custodians simply digitize?Mathew Kathayanat, BNY Mellon
What these deals don’t do, however, is address the fundamental changes in client demand regarding data. Banks, especially custodians, have tons of data. They are awash in data. Yet even these institutions, for all their technological might, are struggling to turn it into a business that can safeguard their margins.
Kathayanat acknowledges this. “Data has huge value, but does that mean custodians simply digitize? That’s not a replacement for the custody business. The alliances will bring critical data further up the value chain and give clients a better end-to-end experience.”
Data’s integrity problem
One reason is data integrity. In a nutshell, data is messy. Even asset owners that use a single global custodian hire vendors to sit between them and their bank in order to reconcile data.
Even though in this case the settlement and transaction data is all from the same bank, there are discrepancies. A single bank relies on multiple operational centers, on multiple sources of reference data, and still has to use manual procedures for a lot of work, such as fund accounting. This inevitably leads to errors.
Most asset owners, particularly in Asia, prefer to use multiple custodians. Therefore the problem of data integrity is compounded. That makes it hard for banks to sell, say, services based on artificial intelligence. Instead, banks and vendors have been amassing “data lakes”, to try to pool their data into a single, reconciled format.
In the end, though, this means that clients continue to operate their own books of record and cut their own NAVs. The system works, but it’s inefficient.
The best response to the problem of data integrity has been enabling clients to pull their information directly from the custodian, rather than passively waiting for the bank’s scheduled report.
“APIs have been a great help,” said Kathayanat, who has seen asset owners leapfrog from relying on faxes to A.I.-driven KYC and other functions, supported by the rise of fintechs as well as a desire among institutional clients to have a retail mobile experience, seeing their trades on their phone whenever they wish. “We have to stay relevant.”
That’s where BNY Mellon’s partnerships come in, integrating digital tools directly to order-management systems like Aladdin and AIM to allow real-time settlement data, cash forecasts, corporate actions, and other information be visible to the client’s front office.
These deals are large, but Kathayanat says they won’t be enough. “We have more partnerships in the works,” he said.
High-speed finance looks to flexible hardware
“FPGA” may be clunky tech jargon but it’s at the cutting edge of high-frequency trading.
For financial firms obsessed with speed – getting data, parsing it, executing on it, getting trades into the market – the solution is increasingly found in more flexible hardware.
While artificial intelligence remains the most prominent, sexy end of financial innovation, the ability to put it into play in low-latency strategies relies on the physical circuitry.
And it’s not just the most niche set of high-frequency traders that are looking to more flexible, agile versions of hardware. So are prime brokers, broader quant investors, crypto-currency miners, and banks’ trading floors.
What is FPGA?
At the heart of this is a hardware technology called field-programmable gate array, or FPGA. For anyone not in I.T., that’s a mouthful. The clue is in the first word: field. As in, out in the wild. FPGA is an integrated circuit – hardware – that a customer can configure after they buy it from a vendor.
Traditionally, hardware is delivered in the form of CPUs or GPUs, central processing units or graphic processing units, which are generic machines to carry out programs. They’re too general and too off-the-shelf to meet the needs of, say, high-frequency traders or other high-usage businesses.
On the extreme end to meet such demand, hardware has become very specialized, as is the case with application-specific integrated circuits, or ASICs, which are processors designed to do just one thing. ASICs are popular with bitcoin miners, for example, as the computers need to focus solely on solving the mathematical puzzles required to generate a new block of data.
The volume and variety of data keeps increasingMutema Pittman, Intel
But ASICs can’t be used for anything else than what they’re built for. And trading algorithms need to be adapted all the time.
That’s where FPGA comes in: it’s hardware that you can adjust. FPGA is not a new technology, but it’s new to financial services. It’s been adopted by tech-heavy players in the U.S. but has been slow to make its way to Asia.
Adaptable – and fast
It was the focus of discussion, however, during a conference last week for technology officers in Hong Kong organized by STAC, a U.S.-based association that tests and benchmarks finance-oriented hardware.
“FPGAs give you the power of hardware-dedicated architecture as well as flexibility because you can reprogram them,” said Mutema Pittman, who heads the enterprise business division for network and custom logic at Intel. “The volume and variety of data keeps increasing, and firms need to react to this in a timely manner even as market requirements continue to change.”
There are other aspects of FPGA that make it more adaptable. It can talk to other devices with ease, making it a useful server for communicating with, say, a stock exchange’s API. It can also access computer memory directly, without intervening layers, which makes it faster than traditional CPUs.
The first use case for FGPA is market dataMiguel Ortega
“The first use case for FPGA is market data,” said Miguel Ortega, who heads market data for a global bank in Tokyo. “It makes it easier to convert data feeds from exchanges into applications to make decisions,” such as trade signals, placing orders, and ensuring trades comply with mandates or rules.
“FGPA are used for strategies that require the lowest latency,” said James Morris, Sydney-based technology leader at Optiver Asia Pacific, an electronic market maker. “FPGAs enable firms to access data from exchanges, make decisions, and execute – at the speed of nanoseconds.”
Although firms like Optiver build their own hardware, not all firms need to be at the bleeding edge of speed, depending on the trading strategy. But some vendors are producing technology to allow their FPGA boards to operate as fast as possible. One such company, Exablaze, enables trades at latencies as low as 31 nanoseconds, says Matthew Grosvenor, Sydney-based senior vice president of technology: “That’s easily a 10-times speed improvement by moving software from CPUs to FPGA firmware.”
A nanosecond is a thousand-millionth of a second, or 1/1,000,000,000 of a second.
Other use cases
Other vendors cater to quant shops and investment banks’ trading floors that don’t need to operate quite at that speed, but still need to be fast.
While FPGA’s most obvious use case is ultra-low latency, some functions require computing to go along with the processing, such as smart-order routing or sentiment analysis. These don’t need to be done at the pace of nanoseconds, and flexible hardware could be a substitute for, say, co-locating servers at the exchange’s data center.
FPGA are used for strategies that require the lowest latencyJames Morris, Optiver
FPGA may also be a good hardware choice for even less time-sensitive functions such as pricing options or running Monte Carlo risk scenarios, because they can draw the data directly from sources. But they don’t make sense for heavy computing needs, such as anything requiring complex mathematics.
So why is FPGA still an obscure technology in Asia?
First, it comes with DevOps challenges. Not a lot of programmers know how to use it, and even fewer in finance. Second, there’s no open-source tools for FPGA (unlike for software), so firms must either buy from vendors, or build it from scratch themselves.
Third, most stock exchanges in the region haven’t invested in FPGA either, preferring to hand off data through software solutions like APIs. Some exchanges, unfamiliar with the tech, are concerned it will invite a barrage of customized orders they won’t be able to handle.
This view might change as they compete to ensure their matching engines remain able to handle ultra-fast trades, but it’s mainly venues in developed markets like Japan and Australia that cater to delivering data to FPGA hardware.
Fourth, Asia’s market is fragmented. Yes FPGA is flexible, but it still needs to be adapted for each market’s particular environment but vendor solutions (primarily developed for the U.S.) don’t cater to such nuances.
For banks trying to keep up with their lucrative HFT clients, they also need to invest in bespoke FPGA connectivity. It’s an expensive proposition.
“But for someone sending enough orders, it’s worth it,” said Ortega.