The next step for open architecture
Changing client demands have fueled the trend towards greater choice in distribution
New regulations and more demanding client expectations over the last decade have increased the pressure on wealth managers to offer investors a wider range of non-proprietary investment products.
This trend has resulted in the decoupling of investment product manufacturing from investment product distribution and is at the heart of “open architecture” product choice.
Open architecture’s approach is to offer a broad choice of funds and products to put the investor in control of which investment it wants to select. Under so-called guided architecture the distributor filters investment solutions on behalf of the customer.
Research from accountant Ernst &Young shows that almost 80% of wealth managers are planning to increase the level of open architecture in their investment solutions within two years to offer more third-party choice and a wider selection of product types.
This shift on the “sell” side of the wealth and asset management sector has two driving factors. One is the regulatory evolution, particularly under the proposals of Mifid, which has pushed increasing numbers of wealth managers and advisors to build strategies which are demonstrably in best interests of their clients. Second, the 2008 financial crisis has forced managers to respond to risk not only with investment diversification but also investment manager diversification.
Moreover, the performance of traditional asset classes, such as bonds equity and real estate, are now more closely correlated. As a result, investors who want to diversify may need to use an open architecture framework that offers also non-mutual fund products available through exchange traded funds (ETFs) and alternative investments vehicles.
Financial institutions are diversifying their investment strategies to mitigate the growing alignment of risk between previously distinctive asset classes and the managers who direct them, chiming with the wider range of investment options that drive open architecture. For example, long-term investment schemes such as pension funds or plans are now more likely to consider open architecture solutions.
How will this change the way distribution platforms should operate? In our view a significant challenge for institutions on the “buy side” will be how to find the best business model within the open architecture framework. It will require different interfaces and communication standards in which the use of a single platform has the potential to provide greater operational efficiency and minimise cost.
Ideally, such a platform would have a high number of products from which to select a suitable investment which is delivered using a robust IT infrastructure to facilitate product access and high standards of data quality.
Expanding open architecture choices this way, however, requires significant investment. For wealth managers, advisors and long-term investment managers, outsourcing a back office and IT platform is an attractive strategy.
It could offer direct connectivity with a larger number of managers and handle data communication standards such as Swift and XML to ensure efficient reconciliation, fund investment order routing, trailer fees management, payments and reporting.
As market volatility looks likely to remain a consistent feature in the months ahead, open architecture is likely to become an increasingly important tool for investors to protect themselves against risk and ongoing uncertainty.