In the last decade the banking industry has made tremendous efforts to digitalise its services. The investment industry has been slow to catch up, but has begun to find its footing with robo-advisors making a loud entrance.

But what about funds? Have you ever invested with your smartphone?

Funds are mostly sold to retail investors via distributors (e.g. banks or financial advisors) that receive commissions on the volume of fund sales—but this model incentivises distributors to push funds with high commissions to retail investors instead of searching for products that suit their needs best.

Thus, the European Commission has decided to put an end to this system with the MIFID II directive, which bans the payment of commissions to independent advisors. This represents a real paradigm shift for fund distribution. But it also brings some unintended consequences: independent asset managers (i.e. those without a proprietary distribution network) will face a more challenging environment in which to distribute their funds; and banking institutions with an in-house asset manager will close their product range to become dependent, if they haven't already—this allows them to continue receiving commissions.

Selling funds via mobile apps

In this context, some independent fund houses dream of directly reaching final investors by digital means such as mobile apps. I.e., e-distribution.

Unfortunately, this is not as simple as it sounds. First, for average customers, asset managers are virtually unknown compared to the familiar bank names. Building a strong brand name is thus essential to get in touch with final investors. A similar transformation has been observed in the pharmaceutical sector, for instance, which also used to be a B2B-industry with low brand recognition by patients. With massive marketing campaigns, these companies have succeeded in drastically increasing brand awareness.

Secondly, operation costs must be significantly cut. Large amounts of money per transaction have made the transaction cost bearable for investors. E-distribution would bring a higher volume of transactions with much lower amounts. The current cost structure risks making e-distribution unprofitable. We see AML/KYC and order processing as two areas where costs might be cut.

Digitalisation of the back office

Heavy AML/KYC procedures need to be automated and made paperless. Indeed, solutions are already available: mobile solutions, for example, prompt an investor to take a selfie and submit it as his or her ID; the name is then run through a PEP database; if no anomalies are found, the account is immediately created. Errors, on the other hand, can be further investigated manually. The procedure can also operate on a stratified basis, applying more rigorous verification for users investing large amounts, and quicker verification for those investing small amounts.

On top of digital solutions, costs could be shared across the industry with a central repository of AML/KYC documents. The investor would just need to grant access to the financial institution in order to retrieve his or her personal data from this repository.

Order processing also needs to be redesigned to make small order processing profitable. Currently, fund order processing entails many manual tasks and reconciliations. With distributed ledger technology, i.e. blockchain, order processes could be automated with smart contracts that check and validate orders. Investor registers could be updated and stored on a distributed ledger that is shared between the fund accountant, the custodian, and the asset manager. Order processing could be automated and reconciliation decreased, which would lead to lower operation costs.

A new fund market infrastructure evolves

Significant development costs might hinder many small and medium asset managers, but concurrent with that would be an opportunity for providers that could develop an infrastructure allowing costs to be shared amongst asset managers.

In the last decade, we have seen many industries digitalise their activities or products, banking, retail, music, and movies being but a few examples. We believe that these transformations are inevitable for asset managers, who must now give attention to their own reinvention. The challenges are not unsolvable and the cost of not acting is too big—and new actors may be entering the market as well.

As a last word, we believe that e-distribution will benefit final investors by providing them with a new and more direct channel with which to invest. From a macroeconomic point of view, more money invested will lead to a more prosperous economy.

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