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91% of global investment firms report inadequate internal risk controls - PwC

07 July 2006  |  1312 views  |  0 Source: PwC

Investment managers are far more optimistic about their growth prospects than they were when the current bull market began three years ago and are focused on revenue expansion rather than cost-cutting.

However, as they chase performance through product diversification, they also face enormous challenges in expanding distribution, attracting specialized talent and managing risk, according to the 2006 Global Investment Management Survey, released today by PricewaterhouseCoopers LLP.

More than half (55%) of global investment company CEOs surveyed expect revenue growth of 20% or greater during the next three years. America's investment firms are less bullish, with only about a third (35%) expecting revenue growth of 20% while two-thirds (65%) forecast more modest growth of 5% to 19% over the next three years.

"Our survey shows that chief executives are optimistic about revenue growth, but evolving investor demands, weak internal controls and risk assessment strategies and the disruption to existing distribution channels will present a demanding environment over the next few years," said Simon Jeffreys, PricewaterhouseCoopers partner and global investment management and real estate industry leader. "The likelihood is that this will occur against a background of rising interest rates and more difficult market conditions."

Lack of Confidence in Distribution Strategies

Facing competition from new players and products, investment management firms are concentrating on expanding the breadth of their products. They are looking to develop sources of alpha, which is the extra return that active fund managers claim to earn above normal risk and market related factors, in order to complement existing strengths, and they are actively managing specialized investment and research capacity for hedge funds, private equity, real estate and use of derivatives. Yet many lack confidence in their ability to execute these strategies.

Increasing distribution of existing products in existing markets was cited as a top concern by more than half (53%) of firms in the Americas. Yet nearly half (47%) rated their own organizations below their competitors in managing new markets while a third (35%) think they do not do as well in the areas of breadth of product range or distribution.

With growing competition for talent that demands specialized skills, improving resource development and talent retention ranked as a top concern of CEOs both in the Americas (29%) and globally (17%). Firms in the Americas were more likely to use short-term incentives such as bonuses or long-term incentives such as shadow equity schemes to recruit, retain and motivate portfolio managers, while firms globally also relied on base salary and equity ownership.

Surprisingly, four years after enactment of Sarbanes-Oxley, many U.S. firms still are not confident of their risk management and internal controls.

Nine in 10 (91%) survey respondents globally and even more (93%) in the Americas said that they did not currently have appropriate internal controls in place to adequately manage risk. Globally, 89% of firms and 93% of U.S. firms also had not completed a comprehensive risk assessment.

Nearly a quarter of survey respondents globally see the increased regulatory burden as their greatest and most immediate challenge. The number of new regulatory requirements being introduced worldwide has created a significant workload for firms and consequently strained resources.

"Focused on growth and facing demands for results, especially from institutional investors that have grown more sophisticated in examining performance attribution, investment managers are working to balance the need to achieve results with risk and regulatory constraints, said Barry Benjamin, PricewaterhouseCoopers partner and U.S. leader of the firm's Investment Management Practice. "To achieve this in a cost-effective manner, they are turning to outsourcing and technology. The firms that will win will be those with a clear vision of their competitive advantages and flexibility to seize opportunities by strengthening their core competencies and outsourcing or selling non-core operations."

Outsourcing Trend to Continue to Grow

Driven by the need for efficiency, the trend towards outsourcing will continue, with a majority of firms globally outsourcing more of their back- office functions such as fund accounting and custody work. Investment firms in the Americas, many of which already outsource a majority of their fund accounting and custody work, will expand their outsourcing more slowly and cautiously with a greater eye than in the past on expanding their capabilities versus cutting their costs.

Although cost savings was initially thought of as a primary driver of outsourcing, only a handful of firms that outsource cited this as their reason for outsourcing going forward. Instead, having the flexibility to focus on core competencies was the top reason for outsourcing, cited by half of firms both globally (49%) and in the Americas (50%), with quality of service and delivery listed as the secondary reason.

Globally, automation of processes and procedures is proceeding. For example, 77% of firms globally already employ a risk monitoring system that is at least partly automated (although only 56% of companies in the Americas currently use automation in risk monitoring). Within three years, 96% of firms globally, and 94% of firms in the Americas, expect to have at least partly automated risk monitoring systems, with 42% of firms globally employing enterprise-wide automated risk systems.

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