What is driving the purported ‘comeback’ of traditional asset managers? Is it a trend that’s set to continue in the long-term?
To start, it is interesting to look at the transition of market conditions from 2022 to today. In 2022, the market saw the highest sustained real price volatility since the Great Financial Crises. This alone was enough to make institutional asset managers wary of making moves. The situation was exacerbated by historically high levels of correlations, which made the selection of fundamental winners and losers very unappealing. Non-traditional volume sources such as passive indexing, high-frequency trading, non-bank market making, and quantitative trading were gaining market share over institutional asset managers. The subsequent lack of continuous institutional volumes contributed to an unhealthy market backdrop in terms of liquidity, efficiency, and attractiveness, as evidenced by the highest levels of cash raises in over 20 years within the fund manager segment.
In 2023, market conditions showed signs of improvement in terms of correlations and real price volatility. However, macroeconomic uncertainty, particularly due to historic inflationary pressures and rising yields, kept traditional asset managers cautious. Despite this, the groundwork for improved trading conditions was being quietly laid. All that was needed was some macro clarity.
As we move through 2024, macroeconomic volatility remains high, but there has been a sharp shift in sentiment indicators such as overall bullishness, recession fears, the disinflation narrative, growth expectations, and peaking interest rates. Correlations are approaching historically low levels, indicating rising risk but also presenting an attractive backdrop for asset managers. With increased macroeconomic clarity and sustained low real volatility, traditional asset managers have re-entered the market to a considerable degree, creating the healthiest trading conditions seen in five years.
Is the industry set to see a shift away from passive investing, high-frequency trading, and retail investors (strategies which have recently been dominant)?
We don’t see a shift away from passive investing. If the job market remains tight, which it has, and supports the soft landing narrative that boosts equity performance, this ensures a constant passive bid in the marketplace. Employers’ shift from pension-based retirement plans to 401(k)s means a steady influx of passive funds into the market.
High-frequency trading and traditional electronic market making will ebb and flow with market conditions, while retail investment will follow equity performance accordingly. These avenues are here to stay, but when conditions favor institutional asset managers, their larger share of overall volume enhances market liquidity and efficiency.
How has this shift affected market dynamics and overall stability?
The return of continuous institutional volumes, not seen with such consistency since before Covid-19, brings healthier liquidity to the marketplace. This translates to better depth of book, the ability to trade in size, lower expected impact costs, and more attractive contra. Traditional buy-side firms prefer trading with their counterparts, and improved confidence, as seen in 2024, creates a snowball effect that brings a level of health and normalcy to market conditions.
What impact are forthcoming regulations expected to have on this uptick of traditional asset managers?
The SEC’s market structure overhaul proposal presents some troubling components for institutional investors. The cap on access fees could dent the margins of single dealer platform/wholesaler participation in the marketplace. Retail participation, a significant change induced by Covid-19, appears to be secular rather than cyclical. While retail volume tends to rise when equities perform well, the presence of the retail player is something that is here to stay. Should access fees become prohibitively high for wholesalers, their disappearance could severely impact the quality of trading that retail participants currently enjoy, including zero commission trading, unlimited size, and totally accessible markets.
The proposed tick size adjustment could have harsh consequences for large institutional money managers attempting to move large blocks of stock. It will become more difficult to find real liquidity at a price point, with concerns around quote fragmentation, volatility, sub-penny quote jumping, flickering quotes, and increased messaging traffic further complicating the trading landscape.