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Vendor Viability

Landscape Description

In the context of investment management software, the longevity of a system can indeed be a positive attribute. A system that has been around for a long time is likely to have a wealth of experience and knowledge built into its design. This can result in a rich set of features that have been refined and improved over time based on customer feedback and requests.

The ability of a system to adapt and evolve in response to customer needs is a testament to its flexibility and robustness. This can lead to a comprehensive set of features that cater to a wide range of investment management needs. As customers request new features and the system evolves to meet these demands, it can become a valuable tool for investment professionals.

Furthermore, the longevity of a system can also lead to a strong community of users who are familiar with the system and can provide support and advice to new users. This community can be a valuable resource for learning about the system and getting the most out of its features.

The longevity of a system and the richness of features gained from customer requests can be seen as positive attributes in the context of investment management software. These factors can contribute to a system that is flexible, robust, and well-suited to the needs of its particular users.

Decision making criteria for an investment management platform should include considerations of

- The system creation date to determine the product maturity implying functional depth.

- The number of customers to explain support capabilities especially at crunch times such as end-of-month reconciliation issues.

- Average $AUM of customer to determine a fit with new firms profile.

Note: As follows, all values are educated guesses derived from reported information.

How big is the pie for investment management software?

- Global assets under management (AUM) estimated at $150 Trillion. Reporting firms, generally registered investment advisors (RIA), $AUM estimated at $93 Trillion (Note: Adding a completion factor to size up the market that accounts for 'unknown but understood to be there' assets under management.)

- From the global estimate, about $50 Trillion remains for approximately 6,000 hedge funds, 60% of which have fiduciary responsibility that requires a shadow accounting platform to augment fund administrator reporting. The total addessable market (TAM) for investment management software-as-a-service (SaaS) and related businesses, could be estimated at (software vendors market share derived from known information)

• Number of hedge funds: 3,600 (60% of 6,000)

• Total number of users: 14,400 users (3,600 x 4 users/firm)

• Cost per user monthly: $2,000 ($24,000 for 12 months)

• Total customer value: $96,000/year (4 users x $24,000)

• Potential market revenue: $345 Million (14,400 x $24,000)

Observations from curated information

- Blackrock Aladdin and Bloomberg AIM likely cater to the highest quality institutions estimating $AUM for each customer to be greater than $500 Billion. The top 10 investment management firms account for almost $70 Trillion or more than half of known reported $AUM of quality institutions. Prime brokers providing investment services to institutions will often sponsor technology expenses depending on commission 'wallet' (monies paid for services rendered).

- Enfusion, the sole publicly traded technology provider, estimated (generously) at 5% market share of AUMs has about 800 hedge funds with a few larger asset manager strategies, that each manage on average $1.7 Billion.

How many users are available for a vendor product? 

As assumed above; 3,600 hedge funds with 4 users each results in the total market having 14,400 users. Many of which could be under prime broker accommodations.

How much revenue is available to fuel the business?

- The total dollar revenue available for vendor product comes from 14,400 users paying $24,000 each year (for a two-year contract) resulting in $345 Million.

For example; Enfusion has 800 customer firms representing 3,200 users (4 users in each firm). If they charge $2,000 for each of 4 users every month ($8,000), the company will gain revenue of $96,000 each year (for a minimum contract value of $192,000). With 800 customers, revenue from product licensing totals about $76 Million. Then account for system maintenance expenses (servers, offices), personnel compensation (500 employees at $75,000 results in $37 Million). Let's make it $42 Million in expenses resulting in profit of $34 Million. In real life, the margins are likely tighter.

Margins will vary greatly by technology vendor and baked in costs of doing business may wind up as profit through a line-item customer billing (ie- File transformations from known data providers for vendor use may already have been coded but a requesting customer may be charged for it.).

Note: Enfusion reported Dec 2023 revenues of $46 Million versus a ballpark estimate of $76 Million which may indicate that product licensing charges are lower than $2,000/month.

Additional revenue opportunities may arise from programming modifications for proprietary applications, with an engineer's hourly rate at $250. Customers should also account for pass-through charges related to operational needs, such as exchange fees and routing charges, as part of their monthly expenses.

How would a vendor system grow the number of customers it has access to?

Estimating the cannibalization of the market share between Eze Eclipse, Enfusion, and a couple of other systems is challenging. However, this competition leads to customer churn as funds experience boom and bust cycles, causing vendors to compete on charges and services.

Looking at the broader market, funds either grow or downsize based on their financial performance. This dynamic presents opportunities for vendor systems to expand their customer base:

1. New funds seeking a system: If large enough, these funds may require a platform to manage their operations. A simplified version of an existing system could meet the introductory needs of these funds, ensuring future usage as they mature. New funds are regularly created, and a standardized product could satisfy their needs while securing a sales pipeline for future growth.

2. Growing funds upgrading their systems: As funds become more successful, they may need advanced functionality and features to accommodate changes in investment directives. Market expansion is possible for a more mature system that has developed industry-standard accounting and rebalancing functions.

3. Downsizing funds seeking cost-effective solutions: Even if a fund is failing but still operational, they may need to move to a less expensive platform. Vendors can retain these customers and maintain revenue streams by offering scaled-down versions of their platforms.

What are the costs of acquiring a new customer? 

While new funds are starting on a regular basis, likely as many are failing all the while, others are growing without needing to change platforms and prime broker facilitations. There's not much meat left on the bone for a new entrant. That said, for traditional investment management firms, there does appear to be a need for digital asset solutions.

The actual cost has more to do with resource allocation. A technology vendor would need to be willing to spend money on resources to build functions and features that existing customers haven't requested but sales needs to expand market share. Existing customers will be disappointed with continuing broken promises (e.g., delaying short locate automation) that complicates account management and impacts reputation.

The size of the pie is growing ever so slowly by customers adapting existing systems to workflows and processes that new strategies or investment opportunities require. Proprietary systems can grow with vendor APIs if vendors create useful endpoints. So the expenditure on functional development can be delayed while appealing to innovation that usually exists in new funds.

A few conclusions

The intent of this piece is to lay out the case for an investment in an investment management platform. That could be by spending cash to implement an operational solution or through capital allocation from a fund into the only publicly traded company. 

However, the potential for adequate growth is questionable as the appetite for software is at best satiated and at worst- diminishing. In addition, prime brokers offer compatible technology solutions when assets are facilitated by that broker. A cash investment seeking a profit may be limited by a product's access to users. It appears as though some new users and those in need of a new set of features select a solution by recommendation. 

There does not appear to be an innovation in position adjustment and portfolio rebalancing that would compel changing systems. Selection of a system is highly dependent on the assets and as such further narrows the market.

The best option for any single vendor's growth is to craft an inexpensive solution for new firms that provides a feeder for a more mature offering.

Market definitions

When discussing technology vendors, the conversation often turns to the differences between asset managers and hedge funds. From the point of view of a technology vendor, an asset manager is a collection of hedge funds in the form of strategies. A hedge fund system specializing in the strategy's workflow and asset could be the solution for that asset manager.

Hedge Funds: These are private investment vehicles that aim to generate high returns by employing a variety of strategies, often more aggressive than those used in traditional asset management.

Asset Managers: These are professional money managers who invest in a diverse range of assets, such as stocks, bonds, real estate, and commodities. Their goal is to grow their clients' wealth through a more conservative approach, often focusing on long-term appreciation.

Fee Structure: Hedge funds typically charge a management fee of 1.5% to 2% of assets under management (AUM) and a performance fee of 20% of profits. Asset managers usually charge a management fee of 0.1% to 2% of AUM, depending on the type of assets and the level of service provided.

Risk Tolerance: Hedge funds are known for their higher risk tolerance, employing strategies like short selling, leverage, and derivatives to chase higher returns. Asset managers, in contrast, tend to take a more conservative approach, focusing on risk management and diversification to protect their clients' investments.

Investment Strategies: Hedge funds employ a wide range of strategies, including long/short, global macro, and market-neutral. Asset managers focus on building diversified portfolios that aim to provide steady returns over the long term.

Regulation: Hedge funds are subject to less regulation than asset managers, which means they have more freedom to pursue high-risk, high-reward strategies. Asset managers, on the other hand, are more tightly regulated, which can provide a greater level of protection for investors.

Accessibility: Hedge funds are typically only available to accredited investors, while asset managers are more accessible to the general public, with a wide range of investment options available to suit different risk tolerances and financial goals.