A month or so ago I published my Top 5 Institutional Investor Themes. Number 3 on the list was Continuing Innovation in Access Routes. With drawdowns still threatening contributions to operating budgets/ endowment spending policies and pensions under significant pressure to correct funding levels, institutional investors have been forced to change the structure of their investment teams and approach. This in part has also impacted the routes preferred by investors to access underlying investment exposures. It has also contributed to a broadening industry move away from an asset class based asset allocation philosophy (built upon return targeting assuming long-term out performance from equites)  to one built upon outcome orientation.

Given the factors mentioned above, many institutional investors have reduced the size of their in-house investment teams, more still are increasingly relying on strategic partnerships with preferred asset managers who assist with board support/ presentations, trustee education, and other ‘non-investment’ activities such as asset/liability studies. Others have become fixated on reducing their cost bases and squeezing managers’ fee loads. Some investors have even moved towards full or partial outsourcing of their portfolios. Taking the pressure off in-house teams to manage investment boards and committees, reducing operating costs and employing investment specialists in complex strategies – such as hedge funds – are the main drivers.

This week Pensions & Investments published the results of its investment consultant Research Advisory Panel which considered the trend towards investment outsourcing. The results show a clear preference for asset managers as preferred outsourcing partners followed by investment consultants (who according to Create Research’s Investment Innovations white paper are seen by investors to be horribly conflicted by their advisory work). Specialist outsource CIO firms/ individuals remain very niche. According to data from IAM, $1.76 trillion was outsourced by insurance companies alone as of December 31, 2010. A little over 2/3rds has come from general accounts with the remainder from separate accounts. BlackRock, Wellington Management, PIMCO and GSAM dominate these mandates.

The large players have business lines dedicated solely to servicing insurers and pension funds and armies of marketers and investment analysts to provide education, board and committee support.  At the other end of the spectrum, smaller, high quality asset managers dedicated to institutional clients have carved out a niche for themselves in this area. In addition to delivering outstanding risk-adjusted performance, these businesses do a lot of heavy lifting for their clients: portfolio analysis, completion portfolios, custom analytics and asset/liability modelling etc. You won’t see their names in too many surveys but the top tier fund of hedge fund businesses – Aurora, Grosvenor, Paamco, K2, Blackstone and Unigestion – are good examples of asset management businesses with strong customization capabilities.

Several of these businesses also offer investors the ability to co-invest in underlying hedge funds or to take investment exposure through managed accounts or funds of managed account portfolios. Given the growth in managed accounts as well as the increasing success of seeding/ capital acceleration businesses and emerging managers, I was surprised not to see this trend confirmed in Prequin’s 2011 Investor Report (Hedge Funds). It may be of course that the survey did not capture allocations via funds of managed accounts. Managed accounts provide greater transparency into underlying positions, superior control over the assets of the investment vehicle and enhanced liquidity. In some cases managers are providing their clients with access to live reporting portfolio management and real-time chat functions with PMs via the internet.

With in some cases over two decades of experience building customized solutions and focusing on the entirety of the client experience, asset managers focused on finding solutions rather than product pushing are well positioned to gain market share, particularly from public and corporate pensions.  It will be difficult for more niche managers, such as start-up outsource CIO firms, to compete with these better resourced managers, particularly for pension mandates. Perhaps it is more in the family office space that the niche outsource CIO firms will find traction. Then again it is a tough ask to compete against the private banks and FIO business lines established within independent asset management firms.

Meanwhile traditional asset managers are building out alternatives capabilities and alternatives shops are increasingly branching out in the long-only world. Institutional investors will increase their buying of ETFs as asset allocation tools and pressure asset managers to bring down pricing and increase reporting on funds and managed accounts. I firmly believe that it makes sense for the large players mentioned above to offer the full range of long only, hedged, active and passive strategies. They have the scale, expertise and infrastructure to deliver end-to-end investment solutions.

If there is anything to take away from Create Research’s backward looking, lumbering, new white paper on asset management innovations, it is that the 2000s were dominated by a siloed approach to product development, driven by thinking, reflected in the paper itself, which is rooted in the style bucket thinking of yesteryear. For institutional investors, their asset managers and investment consultants, the challenges of tomorrow require an investment philosophy grounded not on long-term return assumptions from individual asset classes, but instead in commonsense principles of deep value investing, liability, volatility and liquidity management, and unconstrained implementation.

During the last decade many of the larger asset managers outsourced their back-office functions as well as distribution to third parties. The smaller players would be well placed to focus on delivering robust risk-adjusted performance in their flagship strategies, enhancing their investment processes as required, and avoiding the temptation to launch new products that promise access to the latest market trends and pools of advisor directed retail wealth. Smaller managers should focus on innovating in value-added areas: asset/liability modelling, customization capabilities, deep client service engagement and creative, original, thought leadership.

 

One Response to Investor Trends: New Access Routes

  1. [...] 3. An Industry-wide Change in Asset Allocation Philosophy: In line with 2, the industry as a whole has woken up to the flaws of style bucket investing and the volatility brought by over-exposure to long-only equities. I covered this in a recent post. As investors embrace a more dynamic and flexible investment philosophy that looks at portfolio level exposures and liabilities, they will continue to tailor asset allocation and implementation routes.4: The Institutionalization of the Asset Management Industry: Asset managers have continued to evolve their business models to meet changing investor requirements. At the big end of town, the pure institutional players are focused on delivering investment solutions across the full spectrum of risk factors. The smaller, more niche players, are becoming increasingly sophisticated at high end client service. Education, modelling, completion portfolios and customized solutions.A more detailed version of this post and references to source material can be found here. [...]

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