Hugo Lasat, CEO, Amonis Pension Fund
"The funds industry is a good shelter for the anxious client. But this is only true on the condition that fund managers can perform their role as risk managers"
It is unclear today how the economic crisis will be written in the history books. What is certain, however, is that the asset management and pension fund industries will look very different from the way they did in the years of significant economic and financial expansion that preceded it. The crisis is not over yet but the worst is possibly behind us. Already, though, we can draw a number of important conclusions from it.
Historically, the asset management industry could be divided into traditional and alternative management categories, the latter being that in which hedge funds reside. Each has a distinctive business model and different ways in which returns are obtained.
One of the primary benefits of alternatives was meant to be the so-called decorrelation or diversification effects of this asset class in the portfolio. But the recent correction has proven that this asset class has, temporarily, contributed little on the positive side to the risk-return or liquidity of many portfolios. Furthermore, a number of scandals, including the Benard Madoff case, have cast this sector in a poor light. It is clear that this part of the asset management industry, which was the most deregulated, requires stronger policy control of all participants, something that would benefit the industry's employees and its clients.
In addition to the disappointing outcome of the diversification benefits, it also seems that for one major branch of this industry, the fund of hedge funds, the paradigm has changed. The manager's responsibility for these hedge funds - funds that are judiciously spread between different managers and different strategies - has increased.
Despite this sector coming under pressure, it still has its benefits. The survivors in this industry will be those managers who already have a good track record, as well as those who are able to withstand the current crisis with a proven track record. Successful future managers will have a sound investment process that does not depend on a single individual, and a strategy which improves the risk-return profile of a diversified portfolio.
Conversely, this means that the managers who do not regard alternative management as their core business, and the small ‘hedge fund boutiques' that have used the hype in hedge funds to get themselves off the ground, will disappear. Could this be an example of the destructive innovation that Schumpeter discussed in his economic thinking?
Classic management, where the correlation with the underlying markets is higher, is also going through a difficult period. In this management style there is a high correlation between the ultimate return of the client's portfolio and the performance of the underlying equity and bond markets - unless active asset allocation has made a particular contribution.
The average continental European investor, however, only discovered the equity markets at the end of the 1990s. Their initial enthusiasm was quickly cooled by the correction of 2001-02. Despite this, the average investor has retained confidence in the products offered. The present financial crisis, and in particular its duration and severity, has caused many a private and institutional investor to also reorganise their portfolio, One can also ask the question whether strategic objectives must be revised because of short term influences.
This crisis has highlighted an unmistakeable advantage of the funds industry. In the middle of the crisis, in the second half of 2008, concern arose about the liquidity or solvency of a number of European financial institutions. The images of people waiting outside the branches of Northern Rock in 2007 will without doubt have damaged client confidence. What escaped many a customer is that whatever the difficulties of the financial institutions, mutual funds remain a suitable investment vehicle, irrespective of the specific objectives of the client.
Cash, bond, balanced or equity funds offered as a ‘fund' to the individual client are independent corporate bodies. For example, they have their own management board. These funds are managed in the exclusive interests of their shareholders, the assets are in the custody of a depository bank and they are separate from and do not belong to the financial institution involved that may possibly have found itself in a temporary crisis situation.
As a result, because of this strict separation of assets, the funds industry is a good shelter for the anxious client. But this is only true on condition that the fund managers can perform their role as risk managers according to the rules of the art.
In addition to the above-mentioned structural advantage, reference must also be made to the day-to-day liquidity, transparency, adequate pricing, absence of leverage and appropriate regulatory framework for these funds that find their place in traditional management.
The sector faces a number of challenges. On the one hand there is an overcapacity in certain parts of the industry, and on the other there is the emergence of exchange-traded funds (ETFs). These ETFs are often a suitable alternative to a number of classic funds that generate insufficient added value (read return). Furthermore, ETFs put pressure on the margins of existing asset managers.
How the asset management industry will react to the question of overcapacity is unclear. Many financial groups are questioning their asset management entities' strategic fit in the portfolio as the boardroom picture of a stable, recurrent income flow from the asset management subsidiary - and without very much risk - has changed considerably.
The ultimate long-term picture of the asset management industry will very probably have one of two outcomes. One outcome will be the domination of big players who position themselves as all-weather asset gatherers; the other will be see so-called small to medium-sized investment boutiques providing specific added value, forging ahead.
This polarisation can already be found in Anglo-Saxon countries. Many asset managers, or their shareholders, now have to consider their future. One thing is certain. Whatever direction one travels, the ‘engine' of the asset manager, in particular the investment process, will need to be handled with a great deal of caution.
Hugo Lasatis CEO of Amonis, the Belgian pension fund