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UK - Four ‘winning strategies' will provide the majority of growth for the investment management industry, according to a new white paper.

‘The brave new world' - a joint report by specialist US-based consultants Casey Quirk and investment bank Merrill Lynch - looks at the forces at work within the industry and how these will drive the next generation of mainstream products.

The first strategy ‘Liberate the efficient frontier' consists of "eliminating all investment constraints, for which there is little economic rationale". So out go criteria, such as liquidity of issues, style adherence and restrictions on shorting and leverage.

Modern portfolio theory calls for a wide array of uncorrelated assets, the paper says. Long-only bonds and stocks still make up 90% of global institutional assets. Managers with products to expand investors' efficient frontiers could see demand double over the next five years.

As investors search for illiquidity premiums, they will up their exposure to private equity, venture capital and real estate, as well as to timberland, commodities, natural resources and infrastructure, the report predicts.

Cheap exposure to alternative assets is an expected development and labelled as ‘alternative betazation' in the report, as authors believe "there is a growing notion that much of the upside in these assets can classified as beta and achieved cheaply". 

An explosion in the ‘betazation' of real estate is seen using index swap contracts and private equity is predicted to go the same route with the arrival of liquid secondary markets and fund of funds.

"By end of 2011, we estimate that 10% of global institutional investments in alternatives, a total of $330bn, will be placed through these lower fee vehicles," say Casey Quirk and Merrill Lynch.

Moreover, the report sees ‘shorting' becoming mainstream in most portfolios within five years as a high alpha strategy, as will the use of concentrated portfolios, leverage and wider derivative usage. All in all, assets in such efficient frontier liberation strategies are expected to exceed $12trn in five years' time.

‘Packaged solutions' are described as the second ‘winning strategy', designed to combine the strategy and execution components of the investment process. "The institutional investment process has been bifurcated between planning - carried out by investment consultants and execution carried out by managers," continues the paper/

Small and medium-sized investors will increasingly outsource elements of the investment decision-making," it notes, which means consultants will need better investment skills and managers will require better consultative abilities in order to compete.

The third strategy, termed ‘Outcome-oriented investments' will focus on investors' ultimate objectives, such as servicing future liabilities - a strategy which sees pension funds adopting liability-driven solutions in a variety of forms.

While investment banks have taken the lead in this business, the white paper reckons managers who develop the capability "to provide these interest rate hedge wrappers on pension plans" could expand their business.

Another product highlighted is ‘terminal value insurance', which in the US refers to transferring pension liabilities to an insurance company. But the paper does not see this really happening until interest rates rise to reach the 7-8% level.

That said, better products alone will not solve investors' problems, the report goes on to say, as the issue of appropriate funding needs to be addressed. So far, the industry has done little to come up with what it refers to as ‘Creative funding solutions' - the fourth strategy mentioned in this paper.

The final element of tomorrow's investment world looks at the use of ‘Collateralised pension obligation', where sponsors transfer both assets and liabilities to an insurer so "any gap between assets and liabilities will be compensated for by sponsor-issued bonds", in much the way pensions buyouts are now building momentum.

Additional proposals suggest under the ‘Home pensionisation' approach, investment managers will provide pension plans under which homeowners will receive a pension in return for a portion of equity on their homes" while other solutions will be developed to meet investors' funding requirements.

Development of these products and strategies will see changes to the industry's business models and managers' skill sets will grow to include those now found in  insurance companies, investment consulting forms, banks and other financial providers.

The white paper - available at www.caseyquirk.com - sees the industry evolving into three areas - sophisticated manufacturers, similar to today's managers; outsourcing platforms, and private pension providers focused on delivering funding solutions with insurance skills.

If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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