Bridging the credibility gap

Asset managers are preparing to offer a range of new and complex investment to pension fund- but a recent study indicates that they first should focus on winning back their clients' trust.

Written and compiled by Amin Rajan, of CREATE - and co-sponsored by T Rowe Price and Citigroup - the report was based on a survey of more than 300 financial institutions around the globe: asset managers from 38 countries with a total of $28trn (€21.9trn) assets under management; and pensions funds from 24 countries with $1.5trn under management.

"One of the most interesting aspects of the report is that there is a lot of good empirical data that is immensely global in nature," said Neeraj Sahai, managing director and global head of securities and fund services at Citigroup. Todd Ruppert, CEO of T Rowe Price Global Investment Services believes that it uncovers many significant "trend issues" that accurately point the way forward.

The report identifies some serious discrepancies in views between asset managers and their pension fund clients, but it also points out significant areas of common ground that will influence future developments in the industry.

"There are marked differences in what pension funds plan to demand and what asset managers think they will demand," the report states. When asked which top five asset classes will be most and least suited to meet the needs of DB plan sponsors over the next five years, pension funds responded with a list that includes the basics: global equities, emerging market equities, real estate, manager of manager mandates, and last, private equity. Only private equity is on the top five choices offered by the asset managers, who were more focused on sophisticated products such as liability driven investments and portable alpha.

"None of the new product classes appears in pension funds' top five list. Indeed some of them do not even feature in the top ten," points out the report. That said, DC plans are more interested than DB plans are in the sort of products that their asset managers think they want, in particular in terms of liability driven investments - in fact, they are even more confident about what they need than their asset managers are. These products require explanation and education, and "there is a gap between the packaging of and the finding of solutions," pointed out Citigroup's Sahai.

Asset managers believe that DB and DC plans are pursuing aims that could be met by the complex products that they are planning. When asked what their clients' key goals are, four-fifths responded that their clients are looking to achieve more intelligent asset allocation; three quarters said that they are looking for separation of alpha and beta and liability matching. These are all solutions-oriented goals that can be met with the right product.

"Asset managers see their DB clients continuing to diversify into alternative asset classes, investment strategies, and geographical areas alike… The advance will take most asset managers where they have never been before, It will undoubtedly amplify the complexity of asset management operations in front, middle and back offices alike," the report states.

o Citigroup's Sahai, this finding has fascinating ramifications for the asset management industry overall. "Complexity in the front office will expand, and this will be mirrored in the back office. This change at the front end forces change in structure and organization. People have been trying to run their business on an end-to-end structure, but this will demand more networking and finding alliances for distribution and manufacturing."

But the report does not only offer bad news and imposing challenges. It notes that asset managers and their pension fund clients do share much significant common ground.

Both asset managers and their pension fund clients agree on the factors that make for a good working relationship. The report puts it this way:

Trust = credibility + synchronicity + stability

Or in other words, a good track record combined with an alignment of interests between clients and their asset managers and continuity in management and investment culture.

"There is a high level of similarity between what asset managers and pension plans both deem to be important factors in making their decisions on awarding mandates," said T Rowe Price's Ruppert. "This ‘back to basics' message is music to our ears, because it is what our organisation is all about,"

When asked what factor will have maximum influence on your decision when awarding mandates, more than 80% of respondents said that they were looking for a high quality investment process. This was followed by a consistently good investment performance, with three-quarters of respondents looking for this, and organizational stability, looked for by around two thirds of respondents.

"These and other relevant factors suggest that, in future, both DB and DC plan sponsors are likely to take their fiduciary role more seriously than ever," the report states. "Regulation is a major contributory factor; the other two are the sheer scale of losses sustained in the last bear market and a bewildering array of choices presented by new asset classes and investment strategies."

here is significant overlap with the responses offered when asset managers were asked what the dominant sources of competitive advantage will be in the global marketplace. Around 90% maintained that consistently good investment performance would be the key; organisational stability was noted by around 70%, and 6% of respondents cited that a high quality investment performance would be important. "Clients want decent returns. But they also want sustainable returns. They will look out for talent; but more than ever, they will also be interested in the work environment in which talent is nurtured and deployed," the report states.

This offers the key to asset managers in their attempts to offer more complex products to their pension fund clients, notes the report. "As asset managers move into new asset classes or investment strategies, they realize that organizational stability will become an even more important factor in attracting and retaining clients. It allows clients to examine past track record and assess the chances of its replicability in the future. It also raises their comfort level about the retention of the underpinning investment culture and talent pool."

This is a key point, according to Ruppert. "It's not that the pension plans do not want innovative products, but they are taking a wait and see attitude. Things like LDI and portable alpha are complex with a lot of variables. Time will tell with the take-up."

A key lesson of the report, then, is that asset managers who want to succeed in offering complex - and profitable - new solutions to their clients have first to work on the relationship. And the asset managers largely realise this. When asked what changes in distribution they will make to accommodate the needs of their clients, around 85% said that they would aim to improve client relationship management.

Around two-thirds said that they would aim to establish stronger links wit pension consultants, and around 60% are seeking to place greater reliance on prominent distributors. "Principally focusing on strategic and tactical asset allocation and best of breed manager selection, the quality of advisory services is expected to emerge as a major source of differentiation," states the report.