Q1Are we moving out of a low interest rate environment? If so, do investors go from here?

Q2In your view why are mega mergers such as Citigroup/Legg Mason and Merrill Lynch/BlackRock, happening and are there more to come?

Q3The involvement of investment banks in pensions investment has been described as horrible – what do you think of their increasing participation?

Q4Where is client appetite for investment products and where is client demand leading your business?

Q5What do you think the conventional investment management industry can learn from the success of hedge funds?

IPE put these questions to a range of leading asset
managers active in the European market. Here are
their answers:

Frank Goasguen, global head of institutional sales
1. Despite rising interest rates, we expect structural demand for long-term bonds to remain, driven to a large extent by a desire among insurers and pension funds to match liabilities. Such a development will create more opportunities for unconstrained investing within fixed income portfolios. We also expect increased allocations to specialist diversified alpha solutions such as currency, TAA, property and hedge funds.
2. These mergers result from a growing trend to segregate production from distribution, allowing pure open architecture to take centre stage. While there is no reason for this to stop in the US, market structure, strategy and position of financial groups differ greatly in Europe where such shifts will be more case-specific.
3.The involvement of investment banks in the pension market has made the investment choices broader, which is good for our clients. Products are different, approach is different. It is through their attachment to a long-term partnership approach and constant attention to their fiduciary responsibility that asset managers can remain successful.
4. Client appetite is for solutions which help them handle the overall risk/return equation. This translates in demand for overall solutions such as LDI or for specific well-defined alpha-generating products. In this second category, demand is broad in terms of asset classes (equity, property, currency, etc), as diversification plays a primary role.
5. There is already convergence in techniques and methods used by long-only and hedge fund managers. The segregation between alpha and beta and the ability to act on conviction have spread quite widely in the broader long-only market. Given the market pressure in their favour, these trends are there to stay and intensify.

Allianz Global Investors
Joachim Faber: CEO
1. Interest rates have been rising globally because a number of central banks are in the process of normalising abnormally low rates. At same time, yield curves are generally flatter than expected at this stage of economic recovery. This supports our expectation that rates will remain relatively low compared with previous economic cycles. Inflationary pressures are still quite low and investors’ assessment of the risk premium they should attach to bonds because of uncertainty about inflation has declined. Real interest rates will be lower than in previous cycles.
2. Mega mergers reflect a realisation that there are benefits to specialising in a specific function, whether asset management or distribution. Investment banks have tried to be a one-stop financial centre offering both but regulatory requirements and other factors can make it difficult while clients have been reluctant to take investment advice and investment products from the same company. With these mergers, companies are trying for a cleaner separation of asset management and distribution while retaining economies of scale.
3. Investment banks are transaction-oriented by nature and don’t necessarily think like an asset manager would or should. An asset manager should focus on advising clients about how to achieve investment goals over years, not just about the latest hot topic.
4. We see much demand for liability-driven investments, largely from pension plans and insurance companies with liability streams and looking for solutions that offer higher returns but low risk. Many are seeking specialised portfolios that match their liabilities with a certain stream of investments and then add alpha through active investing and portable alpha strategies. Demand is also strong for absolute return strategies, which is driven by investors concluding that they can’t count on high returns because risk premiums are compressed and interest rates are likely to be lower than in the past, and so are looking to squeeze higher returns out of the same basic portfolio through active management strategies like portable alpha and absolute return.
5. The success of hedge funds is debatable. They have succeeded in attracting funds, but there is also a tremendous failure rate among hedge funds and a substantial number of aren’t delivering value. Comparing the top 20% of hedge funds and the top 20% of asset managers shows they both use modern tools and portfolio methods for extracting value from the market but hedge funds use leverage while asset managers do not. Over time, there will be less and less demarcation between hedge funds and asset managers.

Dominique Carrel-Billiard, CEO
1. We have indeed moved out of the low interest rate environment. This is linked to the robust global economic growth and fears of inflation. The nature of the change is, however, such that portfolios invested in equities should do well. Fixed income portfolios need to adjust to higher yields.
2. Mega mergers are the exception rather than the rule and both cases mentioned follow specific strategic logic on the basis of which one cannot generalise. Industry consolidation will, however, not go away as small to mid sized players continue to seek economies of scale.
3. Any form of competition should be welcomed in asset management, it drives excellence from a product and expertise point of view.
Having said that, asset managers have a natural advantage over investment banks in pensions investment because we live and breathe it – it’s at the core of everything we do.
4. Geographically, Asia and emerging markets have been key themes driving business development. From a product perspective, alternative asset classes have grown significantly. The focus now shifts to retirement products as the pension fund market evolves.
5. Investors have increasingly sophisticated demands, and it is clear hedge funds are playing their part in meeting these demands. Hedge funds are developing into an important part of the investment mix, and they certainly embody an investment philosophy that conventional investment managers can learn from – albeit on a small, controlled scale.

Barclays Global Investors
Nigel Williams, CEO of Europe & Asia (ex-Japan)
1. Although interest rates have begun to climb, they remain very low by historical standards and should remain so given the benign inflation outlook despite the surge in energy prices. Bond yields have remained low given the improvement in the world economy and the rise in short-term interest rates but yields have now begun to return to levels more consistent with the economic climate. The rise in interest rates and bond yields means better returns for bond investors while dampening the economic climate and profit growth. As a result, equity markets will deliver weaker returns. Higher bond yields will also help alleviate pension funds deficits.
2. This continues a trend that sees asset managers either looking to be full product global businesses or niche players. Being a global business needs a full product set plus the ability to distribute products across both pension funds and other segments. Both deals are motivated by a desire to create global players.
3. Investment managers have a different approach to investment banks as they have fiduciary responsibilities which most institutional investors see as very important. However, investment banks have a lot to contribute in areas such as risk management and this offers a stronger range of solutions.
4. Clients now understand the potential trade-off between risk, return and cost. There has been a move to liability-linked investment strategies and investors are more focused on the outcome. Consequently, more financial engineering is needed in product design.
5. Initially hedge fund managers heightened the focus on absolute returns in the belief that they were all offering strategies that were highly uncorrelated with the underlying markets. They have typically taken advantage of a greater degree of flexibility in their strategies, an approach that is more challenging in the pensions fund arena given the responsibilities of trustees. Hedge funds have also benefited from being small and nimble in developing and delivering strategies, which traditional asset managers need to achieve.

BNP Paribas AM
Philippe Lespinard, CIO
1. Short-term rates are bound to move higher but yield curves will remain flat, making bonds unattractive over the coming rate cycle. We expect traditional fixed-income investors to shift their sights towards absolute returns and opportunistic strategies and away from benchmark-driven portfolios.
2. Some of these mergers are in response to regulatory pressure, which now equates distribution of in-house products as a conflict of interest.
More may be on the way but asset management remains one of the most attractive activities on a return to economic capital basis.
3. Investment banks have a role to play in providing investment solutions to the marketplace but pension fund trustees will need advice in quantifying and managing the risks of DB plans. We are likely to see a convergence of the skills involved, while investment advisers will earn their keep through management fees rather than transaction fees given their fiduciary duty to look after their clients’ interests.
4. Demand has polarised around core and high-alpha strategies, both in the retail and in institutional markets. High-alpha strategies involve continual investment in new talent and techniques, as well as a more decentralised organisation.
5. Successful hedge funds have shown that highly disciplined managers working in an unconstrained environment and a longer investment horizon can generate strong returns. The conventional managers who expect to succeed will need to adopt similar structures and convince their clients to give up some liquidity in favour of long-run performance.

Bramdean AM
Nicola Horlick, chief
1. The interest rate outlook is unclear but this should serve as a reminder that long-term investors should not try to call market cycles but implement a robust investment strategy that will deliver through such uncertainties. Investors will continue to look for ways of getting more from the markets, with increased interest in hedge funds, private equity and commodities.
A preparedness to consider a broader range of asset classes and take a more aggressive attitude to risk is likely to continue.
2. All businesses face pressure to display constant growth. If this becomes difficult to deliver organically, managers are compelled to consider mergers and acquisitions. These are normally supported by the prospects of economies of scale and increased distribution. No doubt there will be more to come. However the challenges of integrating companies cannot be overstated.
3. The arrival of investment banks reflects an appetite for derivatives due to a search for new sources of outperformance and the increasing sophistication of risk management strategies. But investment banks differ from fund managers in the ways they make money and their attitudes to the markets and their clients.
They can be as ruthless as they are talented, are shorter-term in their outlook and are unused to building the relationships necessary to be a long-term success in the pensions world.
Their participation will dependant on increasing opportunities to make money. Market growth has probably been slower than they had hoped and if they foresee better returns elsewhere some will move on.
4. The ongoing search for better returns has broadened clients’ and consultants’ horizons,
with commodities, property, private equity and PFI projects now much more widely considered, although caution remains about hedge funds. Clients are also looking beyond more traditional benchmarks, to global as well as UK considerations and to median share and equally weighted structures.
5. The best hedge funds are run by committed, talented investors freed from the constraints of traditional mandates.
Their boutique model gives the potential to match the personal rewards on offer in large institutions with greater control over the business and a better general quality of life.
This need not be confined to hedge funds and a range of long-only boutiques is already doing extremely well. This is good news for the fund managers but of some concern to the broader market as not all assets can be managed by this still small community of highly talented individuals.
Cordares AM
Freek Vergunst: Deputy Director
1. The period of very low interest rate levels is over, more restrictive monetary policies by central banks globally will lead to higher interest rate levels. In the long run interest prospects will be encompassed by more uncertainties because of economic developments, inflation and the drive to invest excess cash by far east countries.
2. The reason for these mega mergers is both expansion, a drive to create companies that are less vulnerable to the business cycle and an effort to enter new product market combinations. In this environment we prefer to enhance our existing position in our core business rather than to build a conglomerate with non-core activities in the company.
3. Investment banks will have to pay attention to the long-term character of pensions, the corner stone in the world of pension funds. In addition, the development of a sense for risks and the complex structure of pension fund governance are important factors. We feel that that the manager of managers concept will prevail in the long run. No party is capable of delivering systematically the best performance in all asset categories.
4. The need of the funds will remain the driving force for the development of new investment alternatives. Liability driven investment modelling will be key. In the years to come, asset management will develop in a strongly quantitative direction and will use techniques to optimise the utilisation of the pension funds’ available risk budgets.
5. The hedge fund industry is able to deal with investment styles in a creative and responsible way. We picked their brains with, for example, the introduction of a 130% long/short policy in equity funds and the hedging of credit risk through default swaps is more common in the fixed income field. Pension funds use several techniques developed by the hedge fund industry, which results in better diversification.

Crédit Agricole AM
Pascal Blanqué, CIO
1. Long bond duration has been the name of the game for 20 years because it was all about disinflation. You cannot invent disinflation twice. Though this does not mean necessarily a bond crash, times will be much more uncertain. The equilibrium level of nominal and real interest calls have arguably moved lower in a low inflation world but lows in 2005 were unsustainable in a post-bubble-normalizing world. Repricing of the bond risk is on the cards.
2. Mergers are the logical result of asset managers’ search for critical mass and their desire to expand their skill set and customer base. This trend also leads medium-sized players to consider the future of their business. We should therefore expect some medium-sized players such as insurance company or bank subsidiaries to be put on the market.
3. Competition between investment banks and asset managers is not new and notes are not a recent product. We created Crédit Agricole Structured Asset Management (CASAM), a joint venture between CAAM and Calyon, to overcome the competition.
4. We have seen increased demand from institutional investors for absolute return solutions. We have also seen an increased demand for equities and sustained demand for bonds.
5. What we’re currently seeing, particularly in the fixed income arena, is the convergence between so called traditional investment approach and the use of increasingly sophisticated financial instruments such as long-shorts, CPPI and the global-macro types of product that we are also seeing in the hedge fund industry.

Credit Suisse
Robert Parker, deputy chairman at the asset management division
1. We are moving out of a low interest rate environment. It is probable that the US federal funds rate will move above 5% and the ECB reference rate could exceed 3% in 2007 with the BoJ rate over 1%. Although the outlook for bond investors remains poor in the short term, at some stage over the next two years higher bond yields will represent an attractive buying opportunity, while the rise in yields is not expected to result in poor equity market conditions. Equity performance should be more driven by corporate earnings growth, corporate activity and liquidity flows.
2. Asset management industry mergers are driven by a quest for greater economies of scale, increased capture of market share and, in the US, a recent trend to separate banking and asset management businesses. Merger activity over the next one-to-two years should moderate with a renewed focus on organic growth given the number of mergers that already have taken place and also given the poor experience of many funds in trying to implement mergers. The one exception will be small acquisitions in high-growth markets particularly in emerging economies.
3. There is a clear trend towards liability driven investment, and a clear theme is the use of interest rate swaps, both real and nominal, to ensure a more efficient matching of assets and liabilities. In this area, the investment banks carry out a useful and value added role to the pension fund industry.
4. Across the range of clients, there are clear trend changes in demand for investment products. These changes are complex but three general themes stand out: a demand for absolute return products; a demand for higher income, whether in fixed income or higher dividend equities; and a flow of capital into traditionally more volatile areas such as emerging markets and small-cap equities.
5. There is a clear fusion occurring between the hedge fund and conventional investment management industries with hedge funds developing long-only products and conventional managers diversifying into alternative strategies. Successful hedge funds are having to learn the management skills of running larger businesses, while successful conventional investment management firms have learnt to run their businesses as a ‘collection of boutiques’ and have also learnt the necessity of rapid and innovative product development.

Dexia AM
Hugo Lasat: CEO &
chairman of the executive committee
1. Interest rates will rise, especially in Europe. I do not see a strategic move of investors based upon this event. Tactically, however, asset allocation as well as portfolio construction will be amended.
2. These mergers are a reflection of more clear-cut strategic choices made by different financial institutions and is based upon internal strategic choices (production vs distribution – new clients/markets) as well as external (regulatory) reasons. More deals will come, especially transatlantic transactions.
3. Investment banks often behave as short-term actors with a product push approach. This can conflict with the objectives of a pension fund industry that needs long-term commitment that is adequately offered by the asset management industry.
4. Client appetite is well spread over all asset classes. However, the industry moved towards a solution-driven behaviour, which means that strategy implementation, risk budget and portfolio construction has become even more client specific than in the past.
5. Traditional investment management and the hedge fund industry learn continuously from each other, the former having the objective to be an alpha and beta provider, the latter being normally a pure alpha player. The way in which risk appetite or budget is implemented differently in the alternative investments industry can be inspiring for the traditional investment management industry.

Alain Grisay, chief
1. We have already moved out of a low-interest environment. US interest rates have risen to their highest level since April 2001 and further tightening is expected as economic growth appears to be rebounding strongly. The BoJ is changing its short-term policy and is considering raising interest rates by the end of the year for the first time since 2000. Real bond yields are still very low and are not heading higher because markets have already priced in further rate rises. Regarding portfolios, investors should stick with equities but allocate more to defensive markets such as the US. We favour a shift away from cyclical stocks.
2. Our own integration of F&C and ISIS in 2004 was a forerunner of these transactions and there are more mergers to come. The asset management business remains fragmented as well as competitive, with around 1,000 firms operating in Europe alone. While there will always be room for small boutiques, economies of scale can be achieved through consolidation in terms of cost synergies, access to the market and distribution. Many asset managers are embedded within other financial services institutions, and as these larger institutions embrace ‘open architecture’, some will decide to focus on distribution and no longer require their own asset management divisions, creating further opportunities for deals. There is a strong financial case for spinning off these businesses as their true value is unlikely to be fully reflected in a parent firms’ stock price. The multi-boutique investment model – where firms leverage the advantages of scale while organising their front office in terms of small teams that have strong accountability and ownership over products and specialist franchises – will become more commonplace.
3. Pension funds will pay experts in this field, in this case investment banks, if they are able to create flexible and pragmatic solutions providing them with alpha-return portfolios and upscale potential. The challenge for asset managers is not to be left behind and to develop their own expertise.
4. At the passive end of the market it is increasingly about scale and commoditisation. At the other end, pension schemes are more willing to allocate assets to higher alpha and more niche investments to add incremental returns. Client demand is leading in the direction of developing multi-specialist capabilities. Performance fees are more prevalent in these specialist areas. Also, there is little doubt that interest in both alternatives – whether hedge funds, fund of hedge funds, private equity or property – and LDI solutions is growing.
5. Hedge funds attract and retain talented people both through an ability to earn high fees but also by encouraging a strong feeling of ownership of the product. As a result, you get a productive interdependent relationship between financial rewards of fund managers, fund performance and the size of assets under management. This benefits both investors and fund managers. Hedge funds are widely misunderstood, often dismissed as high-risk investments, yet the purpose of a ‘hedge’ fund is to reduce risk. In fact risk management is often better understood and more sophisticated in the alternative asset management segment than among traditional long-only managers. Some of these tools could, in time, be translated into the long-only investment world.

Fortis Investments
Richard Wohanka: global CEO
1. The US is no longer such an environment and real rates have reached a level that should start to bite. Euro-zone rates remain low and our ECB repo rate forecast of 3.25% around year-end implies additional bond market nervousness along with more expensive funding conditions. Japan’s zero interest rate policy has ended and rates will increase, but only mildly. Three main factors will influence portfolio composition as far as the equity weight is concerned: the starting level of bond yields in comparison to price earnings and the speed and extent of the bond yield increase; the indirect effect via the impact of higher rates on the earnings outlook; and the effect of risk appetite.
2. There will be fewer mergers in the future. The market is beginning to understand that focused, stand-alone asset management businesses are best placed to achieve strong performance. Meanwhile, larger financial services groups will continue to see the benefits of retaining participation in a larger asset management platform while having the freedom to build their own client solutions and focus on core activities through open architecture. That said, asset management multiples are currently well above their historical average, making divestments a lucrative prospect.
3. The important role played by derivatives, mainly swaps, in meeting a growing demand for extended duration and protection against inflation risks has caught the attention of investment banks. They focus on turnover, and try to sell derivative constructions directly to pension funds. But most pension funds lack knowledge in this area and need time to convince pension boards of the usefulness of these constructions, and they also need ‘aftercare’. Many investment banks don’t have this time; they just want to sell a product. Investment banks should ask themselves if they want to be in this kind of time-intensive relationship with the pension industry. The asset management industry will need the investment banks to act as the counterparty for the derivative deals anyway.
4. Institutional investors’ appetite for asset classes offering further diversification remains strong, as they move from traditional products such as European government bonds and blue-chip equities to decorrelated investments. Products in demand include global convertible bonds, non-listed real estate and, most recently, commodities. At the same time, expectations of higher economic growth and inflation are putting upward pressure on bond yields, and we believe that this will further stimulate the demand for absolute return and hedge fund products.
5. The days of index investing, however smartly, are numbered. The success of hedge funds indicates that many investors appear prepared to take substantial risk to achieve risk-managed absolute returns. The emergence of hundreds of boutiques tells us that investment talent yearns to be set free. Active, skill-based investment is therefore the new game. The advent of derivatives will only accelerate this trend. UCITS III legislation allows fund managers operating in the ‘traditional’ fund space to use more hedge fund-type strategic instruments.

Goldman Sachs AM
Oliver Bolitho, managing director and head of UK & Irish institutional business
1. Data are unclear. If we are moving out of a low interest rate environment, investors should be sensitive to any positions built in a search for yield as the marginal yield may appear less attractive in a higher-rate environment. If we are not, investors are likely to continue to consider the implications of interest rate hedging, fearing a return to a low rate environment.
2. Right across the industry corporations are focusing on core competencies. This has led to some selling their non-core capabilities either to those in a better position to manage them or to financial sponsors. I don’t see any reason why this process will not continue.
3. The take-up of capital market and corporate finance advice from investment banks by pension funds suggests the banks are bringing capabilities to the market which traditional suppliers have not offered. This is ultimately in investors’ best interests. Asset managers need to reflect on their core competencies in this increasingly competitive market.
4. We find that our clients are increasingly focusing on the importance of manager-generated returns in the mix. They are looking for diversification and sustainable skill for which they are prepared to pay. This is redoubling our focus on capacity, trading costs and breadth of offering in lieu of any traditional focus on assets under management.
5. Hedge funds have highlighted the value of capacity management, strong risk management and trading techniques as well as the ability to identify areas where they can add value through skill.

ING Investment Management Europe
Maes van Lanschot, CIO
1. In all major regions 10-year yields rose above the March/November 2005 highs and in the US and Japan they even tested the June 2004 highs. An important driver is the global monetary policy tightening cycle. At current bond yield levels we have moved out of the low interest rate environment. Although higher bond yields cannot be excluded, the outlook for bond portfolios is not as negative as at the start of the year. Therefore, investors are expected to cover some short duration positions or even cautiously start to build up some long-duration positions.
2. Net inflow in the funds managed by Merrill and Citigroup are sub-par, sales of proprietary mutual funds within their own retail brokerage channels is in both cases relative weak. For Citigroup the asset management contribution to net earnings on a consolidated basis is a few percentage points. Additionally Citigroup wants more focus on important business-lines. Merrill ‘sold’ its asset management activities into BlackRock for a just below 50% stake in the combined entity. BlackRock is seen as very strong asset manager. We cannot rule out more of these deals. According to press reports, Morgan Stanley was also in the process of doing a deal with BlackRock prior to the Merrill transaction. In Europe we saw a similar deal between UBS and Julius Baer.
3. The European pensions investment market, especially in the UK and the Netherlands, is mature. It is relatively easy to gain market share and reduce costs. In other words, competition is fierce.
4. As a result of the success of hedge funds absolute return/benchmark unconstrained investment strategies are becoming increasingly popular, especially in a satellite/core model. We see an increase in development of long/short products. Client demand will erode the distinction between traditional strategies and hedge funds.
5. The conventional industry can learn a lot from the hedge fund industry in terms of absolute risk management versus relative risk management.

Invesco AM
Jean-Baptiste de Franssu, CEO continental Europe
1. I don’t believe so. The overall outlook is positive, and the consensus seems to be that we are likely entering a period of prolonged low-inflation expansion similar to that of the 1990s. Where investors go from here will ultimately depend on their investment objectives and investment horizon.
2. The current round of M&A activity is spurred by industry growth as businesses look to other organisations for synergies and capabilities which they do not feel they can organically develop. It seems further M&A activity is likely.
3. The issue is not the participation of investment banks in pensions investment, but rather the increasing chasm between regulated and unregulated products at the point of sale. This issue needs to be quickly addressed first to protect investors, to ensure they are aware of what they are investing in, and second to make certain that a level competitive playing field is promoted for all stakeholders.
4. We see an increasing appetite for income generation with principal protection as the largest demographic wave transitions out of the workforce over the next two decades. Our industry must evolve to meet the needs of these customers by offering more innovative income-oriented solutions that are geared to protect the investor’s principal; notably from market performance, healthcare and inflation risks.
5. Buy stocks when they are undervalued and sell them when they are overvalued – don’t be too benchmark driven.

Investec AM
Hendrik du Toit, chief
1. We have undoubtedly started moving from a very low interest environment towards an environment of higher nominal rates. At this stage there is little reason for concern, but investors must be on guard for faster than anticipated rises in long-term interest rates as such moves could destabilise already finely priced asset markets.
As long as this does not happen, our preferred asset class remains equities. Fixed income is far from attractive at this point in the cycle while real estate (excluding that in Germany and Japan) looks rather fully valued.
2. These deals were conceived in the context of a maturing market in the US (especially for mutual funds), regulatory risk (for Merrill Lynch and Citigroup the two vendors and Legg Mason as vendor of its brokerage arm). Legg Mason is one of the few firms that could take on the Citigroup asset management business and make something of it. BlackRock has a world-beating fixed income platform but needed to strengthen its equities capability. A recently rejuvenated Merrill Lynch IM was an ideal partner. I expect more deals of this nature but copycat deals could be much more risky. Clients should be on guard.
3. If there is a demand for the services of investment banks, let them meet it. Asset managers and consultants have no god-given monopoly on their pension fund client base. I would nevertheless caution pension funds about the dangers of transaction-oriented service providers who may not be there to pick up the pieces if any problems result. The current liability driven investment craze in the UK defined benefit market – where investment banks have been called to provide product solutions – will not escape criticism when the history of this era is finally written.
4. Besides the sensible increase in demand for global equities, we have seen investors chase certain historically risky asset classes in an ‘after-the-event’ manner. We see an unhealthy appetite for risk, justified by diversification benefits, and a trend to match liabilities at the most expensive moment in history for such an exercise.
The questionable but insatiable appetite for private equity is also evident. We are convinced that sensible long-term oriented multi-asset portfolio management will re-emerge as an attractive option for clients.
5. The separation of alpha and beta, the fact that good products can and should command a premium and that capacity is scarce are important lessons to learn from the hedge fund industry. In turn, hedge funds will be learning management and operational lessons from the traditional industry. Most importantly, they are learning the importance of values and culture in the sustainability equation. That, however, is yesterday’s question. Today the issue is convergence.

JP Morgan AM
Jens Schmitt, head of
institutional business
continental Europe
1. We are moving towards higher interest rates in the short-term but we expect rates to only rise slightly. Central banks are aware of the threat higher rates pose to economic growth and will continue to remain cautious when deciding monetary policy. As interest rates stay low and equity market returns are not what they were in the 1980s and 1990s, we believe investors will continue to look for ways to give portfolios an added boost and will favour high alpha products.
2. Mergers occur in all industries. In the current market environment mergers are a good way for companies to broaden their product range, expand into new regions, diversify investment approaches and to gain expertise in other asset classes. From an investor’s point of view, mergers should be welcomed as they should make the companies more innovative and dynamic.
3. Liability driven investment challenges require derivatives and those products are investment banks’ core expertise. It is important for there to be a healthy relationship between investment banks and asset managers.
4. The current challenge for asset managers is to create innovative products which fulfil the needs of their clients. We find that clients are demanding high alpha products, for example strategies that aim to earn steady returns over cash like portable alpha, total return or alternative asset classes.
5. The conventional asset management industry is incorporating a lot of hedge fund approaches, for example long-short, total return and portable alpha strategies. Most hedge fund managers learnt their trade in traditional asset managers so traditional asset management has played a role in the development of the hedge fund industry.

Lombard Odier Darier Hentsch
Serge Ledermann, head of investments & strategy
1. The world is moving from an abnormally long period of very low interest rates to a relatively low level by historical standards. In the short term portfolios heavily exposed to long-duration bonds are suffering significant losses but in the medium term investors are perceiving value opportunities in some, mainly Anglo-Saxon, markets.
2. Specialist asset managers like BlackRock and Legg Mason are grabbing opportunities to increase their size, broaden their asset class/investment approach spectrum and diversify their client bases while buying entities that don’t have an owner in the asset management business (ML or Citi). Such operations will continue since larger organisations can better leverage their expanded resources, invest in new technologies and offer competitive compensation.
3. The ongoing financial services revolution is drawing investment banking and classical asset management activities closer. This should not be viewed as ‘horrible’ but rather complementary. The spectacular growth of the absolute return side of the asset management industry, especially hedge funds, has significantly changed the balance of power.
4. Clients have larger appetites for creative investment, integrating a broader set of asset classes or investment styles in their portfolios to improve portfolios’ risk/return profile, targeting more asymmetrical characteristics on an equitable basis. This leads us to develop more sophisticated asset allocation tools and the capacity to offer the expertise either directly (proprietary managers) or indirectly (multi-management or outsourcing). Similarly, the core-satellite approach means we are accelerating the development of more alpha products.
5. Flexibility, versatility, entrepreneurship, creativity. Hedge funds are becoming mainstream and increasingly entering the traditional side as well as the private equity side of the business. The strength of successful hedge fund managers is their ability to generate consistent, regular positive returns in an unconstrained fashion.

MEAG Munich Ergo
Robert Helm, managing director
1. All worldwide macroeconomic indicators are signal that we are moving out of a low interest environment. The impact on portfolios depends on the speed and degree of volatility of rising interest rates. Asset managers will have to be very flexible in their
reactions to the speed and the volatility of interest rates movements. To reduce the negative impact on the portfolios it makes a lot of sense to work with derivatives partly against the negative impact of rising yields.
2. There are various reasons behind mega mergers, the most important being cost reduction and strengthening a market position. In a world of globalisation and an environment of increasingly tough competitive markets it will be no surprise to see more of these mega mergers. Nevertheless, investors must keep close eye on this development because the peaking of mega mergers very often marks the end of a bull market.
3. There are no problems where investors understand the products offered by investment banks because a good risk-controlling framework and a proper decision-making process with respect to the requirements of the liability side will prevent any negative consequences for clients. But it is highly dangerous for their risk/return profiles when investors buy products they don’t really understand.
4. Client appetite for investment products will concentrate on limited downside-risk investments. In addition, a high diversification effect will continue to play a major role. In such a case one could consider commodities or portable alpha. Clients additionally take into account that products should fit the requirements of their liabilities.
5. A close examination of hedge funds poses a question about the success of this investment type in Europe, and especially in Germany. Nevertheless, there are two major lessons to learn from hedge fund management. In conventional investment management, portfolio managers very often conceal the benchmark. So a really positive aspect of hedge funds is the high flexibility combined with a very high knowledge level.

Mellon Global Investments
Jon Little, CEO
1. While interest rates are gradually moving higher from historically low levels, they will remain below long-term averages. Asset prices that were substantially boosted in the low rate environment look vulnerable. Under most scenarios, expected returns will be lower than investors have been used to. Stock selection will be vital with diversified, active strategies being the most attractive.
2. The drivers behind these deals were less to do with asset management and more with distribution. Recent regulatory scrutiny in the US has made it more difficult for large brokerage houses or wealth managers to be primary manufacturers of product. Citi and Merrill looked at their key strengths and decided that they needed to focus on distribution rather than being both manufacturer and front-end distributor. Mega mergers produce mega firms but it’s not clear what these firms will deliver for clients in the long run unless they retain the attention to detail that you get in a small firm.
3. I welcome innovation but investment banks are opaque in terms of their charging. When pension fund managers or consultants tell me that they’ve ditched their ‘expensive’ investment managers and hired an investment bank who’s helping them at a very reasonable cost I worry who’s fooling who.
4. We are seeing demand for absolute returns from both single and multiple asset classes. Continued demand for high alpha, portable alpha and GTAA strategies and straightforward global equities and bonds.
5. We’ve already learnt a lot. Hedge funds showed that clients had an appetite for more risk and/or more sophistication than we were giving and made us dust off some product ideas that no one realised had a market. Now, conventional firms are becoming big hedge fund players by organic means or by acquisition and some hedge fund boutiques are becoming large mainstream businesses.

Mn Services
Rudolf Hagendijk,
chairman and CEO
1. As a result of (expected) economic growth interest rates are likely to be higher. However threats are the US monetary policy (already almost 400bps tighter) and the rising oil prices. Given such uncertainties we expect that positioning will take a middle-of-the-road approach, ie a measured trimming of risk, rather than an outright move to safe havens.
2. In most cases the motivation for merger activities in the financial sector is driven by the ambition to generate the required profitability in which benefits of scale play an important role. Our expectation is that more merger/acquisition activities will follow.
3. We are very cautious about the role of investment banks in the asset management sector. Key to long-term success are a clear commitment and a structure where the asset management unit can operate as an autonomous entity within the big firm dealing with the specific issues be faced by pension funds in the current environment.
4. We seen an increasing demand in high-yield products and, triggered by new regulation and low interest rates, a demand for long duration and inflation hedging. ‘Integrators’ who have the expertise to create a complete and balanced portfolio combining beta and alpha adapted to the specific situation of the client will profit from these developments.
5. There are two main lessons to be learned. The first is that quality prevails; only those organisations with outstanding products and results will be successful and survive in the investment management industry. Second, they must deal with the challenge to (cost) efficiently implement market exposure (beta) and deliver alpha-generating product like hedge funds.

Morgan Stanley IM
Michael Green, head of international business
1. The trend towards polarisation, with enhanced index products at one end and high-alpha products at the other, is here to stay, so we will not see a move back towards balanced mandates and relative returns. Investors have also become much more focused on risk, particularly risk budgeting, and making sure that they are adequately rewarded for the risk they are taking in their portfolios. This means that we will continue to see demand for high-alpha products.
2. One of the key drivers for an asset management business in an era of open architecture and a relative decline of proprietary distribution is an ability to operate as a successful third-party distributor, selling its products through non-proprietary channels. Asset managers that are owned by banks and are unable to pass this test may find themselves being sold. However, there is no reason why bank-owned asset managers that pass the stand-alone test should not thrive.
3. The fact that investment banks increasingly participate in the pensions space is a clear indication that they must be doing something right. It is more of an indictment of the asset management industry’s failure to meet its clients’ demands and needs. In many cases investment banks are offering clients something that the traditional asset management business cannot, such as sophisticated liability-matching tools and derivative products. It is up to the asset management industry to meet the challenge of the investment banks.
4. Increasingly we are seeing client demand for high alpha products, whether through innovative long-only products, such as unconstrained equity mandates and quant products, or through alternatives like hedge funds, commodities, private equity and property. We are also seeing increasing interest from clients in utilising derivatives and structured products within existing portfolios.
5. There are two key, and related, lessons. First, a need to focus on alpha and better utilise the skills of active managers by lifting constraints. Second, the importance of enabling portfolio management teams to operate in a boutique structure, which gives them the autonomy to invest with conviction and a sense of ownership in the products they manage.

Northern Trust Global Investments
Barry Sagraves, CEO
1. Yes, we believe that we are moving out of a low-interest rate environment as central banks gently lift rates in order to normalise monetary policy. We anticipate that the ECB will increase its reference rate to around 3.25% by the end of 2006. Global economic growth continues to improve, with forward-looking sentiment indicators supporting a continuation of this trend. If global central banks continue in their steady-hand approach this should support equity markets without causing significantly higher yields in fixed income markets.
2. These deals reflect two trends: first, the strategic decision by some companies to specialise in distribution or manufacturing; and two, opportunism in markets. At a time when stock market valuations are up and economic growth data are strong, companies are looking at how they can grow their businesses. Against this backdrop, more M&A activity is likely.
3. In general, increasing the dialogue between investors, consultants, fund managers and investment banks is a healthy development. More market participants can be a positive. Healthy competition raises standards across the board and can encourage innovation and provide more choice and alternative insights. However, more choice can be confusing. In many markets consultants have the crucial role of guiding the client through the options.
4. The trend is for ‘solutions’. Rather than saying: “Here’s our product, would you like to buy it?” we’re asking clients what are their challenges then identifying the right solutions to help them address these issues. Sometimes the answer is a pure investment solution, sometimes a more comprehensive combination of investment, custody and fund administration is required. Liability driven investment is important and demand for it will continue to increase over time.
5. To think creatively and develop new capabilities, rather than simply evolve existing approaches; for example, by embracing absolute, not just relative, return strategies. This can enable innovative ideas to become a reality to the benefit of investors.

Joe McDevitt, managing
1. We are moving from a highly accommodative monetary policy environment to one where short-term rates have moved, or will be moving, higher. The Fed funds rate may come to rest at 5% but the ECB and BoJ are signalling that higher policy rates lie ahead. This environment has fuelled increases in a wide range of asset classes, from commodities to real estate, and to many equity markets. Risk premiums are now quite low, so this may be a time for investors to take some of their chips off table, enjoy high real returns finally available in cash and keep their powder dry until they are paid a higher risk premium for investing in these riskier asset classes. We currently see value at the shorter end of the US interest rate curve and in yen versus dollar, which should benefit as the market perceives interest rate differentials can only narrow from here.
2. Each of these mergers had its own strategic logic, but they and others are driven by a backdrop where investment managers want to participate in global trends towards open architecture while delivering strong performance and first-class client service to key markets. I expect to see more big mergers in the months ahead.
3. I welcome the investment banks’ participation in pension investment. They have forced the traditional participants – plan sponsors, trustees, consultants and investment managers – to raise their game and think about pension issues and solutions in a new way. Although there have been winners and losers from this, the banks have brought new ideas and energy. Whether or not pension funds, consultants or managers are working with the banks, they should be better off for having met their challenge.
4. As an active bond manager, we have seen client appetite for ‘higher alpha’ bond mandates with performance targets above traditional levels, and also appetite for longer duration, more customised bond benchmarks for mandates that are more closely associated with pension funds’ liabilities.
5. Two things. First, there is strong demand for ‘pure alpha’ that comes without beta, ie absolute return products. Second, in the hands of traditional managers with the right skills and resources, the tools naturally available to hedge funds (long/short, leverage, derivatives) should over time allow skilful traditional managers to optimise their performance and better fit their products to institutional investors’ investment needs.

Pramerica IM
Bernard Winograd, president & CEO
1. No, we are not moving out of a low interest rate environment. Returns for all asset classes will continue to be low by historical standards. Liquidity is too high for interest rates or other returns on capital to improve dramatically, and an end to Fed easing in the US will hardly change that fact.
2. The two examples were driven by the need to separate manufacturing from distribution. US consumers are not interested in having financial advisers who represent a single investment manager, preferring those with access to a wide range of managers. There should be more of this kind, because the market will continue to punish firms that try to ignore this consumer preference. If these are ‘mega-mergers’ it will be a coincidence, not the driver of the transaction.
3. It is unsurprising that pension plans’ increasingly interest in using derivatives markets to more efficiently achieve their investment objectives has led to a rise in investment bank involvement in pension investing. Traditional asset managers need to adapt by offering these services or, regardless of whether it is a good or a bad idea, investment bankers will play a larger role in the pension investment process for the foreseeable future.
4. There is much interest in liability-driven investing ideas among US corporate plans trying to cope with the arrival of mark-to-market accounting. Among all institutional investors, the demand for real estate investing continues to be unsatisfied by the existing supply of traditional assets. Interest in enhanced indexing of equities is exploding among plan sponsors frustrated by an inability to find many successful traditional long-only managers and unwilling to settle for pure index returns. Hedge funds continue to be of interest to some, but a large fraction of plan sponsors remain sceptical that they are the right solution. We are responding to each of these trends.
5. The motivation for hedge fund investing has been the low-return environment. The resulting discussion about the importance of understanding beta and alpha risk more clearly has undermined the traditional consensus about the right approach to asset allocation, dividing institutional investors between those who think separating alpha and beta can create a superior model for institutional investing and those who regard it as a fad. The consensus is unlikely to be re-established any time soon and every investment manager needs to rethink their approach to investing and their business model accordingly.

George Möller, CEO
1. We do not believe in a further interest rate spike from current levels nor do we believe that an inflation threat is imminent. Global deflationary forces (globalisation, technology and competition) are still in place. When the bearish bond market sentiment has receded yield levels will become attractive for institutional investors who need to match their liabilities.
2. One of the reasons for the mega mergers is regulation aiming to prevent conflict of interests between US brokers and asset managers. More may occur but in our view this would mainly be related to US asset managers. The European M&A scene will be dominated for years the come by smaller, complementary acquisitions looking to add specific product skills to asset managers. This is in line with the increasing focus within asset management on alpha investment returns, which is causing asset managers to convert into multi-boutique specialists. Examples are the various funds of hedge fund acquisitions over the last year.
3. Competition keeps parties sharp. This is a next step in blurring the lines between suppliers. For example, consultants have entered this market in recent years.
4. Of numerous trends, the search for absolute return is the most obvious. Furthermore, investors are looking for flexibility, with portable alpha as the most visible factor. Finally, we see an increasing demand for liability matching solutions in some regions.
5. Recent evolutions are increasingly blurring the difference between hedge funds and traditional asset managers. Nonetheless, there is a major difference between the two. Hedge funds have a clear focus on generating absolute performance every year with an absence of conflicts of interest as incentives are linked to performance fees whereas traditional managers focus on benchmark performance and are still very much beta generators levying fees on total returns, of which only a small portion is actively generated alpha.

Générale AM
Alain Clot, chairman
1. The flood of global liquidity that kept bond yields at exceptionally low levels throughout much of 2005 has begun to ebb on the back of tighter monetary policy from the G3 central banks and stronger domestic demand growth outside the US. We believe some further upward correction on global bond yields is due but two factors will cap yields on the upside. First, inflation expectations remain well anchored across the major markets suggesting still moderate term-risk premium ahead. Second, the latent demand for fixed income products from pension funds remains large and allocation shifts will continue to favour fixed income markets.
2. These mega mergers arose from specific situations. The Citigroup merger resulted in particular from a conflict of interests issue favouring a core business activity, namely brokerage. The Merrill Lynch merger allows it to develop an incomplete model into that of a global player by bringing its asset management business to the third US fixed income manager. While M&As contribute to the consolidation that is taking place in our industry, their number overall has been stable in the past three years, except in alternative investments where they are increasing. In fact, the key factor concerning consolidation in our industry is the concentration of business among the biggest players. Only the biggest asset managers have the means to finance the investments in people and technology that are needed today.
3. Institutional investors have found products from investment banks, notably structured products, that are useful in a core-satellite approach at a time when equity markets have low volatility and are seen as generally favourable, or when seeking out-performance from fixed-income products during a period of low interest rates.
4. Client demand first of all expresses itself in high alpha products that aim to increase portfolio returns: we have noticed a strong appetite for US, Japanese, and Asian (notably Indian) equity strategies and for alternative investments products (hedge funds, private equity, portable alpha) or specialist fixed-income products (CDOs, MBS, high yield). Demand is also high for absolute return products (structured products, total return bonds) sought by institutional investors to control their asset risk – a consequence of the IFRS/IAS norms.
5. I don’t know what is meant by ‘conventional investment’ because we are seeing convergence. Alternatives are becoming a separate asset class and taking a permanent place in investors’ portfolios and ‘conventional investment’ also uses market techniques (leverage, derivatives).
Hedge fund strategies are giving a growing portion to long-only investments and these are merely equity strategies. There is also convergence of investment styles and fee structures, with the development of performance fees that originated in the alternatives market.

State Street Global Advisors
Mark Lazberger, head of international business
1. Higher short-term rates are not a concern at this point because they are not being moved to fight inflation or to slow growth. Rather, official rates have moved up to remove an accommodative stance in monetary policy. Where from here?
Equities are reasonably valued but not cheap so investors should look to moderate rates of return (6-10%) in equities over the medium term. Bond rates will continue to move up to keep pace with short-term rates resulting in total returns less than cash.
2. The current level of M&A activity is likely to continue for the remainder of this year. Many organisations – particularly those where the asset management business is part of a larger, more-diversified financial services group – are examining those parts of their overall business that could represent an enduring competitive advantage, and those that don’t will be disposed of or outsourced. In recent deals, asset management has fallen into this category. These deals have also highlighted a need to resolve potential conflicts of interest and internal cultural differences that mostly sell-side-oriented firms have with their in-house asset management colleagues. A number of boutique managers are also coming to the market seeking a utopia free of the internal ‘bureaucracy’ common in larger organisations. Assuming that some of the founding management stay on post-IPO, they may find themselves back in a position that looks pretty similar to the one that they thought they had escaped.
3. Investment banks represent a necessary input into newer investment management concepts, such as liability-driven investing and their growing profile illustrates the convergence underway in the investing field.
Successful asset management firms will respond by working out where they best add value and concentrating on the delivery of that value to the end client.
4. Alpha is what clients want and expect. Despite suggestions that active long-only management is not where the action is, we find demand for long-only active equity products is stronger than ever. Finally, we believe that demand for index-based investment strategies covering a very broad array of asset classes and indices represents enormous future growth potential. Investors overlook beta at their own risk.
5. I appreciate the focus of the genuine hedge funds – those who create alpha, and not just repackage investments – on the art and science of investing to extract value from markets. The lesson for large global investment management firms is that standards are being raised by hedge funds and that businesses such as ours need to be extremely quick on their feet if they are to continue to be successful.
T Rowe Price
Todd Ruppert, CEO global investment services
1. No. While we expect rates to increase, especially in Japan and Europe, absolute yields will remain low in the context of the last 25 years as inflation volatility is low, inflation is muted and there is structural demand for long-dated bonds. Emerging market local bonds and
developed market credit bonds should remain attractive.
2. First, regulatory pressures; second, focus on scale economies in areas of expertise and exit businesses in which not world class; and third a realisation that it is better to own part of a great asset trading at an asset management multiple than 100% of a so-so asset buried in a conglomerate with its earnings capitalized at the much lower bank/broker multiple. More will come.
3. Not necessarily good or bad, simply a function of the industry’s evolution. Risk reduction has been topical and investment banks have expertise at pricing and trading risk. That said, much activity is supply push by banks rather than demand pull. This can be problematic if not properly vetted. Only time will tell.
4. Clients seek inexpensive beta and reliable alpha at a reasonable price within a risk budget to their particular comfort. They seek this in either a combination of stand-alone products or packaged solutions. This is universal. We focus on perpetuating our ability to generate durable alpha.
5. Many hedge funds are good at risk identification, management and attribution. That said, the more experienced hedge funds are incorporating attributes of conventional asset managers to stabilise and develop their businesses.

Union Investment Institutional
Nikolaus Sillem, managing director
1. We expect slightly rising interest rates in both the US and Europe. Investments with low or negative correlations to bonds – like equities, hedge funds and real estate – are essential for limiting losses. In a low interest rate environment, equities and specialities, such as convertibles, REITs, hedge funds and private equity, will also be the winners.
2. We recognise theses mergers as means to gaining economies of scale.
3. Neutrality is the most important point in judging the role of investment banks in this business. Especially crucial are potential conflicts of interest. Anot, her critical topic is the differing time perspective of pe