Asset managers should revamp business models to face crisis, survey says

EUROPE - Institutional investors are increasingly taking a dynamic approach to managing volatility, as most expect prolonged market turbulence and believe asset managers should take "significant" action to overcome the challenge, a new study has found.

According to the study, carried out by CREATE-Research on behalf of Principal Global Investors, institutional investors are expecting the "unusual" market volatility and asset correlation sparked by the 2008 credit crunch to continue as the sovereign debt crisis grows in the Western economies.

Professor Amin Rajan, chief executive at CREATE-Research, said: "The last four years have been the most volatile in the history of equity markets. Price fluctuations of 4% or over in intra-day sessions have occurred six times more than they did on average in the previous 40 years."

Nearly 80% of the investors surveyed - including asset managers, pension funds, pension consultants and fund distributors - expect the current market turbulence to continue, with more than 60% expecting two or more systemic crises before the end of this decade.

More than two-thirds of survey respondents said the current volatility offered a broad range of opportunities, yet only 13% believed they were capable of converting those opportunities into returns.

Rajan said extreme spikes in market volatility and closer asset-class correlations had been common over the past four years. 

"History shows that opportunity is inherent in periods of high risk, and that high risk can reward active management," he added.

"Investors want to know whether asset managers can convert market volatility into an investment opportunity."

As a result, institutional investors are now calling on asset managers to revamp their business models to meet the challenges posed by the financial crisis and prevent another 'lost decade' of returns by adopting a four-way approach, according to the survey.

First, investors have asked managers to enhance their capabilities around price dislocation, improve their track record on volatility and avoid unrealistic claims about returns.

Asset managers should also adopt meritocratic incentives that share "pain and gain" with their clients, while promoting common time horizons and investment beliefs, respondents said.

Additionally, managers should encourage "nimbleness, free thinking and high conviction" investing within its talent pool.

The fourth and final approach relates to client engagement, with survey respondents saying managers would do well to go beyond regular reporting and engage in issues that deliver mutual benefits. 

Nick Lyster, chief executive at Principal Global Investors Europe, said: "The report reveals that investors, like asset managers, see opportunity in volatility, but that their requirements of asset managers have changed.

"Specifically, in an environment of prolonged uncertainty, they no longer see risk on/risk off trades as a binary choice and are becoming more goal-orientated, managing risk more than return.

"In practical terms, this means investors - most notably DC [defined contribution] and retail - will seek a more dynamic asset allocation strategy, blending elements of both 'risk on' and 'risk off'."

While 57% of DB schemes in CREATE-Research's survey said they were likely to de-risk their portfolio by using an LDI strategy, 56% said they would be more likely to opt for a more diversified approach, while 44% would choose a fiduciary management solution.

As for DC clients, 55% of them would invest in advice-embedded products for their de-risking approach, 52% would choose to diversify and 38% would opt for capital preservation tools.

With respect to re-risking, 45% of DB plans would adopt absolute return strategies, 37% would run unconstrained mandates, and 34% would use active trading strategies such as hedge funds.

Nearly 50% of DC pension funds would go for dynamic glide-path strategies for their re-risking approach, while 27% would opt for absolute return strategies and 24% for high -conviction investing.