Time to be more creative
The defining moment of 2003 for the Irish fund management industry was the decision by UK insurance giant Aviva to reprieve its Dublin based asset management arm, Hibernian Investment Managers, Ireland’s fourth largest asset manager
Aviva had initially considered closing down Hibernian and merging its operations with its London-based asset managers, Morley Fund Managers. However, after a strategic review of its fund management activities Aviva reversed its decision. Key investment management activities, including asset allocation, fund management of bond portfolios, Irish equities, Irish property and specialist equity portfolios, will remain in Dublin.
The move mirrored to some extent the earlier decision by the Belgian group KBC, which acquired Ulster Bank Investment Managers in 2000, to make Dublin its centre for active portfolio management, with Brussels as its centre for passive management and capital guaranteed investment.
Aviva’s change of heart was not complete. Hibernian’s international equity business is being transferred to Morley, which was one of the UK’s worst performing fund managers in 2002. Nevertheless, the decision was seen generally as an endorsement of the Irish asset management industry’s skills.
Three years of an equities bear market have encouraged Irish asset managers to sharpen these skills. The strength of Irish asset management historically lay in managing balanced funds, and managers turned in some impressive performances in the 1990s.
However this has changed over the past six or seven years. Gerry Keenan, head of investment development at Irish Life Investment Managers says bluntly: “Managed funds are dead. It’s been a long wake, but they are dead. You only have to look at the flows in the business, and all the flows are away from the traditional managed fund type structure.”
Core satellite and specialist structures are replacing this, he says. “Indexation has taken a significant share of the market and people are using that to manage risk within their overall portfolio. Once they have indexation sorted out they are squeezing assets, which means that the mediocre active manager is being shunted out. So clients have become very demanding in what they want from an active manager.”
Sean Hawkshaw, chief executive of KBC Asset Management (KBCAM), says that once pension funds feel they have regained a reasonable proportion of what they lost during three year bear market they are likely to look for new investment strategies.
“What trustees expect from investment managers now is to be able to come up with tailored investment solutions rather than the one-size-fits-all balanced fund approach. So fund managers generally are going to have to become more creative.”
An increasing number of pension funds are now looking for scheme-specific strategies, says Kevin Gallacher, head of business development at Montgomery Oppenheim. “Pension funds are setting performance benchmarks and objectives that actually reflect their individual circumstances and not some peer group collective wisdom.”
This is likely to encourage a move from balanced to specialist mandates, he suggests. “Having taken the first step in choosing a strategy in terms of setting an asset allocation that meets the liability profile, it’s a very logical second step to ask whether it is appropriate to employ a single manager to look after both the equities and bonds.
“For the smaller schemes there are arguments still in favour of that approach in terms of cost control, ease of reporting to the trustees and consolidation of returns. But certainly at the top end of the market we’ve seen an increase in the demand for specialist mandates.”
Patrick Lardner, head of Irish institutional business at Bank of Ireland Asset Management (BIAM), says BIAM’s larger clients are demanding specialist single or multi-asset benchmarks. “In the case of multi-asset benchmarks we’re getting specific allocations to asset classes like non-sovereign bonds. On the specialist, single asset class side of things we continue to see a very good flow of specialist equity mandates as well as passive mandates.”
BIAM has also been picking up specialist fixed income mandates. One customer, for example, has given us a benchmark of 50% Euro government over 10 years and 50% non-sovereign over five. That’s a very specific type of approach.” To meet the demand for this type of business, BIAM has increasing the size of its fixed income asset management team by 50%.
However, the shift from balanced to specialist is not always one way, he says. “There have been one or two examples of where people who have gone down the specialist road have almost returned to the balanced route. Balanced strategies have come under some pressure but there are also strengths because you get the totality of the manager’s skill.”
Thomas Geraghty, senior investment consultant at Mercer, says that the move to peer group benchmarking may have obscured the advantages of balanced management. “There’s been some good fundamental questioning about whether to revert to a balanced type of approach where the manager can be given the discretion to make a lot of tactical calls in terms of asset allocation. That’s what balanced management should have been about. But what happened was that we got carried away by this peer group mentality which led to a consensus type of approach where everyone’s doing the same kind of thing.
“We’re now saying maybe we need to get back to a balanced world where the manager isn’t looking at peer group but is exercising complete discretion in terms of strategic and tactical calls.”
From an asset allocation perspective, little appears to have changed on the Irish asset management landscape. Kevin O’Kelly, business development manager at Hibernian Investment Managers estimates that less than 10% of clients have made significant asset class changes.” As you would expect this would have been into bonds and cash. As you would also expect those situations were client specific to their own liability profile or their own thoughts on risk, rather than because of any encouragement from us. If anything we would have proposed that people should stick with the equity content on the basis that the market would turn round. To a certain extent this has happened over the last six months.”
There has been no significant shift out of equities, says Geraghty: “If anything Irish managers and Irish clients have been net buyers of equities. The majority of our clients still believe in the equity story. They still believe that companies will be rewarded for taking on risk and that over the long term equities are going to continue to deliver returns.”
The average managed fund asset distribution at the end of September last year was 69.9% in equities 21.4% fixed interest, 5.11% property and 3.6% cash. “This is not deviating unusually from historical norms,” he says.
However, there has been a significant change in attitudes to risk, he says. “What has changed is that there has been an acknowledgment of the risk inherent in that asset allocation. Risk in terms of the funding volatility, the contributions volatility, and meeting the pension’s obligation. At least they’re acknowledging the risk around these variables.”
This new risk awareness has provided asset managers with much of their business recently, Geraghty says. “What has kept us really busy over the past year has been investment strategy review. Clients are now willing to take on asset liability studies and modelling. They are acknowledging that they have to quantify their objectives and look at the risk inherent in different allocation levels.”
Hawkshaw at KBCAM notes that pension fund trustees’ appetite for risk has diminished. He also finds that the objectives pension funds are setting for asset managers have changed. “In the past these objectives would have been peer-related or benchmark-related. What we are seeing now is more focus on protection on the past service funding. This means that the asset managers are having to re-think the whole risk-reward equation.”
However, the protection of past service funding poses a dilemma for pension fund trustees, he suggests. “Regulation and accounting standards are making it more difficult to take on volatility within a portfolio while at the same time the need for real returns is more urgent.”
Pension funds and their managers are trying to resolve the conflicting objectives of squeezing the assets and matching the liabilities by dealing with them separately, says Keenan of Irish Life IM. “The market is basically trying to separate out these issues by putting them in two separate boxes. In the one box they isolate a portion of the funds needed for some sort of bond matching. This deals with the matching issues. In the other box they have their core satellite and alpha generation structures. We’re trying to prevent an overlap between the two problems by isolating them.”
These are relatively sophisticated strategies, however, and the Irish asset management market is - in international terms - small. Multi-management is one way to make these strategies available to smaller players. The multi-manager concept has been pioneered in Ireland by Irish Life IM, and interest in it is growing slowly but steadily.
“The needs of domestic clients are very similar to the needs of clients in the UK and the US,” says Keenan. “So how do you make available to the Irish market the solutions that a top UK or US pension fund would put in place? If it’s smart for the top guys to have a multi manager structure how do you package that for the smaller guys?”
Irish Life IM offers Global Axis, a unitised multi-manager structure targeted at the small and medium end of the market. Keenan says the aim is to give small and medium size pension funds access to a range of “best of breed” managers.
The Irish Life IM product draws on the experience of global multi-managers such as Russell, SEI and Northern Trust, says Keenan. “We haven’t re-invented the wheel. We just looked at what best practice was in the major pension funds overseas. The Irish market has evolved in the same way as the US and UK markets and its quite quickly gone that way. It takes about three years for something new to take off in the market place, but we think we’re at the beginning of a strong advance.”
One effect of the bear market has been to challenge the central role of consensus in Irish asset management. Gallacher at Montgomery Oppenheimer says: “In Ireland most pension funds have historically been managed relative to consensus benchmarks, so they have all pursued broadly similar balanced strategies, where the performance benchmark has been a peer group target.
“In the 1990s that worked well. But as soon as you get into a negative market environment all of that changes. A negative market has forced institutional investors look more closely at how they structure their traditional approach to asset management. The biggest legacy of the three years of downturn has been that there has been a fairly widespread reassessment of consensus strategy.
Consensus operates across both the pooled and segregated markets. In the pooled pension market managers have a commercial interest in being able to demonstrate that they are above average, and will therefore use the average as their starting point for managing portfolios.
“You find a lot of managers reducing their equity exposure simply to maintain some sort of parity with the average. They might not be seeking to mirror the average but that would be their primary reference point,” says Gallacher.
Segregated pension funds are benchmarked against the Combined Performance Measurement Service (CPMS) which surveys the larger employer sponsored pension schemes in Ireland. Performance targets are set for investment managers round the CPMS Average, again promoting a consensus approach.
The key benefit of consensus is that it limits downside risk, its proponents argue. Yet Gallacher points out that the risk is primarily manager risk. “There is this perception that consensus is low risk. It is low risk for the manager, because if the manager gets it wrong it’s not going to be very far off the average. But arguably it’s very high risk for the pension funds themselves.”
However, consensus can give comfort for pension fund trustees. Keenan of Irish Life IM points out that consensus provide an overlay of asset allocation that a benchmark alone cannot provide. “Consensus is unique because it actually has an asset allocation. It follows collective wisdom whereas obviously the benchmark structure doesn’t. At the moment there isn’t a tactical asset allocation being provided in the market. The only one is the one arising from the consensus overlay.”
He argues that this is what makes consensus funds so attractive to pension funds. “People have become increasingly comfortable with consensus because it has an asset allocation position within it. It has everything that benchmark has with an additional asset allocation structure on top of it. Certainly within both DB and DC funds I certainly would see that clients are happy to see some asset allocation decisions being made.
The market is proof that consensus is popular, he adds. “We’ve had a continued huge growth in benchmark with asset allocation type funds. We’ve had very significant flows into it and half of our assets are now in that structure.”
Irish asset managers also see opportunities in the growing market for defined contribution (DC) pension plans. Although most existing occupational pension schemes assets are in defined benefit (DB) schemes, almost new schemes are likely to be DC. The specific characteristics of the DC market are providing Irish asset managers with business opportunities, says Paul McCarville, director of Setanta Asset Management.
McCarville suggests says that Irish managers have the advantage of overseas competitors in the DC market because they are selling brands that the Irish recognise. Setanta itself manages funds sold under the label of Canada Life which last year chalked up 100 years of operation in Ireland. “The small number of large external players whose brands would have good recognition here would only be interested in the very large schemes. A further deterrent to them even wanting to be involved is the member communication agenda. This is an expensive service to provide from outside Ireland,” he says. Irish managers can also take advantage of the boost given to the personal pension market by the relaxation of the rules regarding annuities. Although members of group DC plans are still obliged to buy annuities, AVCs can be invested in Approved Retirement Funds (ARFs) as can the newly created Personal Retirement Savings Accounts (PRSAs).
This has freed up the personal pensions market, particularly at the top end, says McCarville. “There is no doubt that the compulsion to buy an annuity was a huge deterrent in the individual self-employed pension’s arena. At the higher net worth end of the market it opens up very interesting estate planning opportunities for people. It takes personal pensions it out of the realm of simply being a pensions issue to being one of estate planning for people with greater means.”
Irish managers are now meeting unexpected competition in the domestic market from overseas players, says HIM’s O’Kelly. “A few years ago we would have thought that the international players would only be interested in the bigger portfolios. We have been somewhat surprised at the level we came up against – sometimes as low as E5m to E10m. That competition will only increase.”
To remain competitive today Irish asset managers have to be able to compete in the global market. The National Treasury Management Agency’s (NTMA) award of mandates for the National Pensions Reserve Fund was a wake up call for Irish managers, says KBCAM’s Hawkshaw: “To participate in the management of that scheme you’ve got to be able to demonstrate that with your specialist capability that you can compete with the best in the world. The challenge for Irish-based fund managers is to become rated by the international houses in their specialist areas to be able to compete in the premier league for the assets of international pensions funds. That’s what all Irish based managers should be aspiring to.”
Keenan at Irish Life IM says Irish asset mangers are now under pressure to perform in the new post-bear market climate. “People are looking to squeeze assets. The way to squeeze assets is to say active management is a global business. So the squeeze for alpha has essentially become a global game for local pension funds.”
Some players, notably BIAM, have been operating internationally for many years. BIAM’s Lardner says the wheel has come full circle. Irish clients are now demanding a domestic manager with global experience. “We developed our international business on the basis of a very strong business in Ireland. What we’re finding now is that having a presence globally is important for our continued success in Ireland.”
So for Irish asset managers to survive they must be able to demonstrate not only that they are the best in the local market but that they can compete with the best in the global market. That will be no small achievement.