Asset strategy: Threat or opportunity?
Outlining the dynamics of the Nordic institutional investment market
- Nordic institutional investors are embracing internal management.
- Most manage less than 20% of assets themselves.
- External managers are used for non European equities, high yield, emerging market debt and alternatives.
Nordic investors are faced with a set of external factors that impact on how they manage their investments. Demands for cost reductions are increasingly shaping the way investors organise themselves, and in order to accommodate this focus on cost, many investors have built sizeable organisations with the aim of managing assets internally.
For asset managers it is becoming important to be able to locate these accessible assets. This is particularly the case since investors that look attractive both in terms of size and asset allocation may be irrelevant because large portions of their assets are managed internally or passively.
However, while the trend of internalisation is continuing, over 85% of Nordic investors manage less than 20% of their assets in-house – leaving considerable opportunities for asset managers.
Overall, the share of external management is high when it comes to equities. The most important differences in investors’ use of external management in equities are related to developed and emerging markets.
Looking at developed market equity, it is believed that global strategies require resources, and therefore mainly managed externally using a mixture of local and global managers. This is evident across investors, although some have internal management, often replicating an index. In global equities, many investors favour active management. However, leading investors have implemented passive or rule-based mandates, which are considered to make sense in global structures.
Investors with a regional approach to equities usually manage European holdings internally, whereas US and Japanese shares are outsourced to external managers, primarily due to the perceived complexity of these strategies. Externally managed regional strategies are often managed passively, although with some dispersion on European equities. Active management often relates to the less efficient small and mid-cap markets in the US and Europe, whereas the interest in developed large cap equity is moving from active to passive management. The Japanese market is a good case for active management, and externally managed mandates have an active approach. Nevertheless, passive legacy mandates continue.
Emerging market equity is typically managed externally, and this will probably remain the norm. Most investors acknowledge that these holdings require resources and specialised knowhow. Leading investors focus on satellite investments in frontier markets, small cap, and regional markets, which increases the use of external managers. Few investors have set up internal teams for emerging markets equities, but some leading investors are insourcing this asset class, often in combination with external partners. In emerging markets, investors are most inclined to invest actively, since these markets are considered less efficient than developed markets and most believe that managers are able to deliver alpha in this area.
In fixed income, a large proportion of assets is managed internally. Investors’ familiarity with the asset classes has an impact on the balance between internal and external management. As such, sizeable allocations to domestic high-grade bonds positively impact the share of internal management on fixed income. The majority manage their fixed income assets with an active approach, but interest in passive management is rising, often related to disappointing experiences with active management in high yield and emerging market debt. Factor investing in fixed income is limited to a few investors, although it has gained more ground recently.
Investment-grade bonds are often managed internally, and this is seen as an asset class that requires few resources internally. Of the externally managed mandates, active management is preferred.
High yield is primarily managed externally due to the complexity of the class compared to lower yielding fixed income. However, a few investors have set up internal teams for high yield with tilts towards local or European issuances. Investors have historically favoured actively managed high-yield mandates, as this is considered difficult to do passively. However, some investors have implemented high yield passively, sometimes in combination with active management.
Investors will typically outsource emerging market debt and acknowledge that this asset class requires significant resources and specialised knowhow. Nevertheless, several large and medium-sized investors are insourcing the class, particularly local currency debt, due to the low number of countries in the benchmark. The interest in passive investing in emerging market debt is increasing in line with a more developed offering. Many investors are still careful and concerned about unintended portfolio risk and rule-based investing is considered attractive. Leading investors are inclined to insource emerging market debt as a consequence of previously disappointing returns from active external managers.
Finally, the bulk of alternatives is managed externally. The movement towards single funds and direct investments has been supported by the quest for lower fees, the same driver that has led to a higher use of internal management.
Historically, real estate investments has been focused on domestic and European property, and many manage this internally. For smaller investors, co-investments and club deals are a popular option. In line with the internationalisation of real estate, use of managers is rising.
In private equity, most investors employ external managers. Smaller investors rely on funds of funds, but single funds and direct club investments are becoming popular. The most sophisticated investors are behind a move towards more direct fund and co-investments, but also platform investing. Local managers remain popular, yet the demand for internalisation has introduced specialist managers.
In the case of hedge funds, sentiment is limited and investors work with local external managers. Many investors select local single funds and construct their own portfolio, while some work with dedicated hedge fund managers as advisers and use their platforms.
Although internalisation continues to threaten the asset management industry, most investors still manage the majority of their total assets externally. It is important for asset managers to understand this movement and how the external factors affect the institutional investors, in order to properly navigate the market.
Albert Løchte Jensen is an investment consultant at Kirstein Intelligence