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Impact Investing

IPE special report May 2018

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Sweet on pick and mix

Many of the larger US players are preaching about the benefits of a broader range of asset classes moving away from a single product area, Rachel Oliver takes a closer look
IT has been safe to say that the US market houses a culture where an asset manager who does not have a niche product, may as well pack up and go home. Up until recently, that has been a given, much to the relief of the boutiques. But there has been a certain air of schizophrenia engulfing the US market currently with the market drivers, the giants, advocating a generalist approach and adopting a multi product philosophy.
Departing from the principles of focusing on a single product area only and seeking to lead the market in that investment discipline, many mid-sized and large players are now preaching the benefits of providing that same level of expertise across a much broader range of asset classes. The US has never embraced a balanced approach, but one could fairly compare many US managers’ explanations of their product expansion with the one time proponents of balanced management in the UK who now say with hand on heart that their all-in-one approach is in reality a finely tuned mixture of specialist styles.
Global players JP Morgan, Morgan Stanley, UAM, Dresdner RCM, Chase and the recently merged SSB Citi Asset Management which is marketing 30 products to cover “virtually every major asset class” according to global marketing director Theresa Snyder, have all made their views clear over the past couple of years, that it is no longer acceptable to be exceptional in just one field and are basing their strategic expansion around this belief. And while the idea of boutiques going out of business is pretty unlikely – the US market is too vast to be dominated by any group of players unlike Europe’s pension markets – there is very real concern that the life of the mid-sized manager is drawing to a close as a direct result of this activity.
“The mid-sized firms are going away,” says Bill Cvengros, CEO of PIMCO in Newport Beach. “I think you have either got to do what we did and go for size, go for global, or you remain small.”
PIMCO is currently enjoying asset growth of 20% per annum which is sourced primarily from US defined benefit (DB) business and its recent acquisition by Allianz can only help fund its growth further in Europe. “We are still a mid-sized firm and our challenge is to fill our rightful place in international equity and other product areas and we are making substantial investments in distribution to make that happen and those investments aren’t getting any less expensive.”
“Firms like ours are funnelling back money into all of our asset classes to make them better and better so they can compete as specialist managers in their own right,” explains Jo Rubarsky, marketing director at Dresdner RCM in San Francisco, another mid market player seeking aggressive expansion. “Our mid cap is one of the best now, our international is one of the best, our large cap is one of the best. So we can compete in our own right as specialist managers. What we have to do is to be able to compete across asset classes as if we were a small cap only manager or mid cap only manager and that is our goal.”
Sourcing these kinds of expansion programmes is never a problem in a market the size of the US, with its defined benefit (DB) and defined contribution (DC) markets still neck and neck in size at around $1.5trn each, despite calls at one time that the DB plan’s life span was also short lived. Despite DB’s three year projected growth at a rate of 3% per year being substantially overshadowed by DC’s estimated 15%, the industry will uniformly agree, there are more than enough assets to go round.
“DB is very much alive,” says Mike Fisher, head of BGI’s US DB business in San Francisco. “While admittedly thousands of smaller plans some years back closed themselves off out of the DB market in favour of DC or some profit sharing oriented scheme, in fact of the Fortune 500 companies for example, very few of those have collapsed their DB plans in their entirety. And while they are changing in many cases to the cash balance approach, that’s just another form of a DB plan anyway.
“The aggregate for all private sector clients today is somewhere around $4trn, and the average annual growth is certainly double digits combining DC and DB. And then when you put government sponsored plans in there in the form of states, counties, cities, there is another $3trn, so the pot is approaching $7trn. On top of all that, you have endowments, foundations, insurance company assets, various liability trusts. The numbers get huge.”
For providers who didn’t get into the game first time round, chasing DC assets continues to be one of offering investment-only products. The likes of Fidelity continue to hold on to their very strong positions and recent attempts to challenge them at providing a one stop DC shop, have failed. JP Morgan is a recent player who moved into the DC market with its purchase of American Century and now passive giant BGI is developing plans of its own to roll out a US-wide DC programme. But is it too late for that? “That’s a tough game,” says Peter Johnson, at Nicholas Applegate in San Diego. “We used to have a turnkey set up, but the overriding issue there is profitability. When I was at Fidelity we used to give the recordkeeping away to attract in the money because we knew that the fees, that was where we would make the real money.”
“We looked at it five years ago and concluded that it was too late then,” says PIMCO’s Cvengros. “The reason we didn’t do it, was we thought it was going to take an enormous, increasing amount of capital in investment in the technology side of the business which was never really our cup of tea – the administrative side of it – we felt that our core competency was in money management.”
A positive trend for DB managers trying to crack the DC market by offering investment advisory to the bundled providers, is the cost issue which has been driving the investment decisions of many DC plans over the past couple of years and has come to a head in recent times with some plans deciding against using the favoured investment of mutual funds, much to the dismay of the participants who are used to and comfortable with brands such as Magellan. But this of course is much to the delight of DB managers, as DC plans are now looking at running the money on a segregated basis or at least using institutionally priced funds more in their portfolios.
“I think you are going to see more and more on the DB and DC side of a movement towards an institutionally priced fund menu,” says Rich Tivernen, head of returement services at SSBCiti Asset Management in Stamford. “There is the interest of helping participants in understanding how things are invested and the whole trend associated with that, so many of those separate account managers that were managing DB plans are now being used to set up pooled funds in the DC plans and then they can unitise it, so when the participant looks at the pension plan they can get some frame of reference as to what their account is worth.
“Part of the reason, is not everyone is that thrilled at having to invest their own retirement money. Not many people understand the implications and there is not enough participation in the plans as we think there should be.” Part of the reason behind this is while the DC market is attracting so much interest from DB managers who are now marketing their investment-only services either directly to the plan, or to the overall one stop shops who are now offering supermarket facilities, the market is falling into a category of one that offers too much choice. There is a risk of DC plans giving its participants too many funds to choose from which is causing confusion, he says.
“A few things have happened where individuals have perhaps not understood or invested enough of their income into these funds have come up short and this is of some concern to their employer,” continues Tivernen. “I don’t know if there have been any actual repercussions but I think there is concern over this grey area as to how much responsibility does the plan sponsor have? Because they do choose who provides the investment services, so they provide the menus so there has to be some fiduciary responsibility there.”
In the DB market, since GTE set the precedent by handing out four $1bn mandates, while few other plans have followed with such enthusiasm, there seems to be no doubt within the industry that the days of pension plans employing a multitude of specialist managers is coming to a close. Economies of scale will strongly appeal to mid to large sized plans looking to entrust more responsibility to players of equivalent size and stature. At some point a plan reaches a point that by appointing yet another manager to its already overcrowded portfolio, they are risking a portfolio overlap and with that the extra costs whether that is custodian costs, execution costs or management fees, begin to dictate. “With the rising sophistication generally, particularly with the larger end of the plan market, they are increasingly sensitive to containing their manager roster,” says Brent Harris, chairman of PIMCO Funds and managing director of PIMCO. The result then can only be that fewer managers will be increasingly asked to manage more.
Hence the multi product philosophy. To ensure a place on the roster, asset managers have realised they need to have this wider spectrum of services – a series of back ups in case their core products underperform; knowledge not only in US equity, but also in European, Asian, global and emerging markets; to not just offer equity products, but fixed income, property and alternative investments; and managers need to get assets in to fund the necessary personnel and technological expansion inhouse, or at least form a joint venture with a manager who can provide it for them.
“GTE not only put those mandates in place around capital markets oriented thinking,” says BGI’s Fisher. “They put it in place with the idea of the size, scope and depth of the organisations they were using, Morgan Stanley for example, that in return for the substantial amount of assets, the base fee and the incentive to own it, GTE would be privy to insights they could gain from those firms, almost like an extension of the investment department of GTE to reach into these firms for everything from economic outlook to product design issues. And that is probably the hardest part to get a measuring factor onto –they know what the performances are, but I don’t know how you measure the value of the partnership extension.”
The expansive strategies managers are adopting don’t come cheap. And one key area of expense is technology. For the first half of the year nearly a half of the return of the S&P500 was generated by internet related businesses. Nicholas Applegate’s Johnson views the industry as being in a “90:10 situation” with businesses realising the role of the internet as tool in the realms of marketing and distribution but not having enough net-savvy clients to cost efficiently implement any kind of substantial programme. “We are all pushing it through e-mail, that is the first step. Some managers have been successful setting up intranets that the clients can tap into. We are all wrestling with the 90:10 phenomenon where 10% of your clients use 90% of your technology. You know it is moving that way but it is a matter of how long it will take.
“The market is requiring it more and more and the technology is improving. But it becomes a scale thing for the institutional asset manager. Today we have 265 institutional clients and you have to weigh whether there is enough critical mass there. We are wrestling with that internally right now.”
PIMCO is in a similar situation and is in the throes of looking at how it is going to push its e-commerce strategy forward. And in one of the more extreme moves to come from a money manager, for its lesser technology advanced clients, according to co-founder, Jim Muzzy, PIMCO is even toying with the idea of actually buying computers for those clients just so they can use the CD Roms that PIMCO is sending out. “It’s kind of reinventing ourselves,” he says. “But you must show the willingness to shift and change as the market changes.”
For non US players looking to crack this market, to say it is a formidable task is an understatement, particularly at a time right now when competition amongst the top tier of managers is truly hotting up. Dresdner RCM, of which many in the industry will say is the only really successful merger in recent times, also represents one of the few European successes, though like BGI, it is actually viewed within the US as a domestic player. Cvengros issues newcomers to this market who do not have such a clearly defined strategic plan with a stark warning: “If you are small, you had better be very, very good. If you are mid-sized, then you had better make sure you have a very clear strategy as to what you do.”
The developments amongst players such as JP Morgan, PIMCO, Citi and Morgan Stanley is by no means restricted to the US shores and not only are international players warned about the quality of competition in the US market, they are also equally wise to keep an eye on their own markets as well, concludes Dresdner’s Rubarsky.
“Because we are a mid cap and a large cap manager, we can be a better small cap manager, because we understand the dynamics of demand for global technology, we can be a better manager across all those asset classes. It all works together.
“How can a manager who only has research in Europe be as good a pan-European equity manager as we are when we’re doing that but we are also researching all the competitors that are coming from the US to attack their markets. You can’t possibly know as much as we do. You can’t possibly compete with us.”

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