Top 400: Chief concerns
We asked 28 asset management CEOs, CIOs and other senior figures about institutional investment, regulation and corporate governance
1- What reason would a non-European institution have for investing euro-zone assets today?
2-Institutions face depressed ‘risk-free’ rates and low risk premia, volatile markets and an extended period of lower economic growth. Which of these is the greatest challenge for investors and how should they tackle it?
3-Post crisis, we are in the midst of a wave of new regulation affecting pension funds, asset management, banking, financial product distribution and market microstructure. Are we fighting yesterday’s problems?
4-There is much debate about corporate governance in the post-crisis world. But does anyone in the pensions and asset management industry really take any of it seriously?
Aberdeen Asset Management
1. Blanket generalisations, whether dismissing or favouring a particular geographic area, sector or asset, are a sign of laziness. No-one can deny the manifold problems facing the euro-zone region in aggregate, but within that there are still world-leading companies and interesting niche players who offer opportunities to the careful investor. There are many well-run companies with strong balance sheets listed in the euro-zone region, and other asset classes, such as property or private equity, can also take advantage of mispricing thrown up by the general mood of distaste for the region that abounds at present.
2. Someone said recently that government securities no longer offer risk-free returns but return-free risk. Institutional investors need to have a much great understanding of their true long-term investment objectives and, importantly, the trajectory they are willing to tolerate to reach them. If the higher volatility prevalent at present is too distasteful, investors need to be willing to diversify more and accept a potentially lower overall outcome. But clarity of acceptable liquidity, volatility and final return outcome is vital to manage expectations, and diversification for diversification’s sake is not sufficient: it must be intelligent diversification.
3. Yes. We are, in general, only adding cost, which will reduce overall returns.
4. Yes. Good governance is at the heart of good, sustainable long-term investing - if companies are not well run and well governed, then sooner or later they will become yesterday’s bad investment decision.
Allianz Global Investors
1. Whatever its current challenges, as an economic bloc, the EU remains the largest in the world. It is simply too large to ignore. And while the aggregate picture looks sluggish, Europe contains within it a number of attractive investment opportunities. If one looks at equities, earnings have been robust across most sectors, reflecting the exposure of companies to faster growing emerging economies. A number of corporates are in very strong positions and producing coupon-like dividend returns.
2. Current interest rate policies amount to financial repression. A further, related, challenge is the increased level of government intervention. In this environment, it is all the more important not only to diversify investments across asset classes and currencies, in particular to look for additional sources of income such as spreads and dividends, but also to manage risks in a dynamic fashion, in addition to hedging tail risks.
3. New regulation tends to follow rather than anticipate developments, with the risk of becoming the general who prepares for the previous battle. The current approach to regulation is becoming fragmented globally and risks failing to address the growth agenda so badly needed in Europe. We worry that the thought-through, global approach envisaged in 2009 has dissipated and we now have a slew of rushed-through, wide-reaching and complex regulations, which risk increasing costs, causing unintended outcomes and the real chance that they do not improve the client experience appreciably.
4. There is genuine concern about improving corporate governance and stewardship in the industry. Good corporate governance is relevant to long-term performance and, as managers of our clients’ money, we have a responsibility to consider all factors which have potential to influence and generate sustainable returns for them. The introduction of, and recently announced enhancements to, the Stewardship Code in the UK will help to enshrine investors’ engagement in corporate governance issues going forward.
1. In spite of persistent worries regarding the euro debt crisis, international investors have many reasons to continue investing in euro countries. Euro markets represent a major part of global fixed income and equity indices; the euro has been very stable against other major currencies and is a currency of choice for international investment; and euro markets present attractive valuations following recent underperformance. Europe suffers from too much pessimism - European countries will overcome the current difficulties. The crisis has led to increased divergence between countries, providing attractive diversification opportunities depending on risk appetite.
2. The current environment is of concern, especially for investors with liability constraints, such as pension funds. Equities have not delivered performance, while government bond markets cannot be seen as pockets for capital preservation. This impacts the way we build strategic portfolios. With high correlations, high volatility and sometimes ineffective diversification, asset allocation has had to become asset, risk and liquidity allocation. The only way to tackle such a specific environment is to stick with initial objectives and timelines, monitor risk very closely, and look at diversifying asset classes. Benchmarks also need to be revisited or even, in some cases, abandoned. Investors should pay more attention to absolute-return processes.
3. Financial service regulation must be improved for the industry to appropriately
serve the needs of the economy. But regulation should not miss its target. One should avoid over-regulating sectors or activities that are already well regulated (such as UCITS funds), while leaving aside under-regulated activities such as some investment bank products. More emphasis should also be placed on transformational and liquidity risks, rather than solvency issues.
4. We place great importance in the long-term performance of the companies in which we invest. A condition to that sustained performance is exemplary corporate governance
and strong social and environmental responsibility. Amundi realised the importance of corporate governance well before the last crisis. We established a dedicated team more than 15 years ago to help improve practices in investee companies through constructive dialogue and proxy voting.
AXA Investment Managers
1. There are four basic reasons for non-European
investors to buy European assets: Europe is too big to ignore; it is a necessary component of any well diversified portfolio; economic momentum is encouraging as we have come through the trough; and it offers investors rich pickings with good quality assets at attractive valuations. The key for investors is to select the best managers to identify these opportunities and hedge against potential risks.
2. In this context, investors have to take on more risk, expand in credit and return to equities, real assets and alternative assets. Sticking to what have been historically called risk-free assets has now become the most risky strategy. To implement these strategies, investors need to look for managers who have a proven process in taking a long-term view and whose skill and discipline prevent knee-jerk reactions to short-term market movements.
3. Much of the regulation being proposed makes theoretical sense and has the right intentions. However, regulators are not taking a holistic view on regulatory regimes when operating in their own jurisdictions. The financial industry is desperately in need of a more universal view of regulatory regimes and more realistic implementation frameworks. In any event, regulatory shifts will not prevent crises from occurring again - it is just another component of the ‘creative destruction’ cycle that shapes our economic development.
4. The asset management industry is much more focused on these issues than it has ever been in the past. Just look at the number of collaborative engagement initiatives today. Having said that, as an industry we are still at the early stages of what it means to be a responsible investor. There is still scope for asset owners to challenge their managers on active ownership and engagement, and still some work to do to enable these responsible investment concepts to become mainstream.
Baring Asset Management
1. It is possible to find cheap assets on the periphery, but usually for a reason. Should you buy a Greek island, a Portuguese bank, or a Spanish government bond? You’ll probably only do the former if you have decided to live there, and the others if they constitute a large weight in the index you are trying to outperform. Core Europe is different. With Germany set for a lower exchange rate and short-term rates than the country needs, everything is in place for a rally in asset prices.
2. The greatest challenge will be generating long-term capital growth in an environment of fiscal tightening, consumer restraint and poor demographics in the euro-zone. To tackle it, I’d diversify abroad, taking advantage of what will be artificially low exchange and interest rates to buy multinationals listed in Europe.
3. We are reacting to yesterday’s problems, but not always effectively. Few of the new regulations are actually bringing something fresh and interesting to the party. It appears that politicians, governments and regulators are still too timid to deal with issues such as banking industry concentration, and private and government shareholder activism.
4. Understanding the corporate governance structure of companies and judging whether the structure could inhibit the delivery of good returns, and whether the interests of management are aligned with those of investors in the company, has been an integral part of successful long-term investing since the first joint-stock companies were introduced many years ago.
Head of EMEA institutional business
1. The euro-zone remains an essential and large part of the world economy that long-term investors cannot ignore if they are to meet their outcomes. From an equity perspective, it is home to many attractive world-class companies that source much of their revenue outside Europe. In fixed income, while investors need to think carefully about sovereign credit risk, we see many opportunities for investors who have the right tools and skills to undertake relentless risk management and genuinely dynamic asset allocation. History also shows that pessimism often generates opportunities.
2. Low real rates, sovereign credit risk and risk on/risk off market volatility are the key challenges for investors. There are opportunities, for example in credit and equities, but it requires investors to dynamically take risk within a framework that is explicitly focused
on their outcomes. It also means revisiting governance structures to ensure they remain
fit for purpose. In practice, this will often entail delegation, either on a partial or holistic basis.
3. While this regulation is a legitimate response to the changing world, there is always the risk of regulation being drafted with a rear-view mirror. Therefore, it is essential that investors are fully involved in the drafting and implementation of that regulation. We believe that by sharing capital markets practitioners’ insights with regulators and legislators, investors can play a pivotal role in ensuring regulation is pertinent for the new world and enhances the ability of institutional investors to meet their outcomes.
4. The level of debate is a genuine reflection of the growing importance that investors attach to sound corporate governance, as there is now an extensive body of academic research available that links well governed companies with better long-term performance. As an independent steward of our clients’ assets, we believe it is our fiduciary duty to help foster good governance in the companies in which we invest on their behalf, regardless of whether they entrusted us with an active or passive mandate.
BNP Paribas Investment Partners
1. There are three reasons. Current excessive negativism: markets want a lasting solution to the euro-zone crisis tomorrow, but this will take time. They also underestimate the determination to eventually get there, hence sentiment swings can be huge. Two, equity valuations are significantly cheaper than in other developed markets. Three, for portfolio diversification reasons and risk control reasons. If the strategic benchmark includes European assets, one needs sufficient exposure to Europe against the background of the valuation discount and excessive negativism.
2. To find the right balance between managing risk aversion and achieving positive real returns requires taking some risk, against the background of a regulatory framework, which in many countries is procyclical, and forces risk reduction when markets decline. This should be tackled by smart diversification, and particular attention to conviction levels about expected Sharpe ratios of various asset classes and dynamic risk management.
3. After a crisis there is an inherent risk of fighting yesterday’s problems. It is clear one needs to avoid being hit by the same problem, if only because the available ammunition is less plentiful than before. Yet, it is important to factor in the long-term consequences of regulatory change. In a world of bank deleveraging, the role of capital markets to finance the economy increases, so one must be vigilant that the ability to take risk meets this need.
4. Definitely. Engagement and the use of voting rights are more and more used by investors to make their point, both in developed and emerging markets. More broadly speaking, ESG (environmental, social and governance) considerations are becoming a second family of parameters and risk factors, which alongside the traditional economic and financial parameters guide investment decision making. There is increasing evidence that company CEOs are aware of this and react to the opportunities this creates in terms of communicating with the investors.
1. Overall growth will be slower in Europe, but the region is highly diverse and continues to offer some compelling investments. In fact, given current central bank policies, bond investors may even find certain European sovereigns more attractive than sovereigns elsewhere in the West. At the macro level, the ECB’s liquidity injection has significantly decreased the risk of a near-term disaster in the euro-zone. But this (relatively) benign environment is unlikely to continue indefinitely: some of Europe’s basic problems remain unresolved.
2. Low yields change the game for bond investors. Real rates are negative over much of the curve, income cushions are wafer thin, and interest-rate risk is highly asymmetrical and there is more room for rates to rise than fall. The solution is three-fold: diversify more widely by region, security and strategy; check that guidelines allow sufficient flexibility to generate return and manage risk; and consider moving away from traditional benchmarks towards absolute return approaches or fundamental/risk-based indexing.
3. As ever, some of the new regulations will be positive, some will be less than helpful, and some will be irrelevant by the time they are implemented. The thing to remember is that regulation is an evolving process. Ultimately, regulators, institutions, consultants and asset managers are all working toward a common goal in securing the best long-term outcomes for investors. So I have every confidence the net effect will be positive.
4. Asset managers are (and should be) taking corporate governance extremely seriously. There is strong evidence that non-financial factors - like a company’s environmental policies, as well as other governance issues - can have a significant impact on asset values. Consequently, we have seen an increase in demand for strategies that take account of ESG factors. More of our clients are recognising that these factors are highly relevant both in terms of managing risk and generating returns.
1. Attractive global companies - the market leaders - are domiciled in core European countries with good capital structure. The valuation of European companies is relatively attractive, especially for globally-focused business models. Europe remains a global market leader in technology and production.
2. External political influences and the resulting increase in volatility and asset correlations pose the biggest challenge. Investment vehicles: (AAA) government bonds have definitely lost their status as risk-free assets. Nevertheless, institutional investors still have high demands. This leads to another serious challenge posed by risk limitations, combined with the desire for a higher return. Investors should increase their focus on absolute return strategies, while investing in more risky assets, such as emerging markets and high yield.
3. Regulatory problems are not new but they have hardly been tackled. Current significant changes are in relation to Basel III - tier-one capital and equity ratios, solid liquidity ratios, low debt - and Dodd Frank - a ban on own-account trading in relation to high transparency due to central clearing house proposals, and a lack of tax money for bank bail-outs. A long-term disposal of risk-weighted assets and deleveraging of banks in non-core countries is therefore to be expected. Business growth is now focused on return and liquidity.
4. The quality of corporate governance is undeniably a major factor for companies’ success and the development of share prices. This is therefore an important criterion for investment decisions and the internal orientation of asset managers themselves. Within the asset management industry, strict corporate governance standards have already been expanded - for example, functional delineation, compliance, and conflicts of interest. Within the context of ESG, we are witnessing increasing interest in governance aspects from investors and asset managers, next to social and environmental aspects.
Dexia Asset Management
1. Today, the euro-zone risk premium is high. Nevertheless, the increased level of pessimism among international investors and the low exposure to European assets (equities or credit) make the valuation and potential re-rating of the euro-zone attractive over a longer-term perspective. I would remain selective and opt for internationally exposed and growing European companies. Their financial situation is globally healthy and they have proven their resilience during the last crisis.
2. Current risk premia are extremely volatile and difficult to capture without
suffering large drawdowns from time to time. The best way to profit from these attractive but unstable risk premia is through a very dynamic asset allocation process, supplemented, if need be, with a dynamic risk-budgeting process to control and avoid short-term downside risks.
3. Indeed, many new regulatory rules are being imposed and it is questionable whether this is the right timing. Sometimes it does feel like we are fighting yesterday’s problems, but these reforms were duly necessary, in particular for banks with regards to their capital requirements and leverage ratios. I would definitely urge the supervisory authorities not to be overzealous and to avoid too rigid ‘risk-based’ supervisory regimes, such as the first versions of Solvency II and IORP II, which tend to be much too pro-cyclical and lead to systemic supervisory risk.
4. Throughout different market cycles I am, more than ever, convinced that good corporate governance is our responsibility both as a corporate citizen and as a competitive differentiator. While focused on growing our business in a difficult economic and corporate climate, we will take no shortcuts in responsibility to achieve our goals. The mark of a great business is not how you perform during the good times, but how you deliver results when times are tough.
1. Most European countries are currently restructuring their public deficit, taking hard decisions and modifying the trend of the last two decades. They are implementing some structural changes through new laws in pensions, labour law and in more open competition. Europe should become much more competitive in the next years and valuation of risky assets is quite low, below book value. This is the right timing.
2. In the current period of low risk-free yields and slower economic growth, which means low visibility with more regulation, one of the greatest challenges for institutional investors is to retain a completely diversified asset allocation. There is a clear preference for bond and debt products at the moment. But with such a low risk premium, it is always dangerous to concentrate investments in the same asset class, which would not remunerate the underlying risk.
3. We needed more regulation after the uncontrolled increase of banking balance sheets over the past decade and the consequences of this. And as usual after a crisis, we are experiencing a period of excess regulation. Adequate levels of capital, transparency of financial products and keeping various risks under control are clearly key points to be addressed. But it is crucial to make sure economic forces remain the main drivers of asset prices. Prices led by regulation are not a sustainable solution.
4. Step by step, institutions have adapted their governance to the post-crisis environment. Corporates are taking SRI (socially responsible investment) issues more and more into account. Committees dedicated to conflict of interests, sustainable development, corporate governance and independent members within management boards are rules already applied, and they highlight the fact that this industry is ahead of the curve and not behind. There is always room for improvement but we have already implemented real and concrete changes in the past few years.
Hermes Fund Managers
1. A bond investor might want to invest in periphery paper on a view that a breakdown of monetary union is unlikely, thus picking up an additional coupon for essentially the same risk as the core. This would be something of a judgement call. An equity investor might hold off investing, knowing that the regulator in Europe is positively encouraging long-term savings pools to disinvest from equity which would, at a lower price, offer value for a long-term investor.
2. First, regulation such as Solvency II is encouraging divestment of assets that participate in economic growth in favour of lending money to the financial sector via government paper at depressed rates. Second, there is a misunderstanding about what the basis for investment decisions should be. To tackle it, actors should revert to the old fashioned investment theory: all investment is a judgment about return against risk of capital loss, much of which is to do with human nature or politics, and so cannot be modelled.
3. Worse, we’re fighting a battle that exists in our minds and ignoring the precipice on which we are standing. Regulation is attempting to use voodoo (VAR and so on) to control what cannot be controlled (volatility), while encouraging long-term disinvestment from risk capital. It is not that the regulators are being irrational, it is that each regulator, politician, investor, and so on, is acting rationally but within the narrow confines of their particular objectives. When you add all these up, the totality is irrational.
4. Some do, certainly in pensions. Asset managers certainly espouse it. The fear is that, rather than becoming a working norm, it degenerates into a slick sales phrase that has little real bite or relevance.
HSBC Global Asset Management
1. In addition to offering portfolio diversification, the cheaper valuations on European equities and the higher yields on European bonds are attractive, provided investors have the risk appetite for this and do not expect Italy and Spain to default. In addition to European equities being attractively valued across the board, we believe there are many attractively priced, good-quality companies with exposure to the rapidly growing emerging markets, particularly in the luxury goods, high-end automobile or construction space. Share prices of these companies have been affected due to negative sentiment on Europe, but firms with emerging-market consumption exposure should continue to enjoy strong revenue streams.
2. Depressed risk-free rates are an issue for ‘safer haven’ countries such as the UK, Germany, the Netherlands, Finland or Switzerland. In these countries, the challenges are for pension fund and insurance investors to easily reach their target returns through buying government bonds. An additional challenge is the synchronisation of assets. Risk assets are trading with much cross correlation, so effectively diversifying a portfolio has become quite difficult. Amid these conditions, coupled with volatile markets and expended periods of lower economic growth, effective asset allocation becomes increasingly important, and this is often the most important investment decision for delivering good risk-adjusted performance.
3. Previous problems have highlighted the need for tougher regulations and we welcome anything that provides better protection for the investor. However, we are concerned about the cumulative and unintended consequences brought about by the many different regulations we are now facing.
4. Many investors, including asset managers, do take corporate governance seriously - look at the huge increase in signatories to the UN Principles for Responsible Investment. This may be partly in response to the financial crisis - certainly regulators are looking more at the role of investors. Good corporate governance practice is also increasingly a requirement to access defined contribution platforms. For us, it’s about understanding companies’ commitment to their shareholders over the long term. That is particularly important for the emerging markets where we have an emphasis on investment.
CEO and CIO Investments
1. It is a mistake to consider euro-zone assets as one homogeneous asset class: it includes a range of different opportunities. A general lack of interest in euro-zone assets should motivate investors who are willing to seek hidden opportunities and misvalued investments. Distortion in markets is often a good or great source of opportunities. Many European assets are now undervalued. For example, the European asset-backed securities (ABS) market, of which euro-denominated assets constitute a substantial proportion, includes many undervalued assets of exceptional quality.
2. The greatest challenge is to build portfolios that successfully generate returns and exhibit downside protection in the face of uncertainty. Given the current situation, investors are likely to benefit from seeking out sources of reliable income, tangible assets that offer real capital protection and growth such as infrastructure and farmland, and investments that will take advantage of the growing divergence in growth prospects between developed and developing countries.
3. We would probably all agree with the goals behind the current wave of regulation: namely, increased market transparency, reduced systemic risk and reduced counterparty risk. These are hardly yesterday’s problems. However, the unprecedented scale of proposed changes, coupled with the short timescale for consultation and implementation, raises concerns as to their impact on market liquidity and trading costs. Regulators should also remain alert as to the unintended consequence of their actions, and there will be many.
4. Absolutely. Businesses have a substantial impact on the communities in which they operate and, as a rule, the industry has taken this into account. Many asset managers openly encourage companies to adopt better standards of corporate governance and transparency. By doing so, investors can help businesses to grow and generate better returns over the long term. We have always been a strong proponent of socially responsible investing and encourage good corporate governance.
Kempen Capital Management
1. Investors always look for bargains. There is a lot of value to be found in the public equity markets in the euro-zone. The long-term expected risk premia on European large and small-cap equities are quite interesting for non-euro investors. The second area of interest is corporate debt in general, and specifically European distressed debt. Over the coming years there will be a lot of forced selling of assets by European financials.
2. We are involved in a race to the safest haven based on the false ideas of safety imbedded in regulation (Solvency II, Dutch FTK). Eventually the government bonds of the safest haven will prove to be the biggest bubble hitherto, which will have disastrous effects on the real outcome of pension and insurance arrangements for a lot of people. So the challenge is to lower interest-rate-matching percentages at the expense of increasing regulator risk.
3. Not only are we fighting yesterday’s problems, we are very possibly creating newer, bigger problems. The situation we have right now suffers from a lot of endogeneous factors. For example, under Solvency II all insurers will have to do the same things at the same time - ie, buy interest rate protection and sell risky assets, which, of course, create a lot of risks for the system. The biggest question with all new regulation is therefore whether it is capable of dealing with these internal risks. Not only is this question largely unanswered, the layering of all new regulation makes it impossible to analyse. So, it is quite imaginable that the next crisis will be more severe because of the endogenous risks and the layering of so much new regulation.
4. The most important challenge in the pensions and asset management industry is to shift from today’s short-term product orientation to a long-term client focus. This is one of the three goals of a group of international CIOs who have created the 300 Club. The CIOs have put forward some profound questions with regard to the governance of our industry. We very much support this initiative.
Legal & General Investment Management
Managing director, head of global institutional business
1. Asset prices do not always reflect the underlying economic fundamentals, and while there is little doubt that the euro-zone is still in crisis, despite the ECB’s intervention, high quality companies still exist within the region. In addition, the euro-zone represents a significant proportion of global markets (in terms of equity, credit and global GDP), and to ignore such a significant portion would be counter-intuitive to well-diversified investment. Rather than disregarding the region, focus should remain on high-quality investment allocations to source value.
2. As it becomes more difficult to generate returns, there may be a temptation to take riskier bets, and thus getting the risk and return decision right continues to be the biggest conundrum facing institutional investors. As a result, dependable funds and managers are crucial, and effective risk management plays a key role in achieving this. Indeed, we are seeing a great interest in risk management and ongoing monitoring from our clients. This suits our business model well, as it is already integrated into the management and construction of our funds.
3. Whether the introduction of new regulation proves reactive to old problems, rather than proactively anticipating potential woes, does not detract from the influence it has on our business, and thus great importance is placed on ensuring we understand the consequences of regulation and implement the necessary changes. For example, consideration of the extent to which the implementation of Solvency II will transfer investment from the adversely affected asset-backed securities (ABS) to covered bonds, or how Basel III’s effect on bank’s minimum capital holdings will influence return on equity, will influence our positioning.
4. We certainly do. Corporate governance provides the opportunity for shareholders to prompt companies to add sustainable value. We believe the asset management industry must take this seriously, even leaving aside shareholder duties, as clients increasingly demand and expect effective governance. LGIM believes that building and maintaining relationships with companies in which we invest allows us to better understand and respond to their concerns. In addition, better communication enables companies to get a sense of whether investors feel the company is performing well and/or operating efficiently.
Ines de Dinechin
1. The European situation remains dire. The debt crisis has inflicted structural damage and the credit crunch and fiscal austerity will, in all likelihood, depress economic activity. Yet, after decisive ECB interventions, tail-risks have declined. European assets nevertheless still trade at a significant discount to the rest of the world. This probably already fully reflects the more difficult backdrop for the region. In an environment where ‘safe’ government bonds pay negative real returns, Europe offers attractive opportunities to selective value investors.
2. Against this backdrop, the greatest challenge for European institutions will be to meet their liabilities sustainably. This is all the more true in that strong regulatory headwinds are blowing. To control their funding ratio efficiently, they will first have to revisit their asset allocation policy and try to design truly diversified portfolios. They will then have to implement dynamic risk-management strategies that take into account both short and long-term constraints in an optimal manner.
3. We can’t say that we are fighting yesterday’s problems. The issues that are addressed by regulators are permanent and it is important to address them in a consistent and sustainable manner. As of now, asset management regulations do not seem over-reaching. The UCITS Directive is very much alive and efficient. UCITS IV was an excellent improvement and we generally welcome the recent improvements to the framework proposed by ESMA in its consultation on ETFs and other UCITS. We also expect the AIFM directive to become a success, if implemented in a reasonable manner, as proposed by ESMA.
JP Morgan Asset Management
Global head of institutional business
1. The euro-zone offers significant diversification benefits across most asset classes including equities, fixed income, real estate and private markets. Institutional investors globally are increasingly aware that these and other asset classes are not necessarily linked to or impacted by euro-zone sovereign problems. As such, we are seeing particular opportunities in European dividends, senior loans, mezzanine debt, infrastructure debt and equity, and other opportunities resulting from the ongoing banking sector deleveraging and de-risking.
2. The largest challenge for institutional investors is finding sufficient yield and income, as well as managing volatility. This is particularly difficult in an increasingly constrained regulatory environment. Institutional investors, particularly insurance companies, are tackling these problems by identifying varying sources of income/yield and assessing them in the context of the new regulatory environment, volatility and expected returns. This is leading them to (increase) allocations to corporate debt, emerging-market debt, high-yield debt, mezzanine finance, senior loans and infrastructure debt.
3. Current regulatory pressures and proposed changes are trying to anticipate tomorrow’s problems. However, there is a lot of second-guessing as to the final shape of new regulations - Solvency II for insurance companies is still being finalised, and the revised IORP directive is still in its early stages. Market failures usually lead to increased regulation, but such regulation needs to be proportionate. At present, regulations such as Solvency II appear to be at risk of disproportionately impacting investors.
4. Corporate governance is taken seriously, particularly if there is public and political pressure to hold long-term investors to account. Although the social and environmental cases for strong corporate governance and ESG protocols are obvious, the investment case remains unproven. While this continues to be the case, there will be tensions between the two camps.
Natixis Asset Management
CIO equity, asset allocation and structured products
1. Outflows from euro-zone assets since the start of the sovereign debt crisis have created significant relative discounts among assets globally, while many European companies tend to be international players. These discounts should provide historical opportunities for credit and equity investors, assuming an implosion of the euro-zone is avoided, and on condition that investments are hedged against a depreciation of the euro. The latter condition could be a positive for competitiveness and hence a strong catalyst for relative outperformance of euro-zone assets.
2. Risk premia are not considered low, especially with regard to equity or credit risk, which are both attractive compared with historical averages. The greatest challenge for institutional investors is less the absolute level of risk premia and more their capacity to reconcile the profitability of strategic investments, often linked to long-term liabilities, with short-term market volatility. Flexible asset allocation, tactical protection and smart indexing will, no doubt, provide efficient tools to cope with the challenging new environment.
3. Without making a judgment on the content of these new regulations, the timing of their implementation is often critical, as well as the question of their pro-cyclicity. Overall, regulatory reform attempts to learn lessons from the past, but to the extent one cannot predict the nature of the upcoming crisis, greater commitment of institutions as responsible investors should provide for greater stewardship.
4. Corporate governance is indeed a main concern for investors and portfolio managers alike, as reflected by strengthened regulation, such as the stewardship code in Britain or the Grenelle II legislation in France, multiplying voluntary efforts such as the growth of a proxy voting and engagement process. The progress made is still insufficient both in scale and depth because giving weight to these issues in investment decisions implies questioning passive management and benchmarking. Since this runs counter to the prevalent dynamics of the past two decades, ‘mainstream’ actors will require time to adjust.
Managing director and head of London-based business
1. Non-European investors would invest in European assets on the basis of their valuation levels relative to other market opportunities, taking into account potential returns versus the risks taken to achieve those returns. Clearly, given current uncertainties arising from the euro-zone crisis, many investors will judge the downside risks too high relative to the potential returns.
2. European institutions are not alone with these challenges, but the uncertainty around how the politics of the euro-zone crisis will play out adds additional difficulty for institutions in Europe. Traditional approaches to asset allocation need to be transformed to embrace a dynamic approach incorporating more diverse risk factors, such as real assets and tail-risk hedging.
3. Yes, we are fighting the problem of too much leverage and systemic risk at the heart of the financial system. In many cases, public money has had to come to the rescue of private failure, which naturally leads to new regulation. The fact is, we are running out of balance sheets to rescue future mishaps, so policymakers feel compelled to use regulation to create a less free-wheeling financial system which, unfortunately, will come at the expense of higher growth.
4. Yes, many do take corporate governance seriously, but the question might better be ‘how seriously is seriously enough?’. The failure of corporate governance in the cases of RBS and Northern Rock have become poster children for the debate, but what level of engagement and proactivity would have been needed to change the fate of those institutions, and is it realistic for investors to engage in this way with a whole portfolio of shareholdings?
T Rowe Price
President, international investment services
1. To take advantage of depressed valuations on high-quality multinationals with powerful brands that are well positioned for emerging market growth, particularly in the consumer and industrials sectors. Growing emerging market consumerism and the attraction of European brands is a durable trend. When markets embrace the worst possible scenario for Europe’s troubled economies, risk assets sell off, creating opportunities for long-term investors. Overhanging risks related to fiscal and economic challenges are impacting many euro-zone companies, even those that generate their growth outside the euro-zone.
2. The greatest challenge is managing conflicting goals related to volatility. Specifically, plans need to invest for the long term, while regulations are forcing short-term solvency and safety goals to take priority. Balancing return and liquidity is challenging. While long-term relatively illiquid assets can be attractive from a pension plan perspective, investors may want to consider publicly traded vehicles for infrastructure and other real assets classes that can provide return plus the regulatory appeal of liquidity and control, and at a lower cost relative to private investments.
3. Yes we are, but it is difficult for regulators to identify tomorrow’s problems; neither the industry nor the regulatory authorities foresaw the global financial crisis. What we do know is that if new regulations result in conflicting short and long-term goals that effectively reduce the toolkit of investments available to pension plans, making it more difficult to generate sufficient returns, then plans will be forced to reduce benefits, extend retirement age, and take on more risk to meet obligations.
4. Yes, in fact there are few asset owners and asset managers that don’t take governance seriously today. Governance issues can be an important driver of performance for long-term investors. Holding management accountable to a range of objectives is both a risk mitigator and a return generator. Corporate governance is deeply rooted in our investment process. We express our views to management through regular dialogue, engagement, and proxy voting. Why? It improves the odds that our investment objective will be achieved.
Russell Investments EMEA
1. Investors can’t just ignore the euro-zone, the world’s second largest economy, trading zone and industrial production centre. Although there is ongoing turmoil and uncertainty, investors should not be put off this core global market. Indeed, the top six euro-zone economies have returned double-digit performance so far this year. In the short term, yes, there is uncertainty and greater volatility for investors - but they should look at ways of taming that volatility while remaining invested.
2. The last few years have proved there is no such thing as a risk-free asset any more,
starting with sovereign bonds and AAA-rated notes. At the same time, there is limited
reward from low-risk strategies and in real terms they probably provide negative returns. The greatest challenge is to re-risk portfolios, ride the volatility and find opportunities to do it on a consistent and systematic way. The solution is definitely in adopting a dynamic management of your asset allocation, as the opportunities are out there for investors to exploit.
3. They are more the problems of today and tomorrow than of yesterday. Regulation is good; with a bit more regulation and supervision, many investors would not be in such a dire state, and it is bad regulation that is harmful. The challenge for the industry - both providers and regulators - is to make sure we do not stifle solutions for investors through over-prescriptive regulation. In our ever-changing world, with no risk-free asset left, regulation must be fluid, empirically based and allow for flexibility and adaptability. Solvency II, by allowing a departure from the standard formula, is an interesting model in that sense.
4. They should and they do, by and large. Governance is a crucial element of investment decision-making and without a rigorous governance structure in place it would be very easy for pension funds and asset managers to act without due consideration for the people whose money they are ultimately investing. The governance and controls now need to extend to actuaries and investment advisers and, to an extent, organisations such as ratings agencies, as well - none of whom should shy away from their responsibilities. Never forget that funding ratios have fallen dramatically in the UK pension industry over the past 20 years, despite extensive use of professional external actuaries and investment advisers.
1. Too often, institutional investors treat upside and downside risk as if they were the same, but they should not. While European markets could experience a relief rally if the euro-zone’s problems are finally dealt with convincingly, for the moment the economy is mired in recession and euro-zone event risks are growing once again. Diversification for diversification’s sake is not smart.
2. The economic and market environment in Europe is likely to remain challenging, perhaps to the end of the decade. And when we do get back to business as usual there will be a major bear market in government bonds as yields normalise. Return expectations need to be reduced, and that implies that either contribution rates must rise or savings expectations must fall.
3. There is a need for better, smarter regulation. The trouble is, while we will definitely get more regulation, it will not necessarily be better. Politicians do not appear to be good chess players, able to think several moves ahead. We should beware unintended consequences. Remember the lessons from Sarbanes-Oxley and over-reliance on value-at-risk. We all need to play our part in trying to shape a better regulatory environment.
4. Yes they do. A lot of good governance work goes on in many firms. The trouble is you can’t observe the counter-factual and therefore easily measure its success. That said, we do need to improve governance further. While it is asset managers that undertake engagement, more than anything else we need greater involvement from asset owners. Greater client interest will get asset managers to raise their game more than anything else.
Standard Life Investments
1. Europe has valuation support offering access to world-class companies with much wider exposure than just the European economies. Europe, ex financials, is on a prospective P/E of 11.4x with a dividend yield of 4%, supported by strong balance sheets. This is attractive relative to most government bond markets. The European stockmarket is not the European economy. More than 40% of sales are outside of Europe. Within Europe there are world-class companies that offer attractive returns to shareholders.
2. By standing back, not getting drawn into momentum trades, using valuations, and including some solid scenario analysis. Markets are volatile, economic growth is lacklustre, and interest rates will be lower for longer. However, we can still make a portfolio from this: underweight, expensive government bonds, overweight selected equity markets and real estate, especially higher yielding corporate bonds. Fund managers are finding attractive opportunities that volatile markets inevitably create.
3. It is understandable and important that regulators strive to ensure that the lessons from the crisis are not only learnt but also used to insulate the system from a recurrence. A big danger, however, is that in doing so, risk appetites are excessively reduced at the very time the world needs risk capital and the opportunity for long-term investors is improving.
4. Yes, but some take it more seriously than others. We played a leading role in the development of the UK Stewardship Code for institutional investors. A key issue is integrating stewardship into the investment process, and getting the right balance requires careful management attention. I believe we have achieved this, which is testament to the seriousness with which we take our governance and stewardship responsibilities.
1. Due to the extreme pessimism regarding the future of the euro-zone, stock market valuations are at very depressed levels. Although the euro-zone crisis is not yet solved, the first reforming steps to increase competitiveness in the European periphery have been taken. With the EuroStoxx 50 index offering a dividend yield of more than 5%, an investor does not only get a significant recovery potential but also an attractive current income.
2. Many institutional investors are squeezed between the current low market yields and the returns they have to deliver to their beneficiaries. To achieve the necessary returns they would have to take on more risk but many pension funds are not capable of doing so due to low coverage ratios. Given the demographic trends in most developed countries, the coverage gap is likely to increase in the next few years.
3. Regulation very often focuses on past problems and crises - this time being no exception. Some rulings such as increasing the banks’
capital requirements or separating investment and retail banking will certainly help to avoid future crises and are basically a return to the situation before the great deregulation of the financial sector in the 1990s. However, other challenges, like demographic developments that threatens the stability of the social system are still not being approached with the necessary force.
4. Corporate governance - or the lack thereof - will be one of the important challenges in the coming years. Many of the problems leading to the financial crisis, such as over-leveraging or excessive risk-taking, are basically agency problems resulting from the lack of control, given the highly fragmented ownership of big financial companies. But there is an increasing trend for large pension funds and other institutional investors to execute their ownership rights to influence corporate governance in the interest of their beneficiaries.
1. We have been sceptical about the ability of the euro-zone authorities to solve the debt crisis, and moved to a relatively modest underweight as the LTRO came to fruition. The positions that we keep are heavily skewed to German stocks and away from the periphery: monetary policy is inappropriately loose in Germany and this has been helping to support earnings. In addition, there are some world-beating companies located in Europe whose valuations have been made attractive by the crisis.
2. For many years, government bonds delivered real returns and tended to perform well when equities fell, smoothing returns for balanced investors. Today, government bonds neither deliver real returns nor have sufficient nominal yield left to smooth return profiles. However, equity risk premia are meaningful and should deliver high returns over the next decade. The challenge will be to harness these strong returns without hair-raising volatility. Investors should look to active asset allocation using a palette of assets across geographies and asset classes, combined with strong risk controls.
3. Yes, some three years after Lehmans ignited the crisis, we are now in the midst of dealing with the regulators’ response to it. Further reform is being driven by an ambitious political agenda. It would be foolish, however, to argue that most problems are behind us. Instead, it is now a question of ensuring that the new regulations are well understood and the implementation timetable is realistic.
4. There is a core of public and private pension schemes, as well as fund managers, who do recognise the value of effective corporate governance and stewardship. However, not enough have in the past. The FRC’s Stewardship Code is a recognition of the need for investors to up their game, but I’d want to see whether investors actually step up to the mark before saying things have really changed.
Member of the board of managing directors
1. Many European listed companies are global players. Therefore, their business is often more closely linked to global than to European developments. This is why they can decouple growth from the economic situation in Europe - in particular German corporates, including mid and small-caps. Despite the European sovereign debt crisis, their earnings grew again last year.
2. Investors have had a pretty tough time recent ly, during which German government bonds have yielded less than the required minimum rate of return, which is usually at least 4%. This means their income reserves have largely been depleted. Now the crucial factor is to deliberately exploit market opportunities and to mitigate unwanted risk. Dynamic capital preservation strategies and asset classes such as covered bonds can contribute to close the gap between safety considerations and the need for adequate returns.
3. We believe that UCITS regulation and other regimes such as EMIR already provide sufficient regulation to satisfactorily manage risk. Further, the AIFM Directive will introduce a similar level of regulation to non-UCITS. We welcome initiatives to establish a stable framework for all kinds of funds. But introducing new requirements outside the UCITS framework could lead to an increase in concentration risk resulting from fewer asset classes. In fact, such a concentration of risk was part of yesterday’s problems.
4. Institutional investors are increasingly
adopting an approach to encouraging sustainability that has not been very widespread until now in Germany. An increasing number of investors has joined UN PRI. We follow an active engagement approach, trying to influence companies to apply environmental and social criteria, as well as principles of sound corporate governance, by means of regular discussions with the management, by voting and through our frequent speeches at annual shareholder meetings.
1. A better question is why a non-European investor would not have exposure to the euro-zone. Excluding a significant portion of the global equity opportunity
set is appropriate only if an investor knows what the future will be. While an investor could reasonably decide to temper (or moderately boost) exposure to a region or factor, excluding an entire segment of the market due to assumed clairvoyance represents simple hubris. Such a bet is wrong from a fiduciary perspective.
2. The greatest challenge for investors is to keep a long-term, balanced perspective. Markets have always been and will continue to be volatile, reflecting changes in expectations. In addition, lower economic growth does not mean that returns will be lower. Investors should focus on achieving long-term success (such as funding a pension shortfall) rather than shifting assets to reflect the current consensus.
3. While new regulation is often developed in the wake of events, asserting that all new regulation is simply reactionary is wrong. It will always be a challenge to identify future regulatory gaps.
4. We do. Investment firms need to have very clear philosophies on governance, compensation programmes and other key issues. These guidelines should be transparent to clients and the firms in which they are investing.