Though markets have made up much ground lost in 2008 and early ’09, the ride has been bumpy. Investors as a result have changed the way they invest — and their demands on managers.
At the same time, money managers say pension funds’ expected rates of return, often as high as 7.5 percent, are unrealistic. And the funds are intended to support beneficiaries who may live 30 or more years in retirement, longevity never seen before.
“You could rely on equity markets giving you somewhere around 7 percent most years,” says Robert Fairbairn, senior managing director and head of the Global Client Group at BlackRock, which is No. 1 in the II300, Institutional Investor’s annual ranking of the 300 largest U.S. money managers, with $3.5 trillion in assets as of year-end 2011. No longer. “All that adds up to a requirement that assets have to work harder,” he says.
No wonder investors are moving to lower-cost, passive strategies when active managers aren’t consistently outperforming benchmarks. They also want managers to provide advice and investment solutions across multiple asset classes. “There is demand for consistent alpha generators like hedge funds and for high-quality active management,” Fairbairn notes. “There will be a real winnowing out of mediocre players.”
In addition, more investors are judging manager performance based on their own needs — such as income to cover the operating expenses of a university — rather than on how well a manager has been doing compared with its peers.
With first-quarter 2012 gains wiped out in the second quarter, investors are also increasingly aware of the bite that fees take. Volatility may not hurt long-term investors, but older investors nearing retirement can’t afford the sort of severe and permanent hits to their net worth that they took in 2008.
With that in mind, money managers are launching products designed to manage price fluctuations. Pension funds, for example, want liability-driven strategies, which generally include long-duration bonds and derivatives to hedge volatility. Says Ronald O’Hanley, president of asset management and corporate services at Fidelity Investments: “The challenge for all of us is to make sure we have strategies that will deliver managed volatility, and that investors understand they are giving up some element of the upside.” Fidelity is No. 4 in the II300, down from No. 3 last year, with $1.4 trillion in assets.
Uncertainty is leading to new requirements for asset managers as well. “There’s not an institution worldwide that isn’t looking for some degree of input and guidance around asset allocation,” says Michael O’Brien, global head of the institutional business at No. 6–ranked J.P. Morgan Asset Management, with $1.3 trillion in assets. Though portfolio diversification has been talked about for decades, investors are still largely holders of stocks and investment-grade corporate and government bonds in developed countries. Now they’re shifting into other sectors, including real assets, private credit and high-yield bonds.
Investors want managers to anticipate such opportunities, though they may have to streamline their governance so they can more quickly jump on them. O’Brien adds that many missed the 2009 opportunity in distressed debt partly for lack of flexibility.
Not all investment managers see the future as significantly different from the past. Michael Roberge, president and CIO of MFS Investment Management — No. 27 in the II300, with $251 billion in assets under management — says, “Investors are fighting the last battle.” Roberge’s view is that the upheaval of the 2000s, starting with the tech crash, is a cyclical phenomenon — “We’re going to stay true to what has made us successful: running long-only strategies, staying fully invested and adding alpha relative to a benchmark.” • •
