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January 20, 2013 3:21 am
What is a risk-free asset? For Northern Trust’s Wayne Bowers, the question has become so skewed by the financial crisis and consequent ultra-low interest rates that the answer might even be equities – although those of the largest companies.
What is important about this view is that Mr Bowers, who runs the international asset management business of Northern Trust, a US-based fund manager and custodian group, is trying to answer this question for some of the world’s biggest investors.
“Whether you’re a Middle Eastern sovereign wealth fund or a Scandinavian superannuation scheme, your problems are very similar,” he tells the FT on a visit to the group’s enlarged new offices in Hong Kong. “You are struggling to find yield, trying to reduce volatility and facing ongoing geopolitical uncertainty.”
Northern Trust Asset Management is among a wave of large fund groups that are winning increasing amounts of money for newer forms of passive investing. This style has been rather wonkishly described as “managed beta”, although Mr Bowers uses a more plain-English formulation: active design, passive management.
What this describes is a strategy of making big decisions about asset types, industrial sectors and countries, then using indices or exchange traded funds to buy low-cost access to the markets. BlackRock, Vanguard and State Street are among the leading purveyors of this approach and have become giants, each with assets under management in the trillions of dollars.
Northern Trust is a relative minnow, with “just” $750bn in assets under management, about $150bn of which is outside the US in Mr Bowers’ business.
There is growth here as investors have become disillusioned with paying high fees for active managers who ultimately often only deliver market returns – or “beta” – and then sometimes lose more than the market.
Mr Bowers says big clients, especially, are increasingly saying that their decisions about asset allocation are more important than their decisions about managers. “We have seen over the past few years that no matter who the manager is, if you’re in the wrong asset class, you’re toast,” he says.
Active managers as a group have seen big outflows in the past few years. According to Lipper data, Asian investors have pulled almost €41bn from active managers since the end of 2007, while in Europe, investors have pulled nearly €132bn from active managers since 2006.
Not all of this has gone into passive index funds or ETFs, but a good chunk has. In Asia, about 27 per cent of all externally managed money, or $185bn, is now with index trackers or ETFs, while in Europe the share is 18 per cent or $427bn, according to Lipper.
Increasingly, this money is going to come to equities trackers, Mr Bowers reckons, because the alternatives are so poor.
Even holding cash has become a costly business, and clients are struggling with the concept that they have to pay for the privilege, he adds.
“You hold cash for principle preservation and liquidity – but now you face the question of whether to take more risk and let go of principle preservation, or to pay the costs of holding cash and so still let go of principle preservation,” Mr Bowers says.
This is where large-capitalisation listed companies start to look much less risky. “Large-cap equities benefit from low rates because they are able to borrow very long-term, low-cost funding, which helps the return on equity and can allow them to take more risk with investment,” Mr Bowers says.
Companies must be viewed more from the point of view of where their revenues come from than from where they are listed, he says. It is easy to discard companies from, say, Spain, but you can take European equity risk without taking European economic risk, he adds.
“The S&P 500 has outperformed, but that has not been about US growth, it has been about those companies where they do business and where they employ people.”
Indices are increasingly bespoke affairs, designed for the specific wishes of the investor – hence the active design, passive management tag. The biggest investors are getting smart about what this allows them to do.
They can construct an index that includes European companies with operations in growth markets, for example, but they can also better manage the tail risks of another extreme economic or financial event.
“It could be as simple as an interest rate or foreign exchange overlay, or it could be a client says: ‘I want to go risk on, give me European equities but ex-financials’,” Mr Bowers says. “That’s tail-risk management.”
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