A basic premise in the theory of evolution is that species must adapt to a changing environment in order to survive. This holds true for companies as well as flora and fauna. Eastman Kodak, for example, filed for bankruptcy protection last year after adapting too slowly to the shift from 35mm film to digital photography. Service industries, including financial services, are no exception. Asset management companies in particular need to evolve.
Evolutionary pressures come from three primary areas: demographic changes, endogenous changes specific to the asset management industry, and economic changes.
The main demographic phenomenon for the asset management industry is the ageing of the baby-boomer generation. The baby boomers are around retirement age, so are investing less and gradually selling their investments to finance their spending. In addition, they are leaving the labour force, sometimes coupled with too little savings or too much debt. They have a shortening time horizon, and, like most investors, are more risk averse.
Industry dynamics have changed too. Consultants have expanded the range of services they offer. Meanwhile, many asset managers – particularly the larger ones – have risk managers, actuaries, and even manager selection teams embedded in the traditional asset management structure. Who is getting squeezed? It is the midsized manager that lacks the resources to provide a holistic solution but is too big to be a small, nimble boutique.
These changes are against a backdrop of defined benefit (DB) pension plans closing at a rapid rate and being replaced by defined contribution (DC) plans.
In investment economics, the “great moderation” that began in the early 1980s offered two big boosts to investors: steady economic growth with shallow recessions, and falling inflation. This allowed central banks to reduce interest rates over the long term. This formed the basis for a bull market in bonds that has lasted three decades. Falling interest rates, combined with strong growth in gross domestic product and corporate earnings drove a bull market in equities, when sell-offs were generally reversed within a few quarters as the market hit new highs. But the great moderation is history – and so are the outsized average annual returns that investors experienced in the 1990s.
In the 1990s, the equity risk premium was an article of faith: investors believed that equities would always outperform over a period of several years. Now, the equity risk premium looks less reliable – at the time of writing, global equities are below the levels they reached in 2000. Our research shows there were four separate periods when returns were negative over more than a decade: from 1901 to 1919, 1928 to 1942, from 1968 to 1982, and 1999 to date.
For many investors, the 21st century has so far been a period of shattered expectations. Government bonds are no longer risk free, yet they offer lower yields than ever. Investing in equities can lose you money not just over one year, but over a decade or more. Liquidity – the ability to sell assets at close to the stated market price – cannot be taken for granted. Scarred by the financial crisis, investors care more about liquidity and limiting downside losses. The low-yield environment is difficult for income investors.
Asset managers must therefore work harder to satisfy their clients. That entails new types of product with new measures of success. The primary goal of some multi-asset income strategies, for example, is not to beat a benchmark per se but to meet clients’ expectations about the total risk and return they experience.
Investors now have a more global perspective, and the movement of non-domestic assets from the periphery to the core of investment strategies is well advanced, though it has further to go.
While a role remains for specialists in subsectors of asset classes, these can be thought of as components.
Large asset management companies must offer clients comprehensive solutions to their investment needs – needs that the new regulatory and investment environment are creating with increasing frequency.
That requires capabilities in areas including asset allocation, risk management and derivative techniques, as well as investment teams specialising in narrow areas such as US equities or emerging market debt – and/or a manager selection team that can choose suitable third-party specialists in these areas.
Distribution teams also have to change. The emphasis is shifting from selling single products to developing a deeper understanding of clients’ needs, and helping them develop and maintain the right investment strategies.
The investment environment has become harsher since the late 1990s. Asset managers need to help their clients set realistic goals, and work harder and be more innovative to meet them.
Evolutionary pressures are not making life easy for the asset management industry, but they are making it better.
Curt Custard is head of global investment solutions at UBS Global Asset Management. Matthew Richards is strategist, global investment solutions at UBS GAM