As institutional investors re-evaluate their investment mandates, there has been a distinct move away from risk-adjusted performance as the be-all and end-all selection criteria.
The new post-2008 normal is well and truly upon us, and the changes we see in the asset management landscape will continue at pace for some time to come. In particular, the institutional investment landscape has changed and will continue to evolve.
One of the key changes is the not-so-subtle shift in the mandate selection process. There has been a distinct move away from risk-adjusted performance as the be-all and end-all selection criteria. Of course, the investment management process was always a critical selection criteria, as was structure and size of the investment research team – but these tended to act as exclusionary factors.
What we see today is performance per unit risk being used as a low hurdle that all potential providers need to pass – it probably still is the most important of the hurdles, but by no means does it hold the importance it once held.
Some new (or old, but previously not-so-important) selection criteria we see entering the fray are:
- Willingness of the asset manager to share holding data in a much timelier manner — i.e., without the typical 30-day embargoes many active managers like to impose – and its ability to do this on a consistent basis.
- Ability of the asset manager to deliver data on underlying holdings such that there are no black-box investments in the picture — i.e., full portfolio look-through. This is becoming increasingly important for fund-of-fund, multi-manager, sub-advised and fund-of-hedge fund offerings.
- Capital efficiency of the portfolio from a regulatory perspective. In certain segments of the market, specifically the insurance and pension industry, there is a growing use of performance, per unit risk, per unit capital as a key selection criterion. This issue becomes very visible when fund-of-fund type structures are in play – two funds with equal risk adjusted returns could have very large differences in performance per unit risk, per unit capital – specifically where one fund is transparent and provides full look-through, thus allowing the investor to apply a granular capital charging model, as opposed to the other fund, which could be non-transparent, thus forcing the investor to apply punitive capital charging to account for the lack of detail available to feed into a risk model. In a Solvency II environment the relative difference in adjusted returns could be double-digit in size.
All of the above criteria have a direct correlation to the firm’s willingness to be transparent and, ultimately, this is what the institutional investor is asking for. Institutional investors are frustrated with the receipt of embargoed data that is so out of date that it is useless in practical terms when it comes to running an efficient and effective risk management process.
The same goes for black-box investments — institutional investors now want their investments reported with full look-through to the underlying securities so that they can feed this data into their own risk models and reporting platforms.
Consultants are particularly tuned into the problems at hand, and they, along with the institutional investors, are leading the changes we see in the landscape in front of us. The regulators are also getting in on the act – in Europe you have the push for look-through from EIOPA through the Solvency II Directive, as well as the demands for transparency and custody look-through with the AIFM Directive. This is just the thin end of the wedge, though; the FSB, through the FSOC (in the US) and ESRB (in Europe), has a clear mandate to drive greater transparency in the financial markets, strengthening prudent oversight of risk, capital and liquidity, and ultimately trying to ensure the next crisis is not as severe.
So the asset manager needs to carefully balance the need to prevent its special sauce being divulged and therefore exposing its investment strategies to free-riding and front-running predators, at the same time it has to become more transparent in an attempt to grab the opportunities that come up via RFP processes – this is the mainstay of any institutional business.
Asset managers also need to invest in the data management and reporting infrastructure to ensure they can meet not just today’s demands for transparency, but those of tomorrow as well.
Finally, data management – and in particular a firm’s ability to deliver the depth and breadth of information needed to support a demanding investor, and to gain trust in the investment management process – are becoming critical selection elements of the process. This is being exposed by questions such as:
- Do you have a data governance program in place that has specific terms of reference that covers client-facing data?
- Does your data governance program have specific data quality management processes that allow for timely, complete, accurate and consistent reporting of data to investors?
Clearly, if you cannot demonstrate you are in control of your product data, then how can you claim you are in control of your investment management process?
Is it any wonder some RFP teams are being left high and dry with dwindling win rates, while others are mopping the floor…