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Win-win: Pension Funds Seek A New Relationship With Their Asset Managers

Managers collaboratingAsset managers have always had to meet the highest standards when servicing their institutional investors. But a new State Street survey of 134 pension funds, conducted by the Economist Intelligence Unit, reveals that the relationship between pension funds and their asset managers is rapidly evolving.1 A new dynamic is emerging. Pension funds are looking for asset managers who can build innovative solutions that are customized to meet their long-term investment goals. They are also requiring more transparency and insight on issues relating to risk and performance. And as pension funds increasingly bring some areas of asset management in-house, asset managers are also having to find new ways to deliver value.

These trends create challenges for both the pension funds and their asset managers – but there is also a huge opportunity to create win-win relationships based on a new value proposition.

Managing The New Investment Mix

Pension funds are having to work harder to deliver growth in a difficult investment environment. A protracted period of low interest rates has weighed on returns and increased pension scheme liabilities. At the same time, funds are facing pressure from regulators in many markets to cover funding shortfalls.

These challenges are forcing pension funds to rethink almost every aspect of how they invest. In particular, many are allocating to a broader range of alternatives – partly in an attempt to diversify portfolios and drive up their returns, but also to find assets that provide a better match with their long-term liabilities.

These trends have led to the growing popularity of multi-asset solutions, which blend a range of alternatives with more traditional asset classes such as domestic equities and government bonds. Now State Street’s survey indicates that the shift into alternatives is gathering pace. For example, 60 per cent of pension funds said they will increase existing allocations to private equity. Meanwhile, almost half (46 per cent) of pension funds in the survey are investing more into real estate, while 39 per cent will increase their allocations to infrastructure.

At the other end of the investment ‘barbell,’ pension funds are also taking advantage of low-cost strategies including passive investments, as they revisit the way that they spend their overall ‘risk budget.’ Fifty-three per cent of pension funds in the survey said they plan to increase their use of low-cost strategies over the next three years.

Solutions For A Multi-asset World

These shifts in investment strategy change the dynamic between the pension funds and their asset managers. The multi-asset model requires institutional investors to augment their expertise across a number of highly varied and specialized asset classes. The talent and skills required to develop today’s multi-asset solutions are in short supply and pension funds need help to address gaps in their capabilities. 

For their part, many asset managers are trying to transform themselves around these new investor demands. Success is increasingly measured on the asset manager’s ability to deliver against the investor’s desired outcomes, rather than how the asset manager performs relative to a simple benchmark.

These shifts represent a pivotal moment for the industry. The growth in multi-asset solutions creates a huge opportunity for the asset management industry. In another recent State Street survey of asset managers,2 more than two-thirds of asset managers (67 per cent) cited multi-asset solutions as the type of investment strategy most likely to drive growth in their business.

Today, however, only a minority of asset managers are in a position to capitalize on this opportunity. In the same survey of asset managers, just under three quarters (74 per cent) of respondents agreed they have the capabilities they need to thrive in a multi-asset world. The research identified a number of areas where asset managers must now invest to improve their multi-asset capabilities. These included talent to support multi-asset portfolio construction and the ability to analyze risk and performance across a wide range of alternative asset classes.

Insourcing Brings A New Dimension

The rise of multi-asset solutions isn’t the only trend transforming the relationship between pension funds and their asset managers. In recent years, many pension funds have decided to insource some of their asset management. This was one of the strongest findings in State Street’s survey of pension funds: 81 per cent said they intended to manage more of their assets in-house.

Pension funds are insourcing specific areas of asset management in the belief that it can help them save costs, but also bring them closer to their investments from a risk and governance perspective. But it is important to recognize that most pension funds use insourcing selectively. They typically focus on asset classes where they have long-established expertise – for example, equities or government bonds. By contrast, few pension funds have the skills to support alternative investments such as private equity or hedge funds inhouse. As pension funds diversify their portfolios into a broader mix of asset classes, this creates new opportunities for asset managers to deliver their specialist expertise.

Insourcing doesn’t remove the need for external asset management, but it does create a new dynamic in the relationship between pension funds and their service providers. They are less willing to pay a premium for straightforward investment strategies that they can easily support in-house. What they value, however, is asset managers that are able to deliver strong and reliable returns through a tailor-made investment solution.

Partners Aligned Around Shared Interests

As pension funds rethink where and how they invest their money, they are reassessing the criteria they use to select their asset managers. Our research sheds light on several areas where forward-thinking asset managers can gain an edge over their competitors.

Many pension funds are looking for a new type of relationship with their asset managers. In interviews conducted as part of our research, pension funds stressed how important it was to find asset managers who can understand their objectives and investment philosophy. The ability to align interests around shared goals is also key to success in these relationships. More than half of pension funds (52 per cent) find it difficult to ensure their asset managers’ interests are tightly aligned with their own. By contrast, asset managers that can build solutions around their clients’ objectives can gain an edge in a highly competitive market.

Transparency is also a key differentiator. In today’s highly regulated environment, pension funds need granular information on the issues that drive risk and performance across their investments. This is a huge challenge in the multi-asset world: almost three out of five pension funds surveyed (58 per cent) say it is a challenge to gain a complete picture of risk-adjusted performance. Asset managers that develop the analytical tools and reporting capabilities to address this need will again have a huge advantage.

Pension funds are ultimately looking for asset managers that can act as strategic partners. This means delivering specialist expertise across a range of asset classes; developing the unique investment ideas that can accelerate performance; and working as an extension to their in-house teams to deliver well-defined investment outcomes.

A Relationship Transformed

Relationships in the investment industry are being transformed. Multi-asset solutions are providing new tools to manage risk and to boost investment performance. There is no doubt that they also create major challenges for asset owners and asset managers alike.

Many pension funds are reassessing how they work with their asset managers to ensure they gain maximum benefit from the new investment strategies. Meanwhile, asset managers are still learning how best to reposition themselves as genuine partners and solution-makers.

Already, however, the outline of a new industry model is emerging. Asset managers will innovate and evolve, developing the customized investment solutions that are required to fulfill their clients’ long-term objectives. These changes can deliver a win-win scenario for all – creating an industry characterized by more profound relationships and shared goals.

Rob Baillie is president and chief executive officer of State Street Trust Company Canada.

1. State Street 2014 Asset Owner Survey
2. State Street 2014 Asset Manager Survey

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