Asset management companies are putting their faith in new “solutions” business lines. Little wonder, given clients’ disillusionment with perennially underperforming active funds and brutal price competition in passive products.
Bundled solutions extend from multi-asset products, through asset allocation and risk management services, all the way to outsourced chief investment officer functions. They offer asset managers the chance to combine funds that, as standalone products, are rapidly becoming a commodity product. They also offer the chance to boost revenue, do a bit of upselling and add real value for clients. But a problem is looming for the pension funds and other institutions who hired asset managers to provide them with these solutions: knowing when to fire them.
In traditional fund management, that is a relatively easy task. An active manager who lags behind her asset class benchmark will get called in to explain; fall too far behind for too long and she will get the boot. Alpha, or the lack of it, is readily identifiable against market beta as captured in the S&P 500, say, or the Barclays Aggregate bond indices.
But how do we identify below-average performance when it comes to asset allocation? Clients and managers together can set targets, for example a 7 per cent return for a needy public pension plan, within agreed risk limits. But is realising that 7 per cent all that counts, if other managers in similar circumstances might all have brought in 8 per cent?
The confusion could be quite lucrative to an industry trying to protect chunky margins that still tally in the high-30s per cent for traditional asset management.
Without market benchmarks for returns, or the ability to do like-for-like price comparisons on bespoke service offerings, clients are likely to fall back on more impressionistic measures, such as service levels or educational support. Boston Consulting says managers have always been judged partially on the “emotional jobs to be done” for a client; in the solutions era, good sales and good personal support will be paramount in winning and keeping business. It could be like the early years of fund management, before rigorous, comparative measurement revealed the failure of most managers to justify their fees.
The expansion of asset management beyond funds and simple asset class-based mandates is proceeding apace, and occupying chief executives across the industry. BlackRock’s Larry Fink predicted at its annual investor day that bundled multi-asset products would grow at twice the rate of the asset management sector as a whole, and his company’s breadth — spanning geographies, active and passive investing, and most asset classes — is the reason the market values BlackRock more highly than many other managers.
If I were not a multidimensional firm, I would be very nervous, because you can become pretty irrelevant pretty quickly
– Joe Sullivan
Gavin O’Connor, chief operating officer at Goldman Sachs Asset Management, likes to show a slide comparing flows at publicly listed asset managers and the fund arms of listed banks. GSAM, JPMorgan and BlackRock are at the top and narrower companies such as Franklin Templeton, Janus and Pimco are at the bottom of a three-year league table.
And Joe Sullivan, chief executive of Legg Mason, told me recently: “Client demand is truly moving to a solutions-based relationship. If I were not a multidimensional firm, I would be very nervous, because you can become pretty irrelevant pretty quickly, no matter what your performance is.”
There are good-faith efforts to benchmark bundled solutions, but the measures seem crude at best.
Lee Kranefuss, who created the iShares exchange traded fund business inside Barclays, is running a sophisticated new venture called 55 Capital. It uses ETFs in an actively managed macro portfolio that can contain global equities, bonds, commodities and alternatives, complete with tax minimisation strategies to improve returns — yet it is benchmarked to a simple 60/40 portfolio of equities and bonds.
Morningstar, the data provider, faces analogous difficulties in rating the target-date funds that are used inside pension plans. Their allocations to different asset classes vary widely as they progress along different “glide paths” towards a target retirement date. The returns of different funds also therefore vary widely through market cycles, even if their savers ultimately end up in the same place. Comparisons along the way are fraught, but we are not going to want to wait 40 years to count up the number of pensioners who die in penury before we pass judgment.
All of which is to say that the solutions era needs to unleash a round of research into performance comparison and benchmarking, and quickly. Solutions come with problems.
Stephen Foley is the FT’s US investment correspondent