In one of the most significant pieces of research on the path for long-term success for institutional funds, Watson Wyatt Worldwide has mapped out the important trends and challenges for funds and managers as well as the “defining moments” of most impact on the structure of the funds management industry.
The final report resulting from the research, Defining Moments, was published late last month. It incorporates results of a survey, undertaken with the Financial Times, which led to the publication of an earlier report, 2020 Vision, this year.
Of the four ‘defining moments’ identified in the report, the first three have already occurred and the fourth is still to come. They are: . A shift towards absolute returns, which was created by the last bear market ending 2003.
- Fresh thinking on governance and the management of institutional assets, epitomised by moves to external fiduciary management in the first half of this decade.
- New framing of risk, where the sub-prime crisis is precipitating major changes in the assessment and management of risk.
- New regulation, the next significant phase of which will impact the financial industry in a similar fashion as to how Sarbanes-Oxley impacted US corporations.
The report was overseen by Graeme Miller, the head of investment consulting for Watson Wyatt’s practice in Australia.
He said that if one word captured the flavour of the next few years in the financial industry it was ‘complexity’. “This will support increasingly sophisticated investment products and solutions but also weigh down decision-taking,” he said. “In particular, funds will have to face three big problems: an increasingly crisis-prone financial system; high investment costs; and too much short-termism.” He said that while the problems were deep-rooted, they also presented opportunities for those fit enough to adapt.
The report focuses on six macro trends for the near term of about five years and six longer-term trends for the next 10-15 years.
The six shorter-term trends are:
- Pressure for talent – talent needs to stretch in breadth and depth; with talent shortage normal, return on talent is likely to increase.
- Improvements in governance – better recognition of a return on governance means increased attention and new models, with more talent attracted to CIO roles at funds.
- Product proliferation – specialisation leads to product proliferation, with the risk, style and scope of mandates getting broader; growth in absolute returns and alternatives.
- Extra-financial issues – environmental, social and governance considerations grow as influences on sustainable performance and desirable outcomes in their own right.
- Pensions design, towards a DC model – defined contribution, which makes up about 90 per cent of Australian super, will become dominant.
- Organisational change – change addressed in terms of scale, specialisation, HR and global expansion; leadership and survival is put on the line.
The report says that change is happening on a grand scale. “We see the demise of the old long-lasting models like relative return, current DC [offerings], governance…but we also see the union of the distinct investment building blocks, alpha and beta, with separate going rates for each,” the report says.
“This is a world of opportunity for those fit enough to change, where fitness is increasingly defined by the ability to be adaptable and apply new thinking and new theory.”
The six longer-term macro trends are:
- Better multi-period investment design – a new success measure for funds will look more at the key steps in the journey and measurement will fully adjust for risk.
- Better DC – an improved member value proposition needing platform strength, better investment design with glide-paths and technology-supported engagement.
- New food chain – the big moves are away from fiduciaries and committees and towards CIOs and investment professionals, who manage costs more aggressively.
- New investment content – more innovations, such as portable alpha and beta, beta creep, structured products and solutions, all claim an intellectual edge but all are subject to practice.
- Continued crisis contagion – continued prolonged significant distress events are likely given the systemic flaws, excess complexity and compensation in the system.
- New players and new organisational order – under more performance pressure, organisations will need to develop new competencies.
The report highlighted that while pension funds might be the largest institutional funds of today, they are being challenged for influence by non-profit funds such as endowments and foundations – which Watson Wyatt estimates comprise US$4 trillion today – and sovereign funds, which accounted for close to US$5 trillion at the end of 2007.