The ramifications of the global financial crisis are broad and deep, especially for the financial services industry, and super funds need to be well aware of how their service providers are being impacted.
One of the least-well appreciated ways that funds may be affected, according to Stephen van Eyk, is in the breakdown of certain managerial controls which could follow the merger of divisions or business units among large managers and banks.
The managing director of van Eyk Research observes that in many large organisations forms of Chinese walls have evolved between divisions, under different heads of department, which may be servicing the same clients. What happens to these walls when departments merge and staff are rationalised?
The natural competition between executives and business units within the same firm can act as a counterbalance which works in the client fund’s interests. The fund can receive separate informal advice from an insider’s perspective on the quality of the service or price.
One of the many aspects of the current crisis which sets it apart from those of the past 75 years is the willingness of large financial institutions to retrench senior executives. In some cases this may be motivated by a sense of fairness, to spread the pain evenly. But more often the motivation is to reduce managerial duplication, especially in areas of operations other than sales or production. That said, no positions seem safe at the moment.
Redemptions, declining funds under management, present a more obvious signal of trouble ahead irrespective of whether this is performance related. There are plenty of funds suffering redemptions simply because they are more liquid than others in a client’s portfolio.
Discrete mandates provide some comfort but do not completely quarantine clients from the effects of declining funds under management for their managers.
There are so many risks facing super funds this year that manager strength and stability may not be high on everyone’s list of concerns.
However, the staff cuts and other cost-saving schemes by managers make you wonder what sort of financial services industry will be left when markets recover and the economy returns to good health.
It will no doubt be smaller. But if the industry as a whole does not add value, as academics and index managers generally point out, that may not be a bad thing.
According to a report last month by corporate advisory and research firm Jefferies Putnam Lovell, banks and other “distributors” will continue their recent trend to divest themselves of their “manufacturing” arms, particularly in Europe. There is little evidence of this in Australia as yet, although the bank-owned firms at least now have to compete with other external managers on their parent’s distribution platforms.
What happens to the people at the significant number of hedge funds and funds-of-funds which are predicted to close is an interesting question. They are smart people and it is difficult to see many of them seeking out new careers. They are more likely to reinvent themselves by providing new services and strategies. Super funds will continue to expand their internal investment capabilities and asset consulting firms will probably weather the storm better than managers. In fact, the trend to specialist consultants is likely to continue, providing further job opportunities.
There is a good argument to support the view that 2009 will be all about beta for super funds. Most funds have probably made the decision to get their cash levels back down to previous strategic ranges, but they seem to be reticent to implement the decision just yet.
If this is the case, managers targeting high alpha may struggle for a time longer and will probably need to adjust their fee structures. One and 10 (one per cent base and 10 per cent performance above a hurdle) is already looking more like the norm than two and 20 for high-alpha managers.
Asset allocation skills, if they can be demonstrated, should be very much in demand right now, along with simple long-only broad-market strategies, especially index funds. Coincidentally, both Russell and Mercer have recently issued reports including the view that active managers will again show their worth, at least in Australian equities.
Structured products, synthetic hedge funds and other products involving considerable counterparty risk will struggle for some time. Services provided by custodians will be favoured for two reasons: they are generally banks which have had some sort of government guarantee or backing and they have been beneficiaries of the flight to cash. Custodians should win business away from the prime brokers which have been providing “free” custody to hedge fund managers (if they want it).
The trend to more specialisation will not stop for long. It has been a feature of all forms of economic endeavour since the dawn of time.
The fundamental driver of funds management and its attendant services is an aging population and that certainly has not changed.
Skill will continue to be rewarded but a recently hardened and more cynical client base will demand better proof of its existence. This may well lead to closer and better relationships between managers and super funds, which are now more acutely aware of how important each is to the other.
New regulations may well be forced on various parts of the industry, which may mean higher business costs. Hopefully competition will keep those cost increases to a minimum and greater zeal by super funds and consultants will keep a lid on other cost increases.
As we are constantly being told, the crisis has provided the best investment opportunities in living memory. Now if only we could be brave enough to take them. It’s easier to wait a little while longer yet. But it probably always will be, right up until the time the opportunity is gone.