Mixed messages: What is the End Game for Multi-Asset?
This essay appeared in Citywire Selector on February 22, 2016.
The days of traditional actively managed ‘building block’ funds are quickly waning. Funds offering large-part basic market exposure and a (very) small-part market outperformance for a hefty fee are a remnant of a previous era.
Call them closet-indexers, call them dinosaurs. These funds are in the midst of a perfect storm.
A highly disruptive product innovation cycle has combined with a regulatory-driven narrowing of economic incentives for distributors to sell these funds to their clients.
As asset growth stagnates and investors’ focus continues to shift to other products for basic market access (e.g., passive funds & ETFs), active managers risk losing a key component of their AuM, stable revenues and opportunities for growth.
All the while, professional fund investors are demanding more activity from managers. Funds with a high ‘degree of investment freedom’ including high active share and multi-asset strategies have emerged as winners of a new era of funds.
These funds are not without their challenges and asset allocators have to relinquish increased responsibility to external managers. This challenge becomes particularly pronounced as multiple multi-asset strategies are incorporated into portfolios.
The Legacy Model
Before multi-asset investing took centre stage and captured big chunks of new flows post-2009 crisis, investment managers were focused on creating specialised building block funds to meet the demands of asset allocating clients.
A two-part process was in place- intermediaries (banks, advisors and financial consultants) generated a broad market outlook from which was distilled a related strategic asset allocation model. For implementation of that model, professional fund investors within those intermediary organisations selected specialist best in class funds.
“You build specialist blocks and we will choose and assemble the blocks,” was the operating mantra from distributor to manufacturer. From the time that open-architecture became the prevalent operating model 15 years ago, the idea of an intermediary handing over the asset allocation reins to an external manager was out of the question.
Why was this the case?
Several assumptions drove this view:
- Managers cannot be good at everything and therefore should stick with the narrow areas of the market in which they had exceptional expertise and skill (particularly security selection).
- Performance is driven by two isolated decisions – security selection and asset allocation – best done by two distinct entities. Managers are manufacturers not assemblers.
- The value of the intermediary to their clients was divided into two parts: making an asset allocation decision and then selecting the parts to fill it.
A sea change across Europe at the time, open architecture and a best-in-class selection philosophy opened the door to distribution channels previously inaccessible to investment managers. Open architecture access to funds offered intermediaries diversification of exposure to and reliance away from in-house investment managers.
Once tied only to their in-house provider, intermediaries and their clients gainedaccess to best-in-class products identified through an institutionally-derived selection process. Furthermore, intermediaries also benefitted from co-branding with established global players including sizable marketing/educational budgets and very favourable economics derived from the distribution of their funds.
With focus on getting on centralised ‘buy lists’ with building block funds and inclusion in discretionary portfolios, ‘strategic partnerships’ proved to be a huge success for managers and distributors alike. In the mid 2000’s, these were green field projects.
That model is now devolving. Strategic partnerships and recommendation lists within the standard asset classes for major intermediaries have all but been determined – the rate of change within those lists has slowed considerably. In some cases, a return to a preference for proprietary fund ranges has grown.
The building block products that had populated those lists that were the only tenable vehicles for clients to access markets have met new competition.
Rise of Multi-Asset
Following a nearly universally disastrous experience in 2008, a few, then quite nascent, flexible asset allocating funds rose to the top of performance charts. Professional investors took note as clients demanded a solution for volatile markets and its effects.
Increasing recognition that a handful of multi-asset and alternative strategies were some of the only things that worked during the extended period of market turmoil was the catalyst for what is now a pronounced and lasting shift in the market. Demands for income as rates crept toward zero drove another cycle of product innovation and demands for outcome-oriented solutions.
2009 marked a serious shift in product utilisation by investors and product development by investment management companies. This was a complete about-face. For more than a decade, development of specialised narrow themed building blocks, often managed by a single star manager, was the only game in town.
Exceptions to the asset allocation rule are increasingly becoming the rule of engagement but to what end? With the prevalence of multi-asset funds increasing combined with the uncertainty of their uses and potential impact on the role and function of intermediaries, the industry is reaching a tipping point.
Not unlike the dawn before the opening of the fund architecture, we stand at a crossroads. Regulatory, commercial and investment drivers are combined forces driving two investment decisions (asset allocation and selection) into a new breed of funds. The implications of this for investment managers and their intermediating clients are at the very core of what the next decade holds for the industry.
Click here to read part II: Focus on Freedom: Pros and Cons of Backing Multi-Asset Managers