Want Scalability? Think Multi-Asset.
The middle is a tough place to be for investment managers these days. Once the lifeblood of large shops, narrow ‘core’ products have lost the interest of investors. The titan funds built in the 1990s and 2000s are in net redemption – well below their peak AuM levels. These funds are now part of a legacy book of business associated with a former era. Now the question for these funds is less about growth and more about retention.
Investors’ are giving broader flexibility to investment managers. Along with the mainstreaming of alternative investment strategies, this trend towards flexibility is driving growth in multi-asset products and solutions. These developments have opened a range of opportunities for managers.
Contrary to the views espoused by some, active management is not shrinking, it is evolving. This may, in fact, prove to be a golden age for active management.
Split Two Ways
Currently the asset base for many of these large core funds is being used as ‘source’ capital for new investments and being directed in two ways:
- Passive market ‘access’ vehicles,
- Investment strategies with much broader remits – further divided into:
a. Intra-asset class ‘alternatives & flexible’ funds (long/short, flexible global equities, etc.)
b. Inter–asset class ‘multi-asset’ (marked by the distinction of generating returns through cross-asset class allocation).
Large Manager Challenges
When considering the challenging environment for core products, we must also think about the investment management companies who have built their businesses around these funds. Shrinking core product AuM yields less revenue. Fees for the funds still in play are being pushed down. There is a real and present need to replace the shrinking asset base in these funds.
While the distribution and operational platforms built to support these funds are still in place, CEOs contemplating the return of positive flows to these funds have seen the writing on the wall. Large asset management companies are asking, “Where do we find the scale to continue growing at 5%, much less 10%, a year?”
Further, large managers (those with ca. >$100B in AuM) are challenged to generate sufficiently high revenue from individual limited capacity ‘specialist’ products. Raising $1B in a single fund no longer presents the bottom line ‘excitement’ it did when total firm AuM was at $10B. When AuM is above $100B, net of outflows, what constitutes great success for a boutique doesn’t make a blip for large shops. Rising markets have helped, but they aren’t a permanent, nor reliable, bolster to AuM growth.
The industry is coming to again recognize that growth strategies based on a couple of super-sized blockbusters laden with a broad range of operational and key-man risks is a dangerous proposition. The recent events with Gross and PIMCO illustrate the all too present risks in ‘blockbuster’ products.
With prevailing trends moving away from active specialist ‘core’ strategies, the questions to address are: what are the future drivers of growth for investment managers seeking scalability? And, what is the profile of a scalable product that investors will want to buy and that will earn decent fees?
Below is a framework for considering the ideal conditions and characteristics of developing and maintaining scalable investment products. This chart illustrates key elements that either limit or enhance the growth and scalability of a given fund.
When Bigger is Better
As illustrated above, fundamental stock selection-driven funds are the most limited ‘model’ of funds in terms of scale development. These are funds characterized by a concentrated number of small capitalization stocks in a single market, managed by a single decision maker. The opposite end of the spectrum includes multi-asset/allocation strategies – the most scalable of which may be “Lifecycle” or like funds designed and marketed for long-term savings.
In general, ‘multi-asset’ are often more formulaic in nature and less dependent on individual people or single securities to drive performance. They may have many holdings (often including the use of derivatives). They drive portfolio decisions and ‘alpha creation’ from top down geographical, sector, duration, credit decisions, not exclusively from bottom up security selection (even if they invest in cash securities). They have flexible remits. These strategies inherently attract long-term investors and tend to avoid the volatility of flows associated with shorter term theme products. Assets tend to be sticky. While fees on these types of funds are often lower when compared to single asset class funds, their scalability, longevity and other attributes make them potentially attractive options for investment managers seeking to leverage their investment platforms.
Evolving Capabilities, Evolving Positioning
Many managers are known for and historically positioned themselves for their stock selection expertise. In order to develop a presence in multi-asset, a manager must expand its historical value proposition without either tarnishing its known points of strength or threatening the position and role of its (intermediary) clients in relation to end-clients.
To the extent that an asset manager seeks to develop multi-asset/increasingly flexible funds, the company must effectively communicate an evolved story. Their customers have traditionally related to them as a provider of components to fulfill an existent asset allocation model. For asset allocators, relating to managers as a ‘solutions provider’ changes the terms of engagement.
Investment management companies seeking broader reign across asset classes must also contend with their internal investor DNA and history. It is difficult to shift a well established investment mentality from bottom up stock pickers to top down, cross asset class allocators. Early winners have been those products that have, unlike the ‘balanced funds’ of old, targeted a very specific and achievable outcome – income, absolute return, etc. Developing these products as an extension of existing capabilities has proven to ease the challenges of transition.
As managers continue to develop their multi-asset capabilities into broader, more holistic offerings, their client bases will be challenged to determine the extent to which they are willing to play along and further hand over asset allocation decision making. In order to reach the scale required to take up the droop in ‘normalized’ AuM levels, these funds will have to move from the perimeter to the core. With time and a bit of finesse, they will.