4 Ways Investors Are Changing The Rules Of The Game

A month or so ago I published my Top 5 Institutional Investor Themes on Business Insider. Number 3 on the list was Continuing Innovation in Access Routes. What I meant by this was that institutional investors are increasingly negotiating and tailoring the way that they access underlying investments to fit their specific needs. Five examples of this are:

  • Strategic Partners: Institutions are relying on a handful of trusted asset managers to assist with ‘non-investment tasks’ such as board support, presentations, trustee education and asset/ liability studies and financial modelling. They insist on knowledge transfer which is partly underlying a shift in the hedge fund space towards more direct (vs fund of fund) investments.
  • Investment Outsourcing: An increasing number of investors are outsourcing their investment functions to asset managers (and investment consultants to a lesser extent). IAM cites outsourcing of $1.76 trillion by insurance companies alone as of December 31, 2010. The biggest players in this space are BlackRock, Wellington Management, PIMCO and GSAM. Outsourcing reduces the volume of work required to manage the board/ trustee relationship and the size of arguably non-core in-house investment teams.
  • customised Solutions: The days of style bucket investing and a one-size fits all approach to asset allocation and investing are numbered. The sharp end of the industry have been customising their investment exposures in line with specific funding needs/ liability profiles and cross portfolio risk factors for many years. The rest of the industry is playing catch-up. The best fund of hedge funds are exemplary here: Aurora, Grosvenor, Paamco, Unigestion, K2, Blacksone etc.
  • Co-investments & Managed Accounts: Investors are also taking advantage of seeding and co-investment opportunities alongside their strategic partners. Whether this be a managed account with full transparency on an emerging hedge fund manager or a direct co-investment in a large scale infrastructure/ real asset acquisition, institutional investors are changing the rules of the game.
  • ETFs: The growth of ETFs has been exponential. ETFs are increasingly becoming a tool of choice to implement short-term tactical shifts in asset allocation across risk factors.

These changes are driven by four main factors:

1. Cost/ Funding Pressures: The impact of the 2008 market collapse brought significant pressures to bear on funding levels and operating budgets. Many institutions are still feeling the impact with reduced in-house investment teams dealing with an increasing volume of work. This is where strategic partners come in.

2. Increasing Investor Sophistication: Many institutional investors have been allocating to alternative investments for decades. I have previously covered the trends/ statistics and won’t do so again here. Suffice to say that investors are more comfortable with complex investment strategies than previously. The move towards greater reliance on strategic partners is further deepening the knowledge transfer. This is emboldening investors to reconsider stock-standard implementation techniques.

3. An Industry-wide Change in Asset Allocation Philosophy: In line with 2, the industry as a whole has woken up to the flaws of style bucket investing and the volatility brought by over-exposure to long-only equities. I covered this in a recent post. As investors embrace a more dynamic and flexible investment philosophy that looks at portfolio level exposures and liabilities, they will continue to tailor asset allocation and implementation routes.

4: The Institutionalization of the Asset Management Industry: Asset managers have continued to evolve their business models to meet changing investor requirements. At the big end of town, the pure institutional players are focused on delivering investment solutions across the full spectrum of risk factors. The smaller, more niche players, are becoming increasingly sophisticated at high end client service. Education, modelling, completion portfolios and customised solutions.

A more detailed version of this post and references to source material can be found here.

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