Seizing the day

Category: Asia, Malaysia, Global
By Joseph Cherian*

The asset management industry has not been exempted from the doom and gloom talk surrounding the global financial services industry. The same forces that resulted in shrinking sell-side fees, increased regulatory scrutiny, more elusive traditional sources of alpha, and various lines of business encroached by disruptive technology, have been affecting the buy-side industry as well. But before we collectively throw in the towel and get out of town, it is perhaps instructive to take stock of how we got here and what the future holds for our once august industry.

The business of managing other people’s money professionally and prudently probably goes back over a century. However, the size of financial assets under management – some estimates place it at over US$70 trillion globally, which at an average total expense ratio of 100bps yields US$700 billion in fees – makes it one of the most important sectors of the global economy. Depending on what time of day you measure its market capitalisation, Greater China’s equity capital market is worth close to 20% of that, while the top ten global asset managers manage over 25% or about $17.5 trillion of these assets. Asset managers (or their contractors) promise not only to take good care of middle and back-office functions, such as fund administration, accounting and supervision, but more importantly, to either add value to the invested portfolios within certain confidence levels – academically known as risk-adjusted alpha – or in some cases, simply preserve the real value of the portfolios.

Now how did such a simple job description, albeit one that requires good investments and risk management skills, get into such complexities, hubris and trouble? Well, like any other industry with a profit-making motive, the investment management industry was never immune from greed – think of the mutual fund scandal’s late trading and market timing activities in the US; fraud – think Madoff; tail risks and its management (or lack thereof) – think LTCM or Goldman’s Global Alpha or JP Morgan’s London Whale; or overconfidence – think Bear Stearns Asset Management’s High-Grade Structured Credit Strategies Enhanced Leverage Fund’s confidence in subprime (and the market’s subsequent lack thereof), all of which caused this mouthful of a structured strategy to collapse.

Given that some of the GFC dust has now settled, our industry is becoming more regulated, cautious, volatile, unprosperous and generally woeful. Some have even gone as far to say that ours is a sunset industry, with the likes of ETFs, Nutmeg, Yu’eBao, Robo-advisors and FinTech taking over the business of managing assets. But before we write our own obituary, it would be useful to revisit jargon that our industry is famous for coining, one of which is the core-satellite approach to investing, of which origins are certainly not recent. The core-satellite approach to investing makes eminent functional – as opposed to institutional – sense in describing a time-consistent manner in which to describe the expected business evolution of our industry. And like Zeus of Greek mythology fame, it also supremely rules over other sub-jargons like strategic beta, smart beta and no beta (market neutrality), or asset allocation, target date and lifecycle funds, or portable alpha and cash equitisation strategies. The investor and the investment world as a whole has already evolved – or is set to evolve – into a core-satellite, bifurcated investment management galaxy.

Core investing describes the world of index investing which achieves low-cost, diversified portfolios that span the Sharpe-Lintner-Markowitz risk/reward efficient frontier. The term ‘satellite’ today simply encapsulates all the other high-octane, higher-fee, active management stuff, with an approach to core-satellite investing now taking on the following primary attributes:

Size is King (thy kingdom come)

Cerulli Associates once presciently declared that trillion-dollar asset managers will emerge to dominate the industry. Indeed, Cerulli reported in 2013 that the world’s 50 largest asset managers accounted for more than $38 trillion of assets under management. Large low-cost fund managers, such as Black Rock, State Street Global Advisors and Vanguard, who provide core investing services and who have built a global brand name, are likely to eventually dominate this space. Economies of scale are critical to survival within the core investing sleeve, and products are of the plain vanilla variety. Intermediaries such as robo-advisors, traditional financial advisors, market timers, tactical asset allocators, etc., can of course package and offer more complex products off the, shall we say, “lower core” shelf.

Skill is Queen (Hence one has to pay a princely sum)

Satellite investing is the part of the portfolio that orthogonally adds real value (alpha), but at much higher cost. Boutique fund managers, hedge funds and others with the skill and foresight to take advantage of opportunities in the financial, real and digital economy, occupy this space. Here, super-sizing is not as important as a critical mass of assets, with the essential attributes of a good long-term track record and the ubiquitous brand.

Process is the Crown Prince (royalties before loyalty)

Whether it is in the core or satellite orbit, a systematic and disciplined investment and risk management process is key to everyone’s long-term success. Clients will also require a sensible amount of transparency, compliance to internal and external requirements and some form of Uber-nisation of the investment platform.

To summarise, while jobs and compensation in the investment management industry may not be as plentiful as they were in their glory days, a functional view of the business reveals that it will not change fundamentally from what financial jargon already provides for. Asset managers who think functionally and who are quick to seize the day, will continue to reap the benefits.        

*Joseph Cherian is director of the Centre for Asset Management Research and Investments (CAMRI) and practice professor of finance at the National University of Singapore Business School.