ASSET MANAGEMENT: Editorials: Edition: June / August 2020

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Peek into

the future

From the changes wrought by Covid-19, several will have long-term
impacts on the operations of investment firms.
They’re re-evaluating strategies for a different client environment.

It’s obvious that this is a period of profound change. Less obvious is the change from what to what. Like any other business, the firms which manage clients’ money have had to re-evaluate their operational models for post-lockdown relevance and competition.

As the savings pool reduces, which is likely for the foreseeable future, competition for assets to manage will sharpen. TT asked a selection of asset managers to indicate what, to them, was top of mind. A quilt of views and priorities has emerged, perhaps indicative of an industry going through something of a rebirth.

Thabo Khojane of NinetyOne:

The Covid-19 crisis will result in a shrinking economy, retrenchments and therefore an increased number of sub-scale retirement funds. Commercial umbrella funds will continue to acquire and absorb these smaller funds. In the individual retirement-fund segment (retirement annuities and preservation funds), growth might temporarily pause but long-term fundamentals are positive because default regulations require preservation.

Default preservation will make illiquid investments – including infrastructure, direct property and private credit – far more accessible for fund members. While historically the institutional investors have made attractive returns from these assets classes, retail investors couldn’t access them. Going forward, it wouldn’t be surprising to see investment managers coming to market with closed-end mutual funds.

Jon Duncan of Old Mutual Investment Group:

As an external market-systems shock, Covid-19 has laid bare the very real interconnectivity between our social, environmental and market systems. In consequence, the investment industry will become a lot more focused on how the businesses in which they invest their client’s capital are generating profits. Do they support or erode future resilience? There’ll be increasing appetite for long-term green-economy outcomes.

The investment industry will become a lot more focused on ESG (environmental, social and governance criteria), to develop proprietary products supported by growing client demand, that can be signalled in both up and down market cycles.

Paul Rackstraw of Futuregrowth:

The investment world has changed dramatically. There is another whole level of investment business risk/sector risk that has just been brought into decision-making. To consider is how managers have adjusted their investment processes to take into account that some investment models or quant processes might have become irrelevant or inaccurate overnight. And, with uncertainty running high, what seems a cheap investment at the current price might actually be expensive.

The ability to perform due-diligences and monitor certain investments on site has now been curtailed for a lengthy period. The different types of industries and how they are ranked in importance in terms of order of opening under various lockdown scenarios has suddenly become extremely relevant. Consumers’ historical buying trends and the way they shop might change significantly.

Extreme daily volatility in market prices becomes the norm. Whether the firm’s investment process can operate in this type of environment is the question.

Moeli Lesibe of 27four:

The traditional model for asset-management fees has been built for scale, not performance. With increased scrutiny on fees, managers without scale may have to tilt their offerings towards products that can generate higher margins or they might face decline.

Covid-19 has also exposed weakness in the industry’s social contract with investors. It could propel greater interest in products designed to contribute towards the realisation of UN Sustainable Developmental Goals. In our indebted economy, it will become critical.

Positively, the pandemic provided the industry with an opportunity to test the robustness of its operational models. Companies must be sufficiently agile effectively to respond to such disruptive events as Covid-19.

Janina Slawski of Alexander Forbes:

There’ll be fundamental changes in the outlooks for various sectors and companies. This will require active managers to determine whether they should still hold or need to review particular investments against other opportunities. The differences in impact per sector can be dramatic.

Another stark impact can be seen where investments have a narrow focus, e.g. where equity managers have analysts experienced in certain industries focused on companies in specific sectors. These funds could show dramatically different return profiles against competitors.

In this environment, smaller asset managers could be badly hit. Where managers are struggling to break even, and have a high level of fixed costs, a significant decrease in asset-based revenues (after a market fall) will cause significant strain that many may not survive.

Clients may want to invest with active rather than passive managers when markets are as extreme as these. It is hair-raising to be at the mercy of passive index allocations as opposed to know that there is an asset manager trying to navigate through the challenges.

Steven Nathan of 10X:

The asset-management industry was under extreme pressure before Covid-19. There’ll be increasing trends to passive products that generally perform better and have lower costs; fee pressure from clients that will result in lower margins including the removal of performance fees; negative cash flows in the pensions industry, and lower savings flows in discretionary products.

Also to be expected are consolidations of fund managers and administrators. There are too many boutique investment companies with too little differentiation and too many administrators with too little revenue.

Derrick Msibi of STANLIB:

Individuals put aside funds for retirement in a taxincentivised model that they can access when they retire. But in SA we have created a special dispensation where individuals can borrow against or access their nest eggs for housing. Are there other needs equally essential? This raises the question of whether the retirement fund is really a pot solely for retirement or merely for deferred emergencies. Why is retirement seen as a higher need than others?

The way investment mandates and portfolios are structured, some re-thinking is required. There is a great deal of slicing and dicing of the major asset classes in portfolios. It requires ongoing rebalancing and multiple mandates with different asset managers.

Maybe we should be looking at more strategies in a single portfolio, but allowing managers to use multiple asset classes within an agreed outcome or a target and risk budget; for instance, we could slice fixed-interest mandates between duration, unlisted credit, listed credit and inflation linkers all allocated to different asset managers. Maybe we should allow asset managers the full package of options where they can mix and match all these buckets to deliver an outcome.

Kathy Davey of Ashburton:

Interaction with clients is likely to become increasingly electronic. It could also mean that interaction will be more regular as the logistics to set up remote meetings entails significantly less planning. Keeping clients abreast of how managers are tackling the crisis, and encouraging investors to stay the course, will be key to retaining and strengthening relationships.

Benefits of active management are likely to become more obvious, especially with equity funds that have a quality bias. The bear market has revealed underlying weaknesses of certain companies during stressful times. Investors would automatically own these companies when using passive strategies.

The mindset of investors may change in terms of seeing the value of investing in a select group of companies exhibiting strong balance sheets, strong market positions, a good level of defensiveness, or even flexibility within their supply chains.

Delphine Govender of Perpetua:

Many shifts already started within the industry are likely to accelerate, and we should expect new shifts. These include a more evolved assessment of investment and overall portfolio risk management; greater allocation to uncorrelated asset classes (such as alternative investments), and the inclusion of portfolio insurance strategies.

The investment industry should expect casualties. There is likely to be attrition, rationalisation and some general consolidation of firms. We should also expect a marked reduction of the launch of new firms, except where opportunities present themselves in uncorrelated asset classes. And expect that investment firms, whose offering is centred mainly around tracking error-cognisant domestic equity mandates, will have limited runway for asset growth.

Some positives could be that both clients and managers will now embrace technology far more in terms of more frequent and efficient engagement. Industry professionals will be taking fewer flights, so reducing the carbon footprint, and engagement of fund managers with managers of investee companies now has the potential to become significantly more frequent; for instance, by participation in virtual company presentations and shareholder meetings.

Adrian Saville of Cannon: It is likely that there will be more news of investment firms closing or consolidating. Pressure on fees has been in place for some time, and the impact of fees on total returns becomes even more evident in an environment of low inflation and low return. What cannot be compromised in any fee or cost consideration is the quality of investment solutions. If a drive for low fees compromises investment quality, it’s a potentially dangerous false economy. That said, scale and efficiencies are important avenues to remove costs and fees from investment solutions without compromising quality.

There is a strong case to be made for substantially greater allocation to passive investments, not because of Covid-19 but because of the evidence that tips in favour of passive. But the outcome should be “passive and active”, not “passive or active”. With SA portfolios heavily weighted to active, the task in asset allocation is to get the balance right.

Asief Mohamed of Aeon:

Digital communication will be the accepted norm with significant savings in time and travel costs. The biggest disadvantages will be the loss of relationships and loss of signals from body language. If we cannot look managers and service providers in the eye, we might be fed propaganda.

The downside risk of remote results presentations and analyst site visits is that managements can sanitise, to show only positive information. The loss of ‘corridor talk’ before and after results presentations, and public questions not answered, are other big drawbacks. The playing field for larger and smaller asset managers will be more level but still unequal.

In the long term the asset-management industry will probably come out more efficient and profitable for those firms that survive the short-term difficulties of the pandemic. But unfortunately the pandemic will also expose the firms that are less financially prudent and have unlikely prospects for recovery, leading to job losses in the industry.

When it comes to smaller firms that have proved themselves resilient to the Covid-19 impact, it remains to be seen whether larger firms will trust them with more assets to manage.