The debate whether institutional investors are better off by investing in active or passive strategies has been raging for almost two decades.
Yet the death of the active asset management industry is somewhat over overstated. Globally, Greenwich Associates forecasts actively managed assets to rise to $64 trillion in 2020 from $56 trillion in 2015 — a gain of 14.3%, with a compound annual growth rate of 2.7%.
Over the next decade, the nature of asset management and its role within the wider investment landscape will change dramatically, the result of four major, long-term trends.
Democratization of financial risk
In layman's terms, democratization of financial risk means we all have to take increased responsibility for our financial futures as public sector deficits are growing around the world and pension funds are getting squeezed. This is a powerful global trend driven by three factors: demographics and aging populations; large public-sector deficits and debt GDP ratios; and an elevated level of risk aversion, a hangover from the financial crisis.
All three factors are highly correlated. We've known for quite some time that the developed world has been shifting to a position where those of working age will be a declining proportion of the overall population. We are also increasingly aware that financial crises are associated with demographic turning points (see chart below). Financial crises also have a marked tendency to lower GDP and productivity, and subsequently raise deficits. As deficits rise, the state will push more and more financial responsibility down to individuals.
Over time, demographics will have a profound impact on investment vehicles. Defined benefit pension plans are in decline and high budget deficits imply the state is unlikely to increase its support levels any time soon. Power and responsibility are shifting toward individual savers at precisely when saving and investing is becoming more difficult.
A low-growth, low-inflation, low-yield environment
The low-growth, low-inflation and low-yield environment since the financial crisis has produced greater volatility in the financial markets, and has made it more challenging to generate consistent investment returns. A simple balanced portfolio no longer delivers the 10.5% returns it did 35 years ago. Since the pre-crisis peak, the average return on an investment has been 6.7%.
Whether you are the trustee of a pension plan, an insurance company looking after the retirement savings of millions of customers or an individual saver, you have an increased need for investment solutions that deliver particular outcomes. These outcomes typically involve a targeted investment return with dampened volatility.
It is the innovation, flexibility and depth of expertise that lies within active asset managers that makes them best placed to respond to these two trends. Sophisticated portfolio construction with appropriate asset diversification is needed to meet the investor's long-term financial objective, whether that is capital accumulation and protection for a company's defined benefit plan or steady income in retirement for an individual saver.
Against this backdrop, it is increasingly clear investors with both large and small balance sheets are looking for similar return characteristics. They want to see outcome-oriented, volatility-dampening investments, preferably with absolute return, where the returns map with the risks in their own liability profile.
Simply put, it's about the steady accumulation of wealth or the delivery of a retirement invoice.
Low level of trust in financial institutions
Rebuilding consumer and regulatory trust in financial institutions starts with behaving responsibly and being effective stewards of the assets one manages.
We also need to recognize, both as an industry and as a society, that trust in experts is very low. There is a growing gap between the trust professionals have in experts and the average person on the street. If the financial industry is to restore consumer trust, we will have to go well beyond financial fiduciary standards and show we are providing a socially useful service through collectivizing savings and allocating this capital to productive investments that deliver a sustainable return.
As an asset manager, we effect real change in the companies in which we invest on our clients' behalf. Active allocation and stewardship of the capital investors provide us is essential if we are to ensure that investments generate the badly needed long-term improvement in productivity. The effective allocation of institutional investors' money to productive investments creates a socially important role for asset managers, and the opportunity to re-establish consumer trust.
Harnessing technology will enable asset managers to enhance client service by delivering customizable global services that meet institutional investors' complex needs. It also means consumers can get access to their assets more quickly than before. In a world that is fragmenting, it is increasingly important to invest in building scalable, value-add platforms that offer outcome-oriented solutions to the growing pools of investible assets around the world. The demand for a seamless, integrated and tailored solution for investors will drive technology for asset managers.
The ability to invest is always very simple in asset management, which is no more than a combination of people and technology. The firms that will win out in the end are the ones that have the scale and ability to invest in people and technology in order to be global within an increasingly politically fragmented world.
These four trends highlight the fundamental but changing role for asset managers in today's complex world. There's no doubt the eternal debate between active and passive investment strategies will continue. In the meantime, however, the changing needs of big and small investors worldwide is increasing the importance of asset management as we all take more responsibility for our financial future.
Keith Skeoch is CEO of Standard Life Investments, based in Edinburgh. This content represents the views of the author. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.