Chief investment officers at money management firms in the United Kingdom and Europe are overly optimistic about their prospects for asset growth and their readiness for change within the asset management industry, according to a new study done by Greenwich Associates, Greenwich, Conn., and BARRA Inc., Berkeley, Calif.
"Institutional investors may not be fully coming to terms with the scope of the issues they face, even though pension funds are already feeling their full impact," according to the study.
"Institutional investors are sailing into a serious problem, a perfect storm of sour market performance and growing benefits demand, and the pension funds are already there," said Greenwich consultant John Webster in the report. "There is concern that too few chief investment officers are making sufficient changes to tackle their own and their clients' issues. Maybe that's a sensible reaction, given the uncertainty of the times and the actual ability of the CIOs to effect major change. But maybe it's not," he added.
In a separate interview, Mr. Webster said, "Only one in three people we interviewed were considering making radical changes" to their business plans. "If the (investment) model is not delivering to investors, why not make changes?"
"The picture that emerges is one of profitability - or at least cost containment - becoming more important," said Robert Statius-Muller, a London-based Greenwich consultant, in the report. "But the preponderance of the evidence suggests that too few are prepared to do anything dramatic to make that happen."
"It can be tough for a CIO to institute radical change," said Mr. Webster in the interview "The business leader - the chief executive officer - as opposed to the CIO is the one who usually makes major changes.
"If a lot of CIOs are not coming to terms with their needs, pension funds have to seek out CIOs who are coming to terms with it or convince them (the CIOs) to make changes."
Problems so enormous
Mr. Webster pointed out that the scale of investment problems facing pension funds are so enormous that the officials who lead them have to be thinking about the possible collapse of their defined benefit plans.
"The industry has a lot to work through to protect their investments over a long period of time," he said.
"They (pension fund executives) don't see CIOs coming up with solutions to their problems, at least not as much as they should be," said Mr. Webster. "Hope is not a strategy," he added. "They've got to put some ideas on the table to help people get through their problems."
Eighty-eight percent of the CIOs that Greenwich surveyed said they have key qualities that set them apart from the competition. "But a closer look at what these differences are shows them to be not entirely unique," according to the report.
A sign of the managers' overoptimism is that more than half of the CIOs interviewed (57%) expect asset growth to climb in the next year. Seventy-nine percent expect an increase in assets from new client mandates by the end of 2003, and 64% expect to see growth in their existing mandates.
"Everyone is focused on growth, saying no matter what happens, we will be the survivor," said Mr. Statius-Muller in the report. "Yet there must be some losers for there to be winners." However he also pointed out in the report that the growth of specialized mandates "appears to enable the market to gain assets under management in the way all the investors are predicting."
In response to the corporate accounting scandals, CIOs expect pension funds will want increased transparency and tighter risk control. CIOs interviewed for the report said a transparent investment process is the most important factor for investment managers, both now and in the next three years.
Emphasis on tight management of portfolio risks will increase over the next three years, along with transparency of portfolio risk, according to the report.
"This is the issue of trying to avoid investing in the next Enron and being a little bit more savvy about trying to spot potential disasters before they occur," Mr. Webster said in the report.
Sixty-one percent of the CIOs surveyed said rigorous risk control is more important now than a year ago. To increase their controls, 52% of CIOs plan to purchase more specialized risk systems, as do 77% of smaller firms.
Cost control is a lesser priority, with just 17% of respondents saying it is very important now and 30% saying it will be very important in three years.
The CIOs expect hedge fund holdings to grow by 15% next year, far more than what is expected in any other asset class, according to the report. This increase is from very low levels: Just 3% of U.K. and 18% of continental European institutional investors used hedge funds last year, according to 2002 Greenwich Associates research.
When CIOs were asked whether hedge funds and other new asset classes are "lasting and significant profit generators, as opposed to short-term distractions," an overwhelming 84% of those surveyed said they are here to stay.
However, the CIOs also don't believe that alternative investments will become a dominant asset class.
The move to alternative asset classes is unlikely to resolve the major problems facing pension funds, according to the report. "To make a significant difference in a fund's overall investment performance may require a significantly bigger allocation of assets to alternatives than many investment committees are prepared to make," Mr. Webster said in the report.
The survey indicates what one CIO calls "a mixed bag," regarding whether pension funds will prefer global money managers that can manage all asset classes, or niche specialists in fund management. According to the report, both ways have their advantages and disadvantages.
Global companies can offer a one-stop shop and greater resources for research, but their size prevents them from being as nimble as smaller fund managers. The report offers no consensus on which is best. Who wins out "may depend on the way the consultants actually drive this business," said Mr. Webster in the report. "They're not necessarily mutually exclusive."
For the study, Greenwich interviewed 41 CIOs and portfolio managers at the largest asset managers - those managing more than e500 billion ($439 billion) in assets - in the United Kingdom, Belgium, France, Germany, the Netherlands, Poland and Switzerland. n