New active strategies to make others obsolete

Managers of outcome-oriented, active investment strategies — credit, unconstrained equity, hedge fund, private capital, real assets and multiasset-class solutions — can expect a $3.4 trillion windfall from institutional and individual investors globally by the end of 2018.

That new cash infusion will come at the expense of traditional active equity and fixed-income money managers, which are predicted by Casey, Quirk & Associates LLC to lose an aggregate $1.8 trillion during the period.

Passive managers can expect to bring in $989 billion as a group into traditional indexing strategies during this time.

The forecast is from a new report, “Life After Benchmarks: Retooling Active Asset Management,” provided to Pensions & Investments by the Darien, Conn.-based money management consultant. The conclusions are based on 120 interviews with industry executives, CQA survey data and asset-revenue growth projection modeling.

New active strategies, as CQA labeled the six investment categories, will appeal — strongly — to investors “whose appetite for risk ... is significantly increasing,” Daniel Celeghin, a Casey, Quirk & Associates partner and the report's co-author, said in an interview.

“Most existing active investment strategies are becoming obsolete. Investors' requirements and frameworks are moving away from rigid benchmark-based allocations towards risk-factor and outcome-based mandates,” the report said.

Standard Life Investments, BlackRock Inc., Pacific Investment Management Co., AQR Capital Management LLC and larger alternative investment managers are firms that sources predicted will be winners in the new active investment environment of the future.

These firms have substantial investment infrastructure, client consulting capabilities and a head start in establishing, growing and combining benchmark-agnostic strategies for clients, industry sources said.

The pace of adoption of outcome- and factor-based allocation approaches is picking up among institutional investors.

“This is a trend that we absolutely agree is happening now and will strengthen,” said Erik L. Knutzen, chief investment officer of investment consultant NEPC LLC, Cambridge, Mass.

“Unconstrained strategies that utilize the whole range of tools from shorting to derivatives will gain ground as style box lines are crossed or the boxes entirely disappear,” Mr. Knutzen said.

A thriving future, or indeed mere survival, will depend on a manager's ability to adapt its ”investment engines to new demands by introducing tools and investment approaches from the alternative investment world,” the report said.

Sources were not optimistic about the prospects for traditional long-only equity and fixed-income shops without alternative investment capabilities and a willingness to build, buy or poach what they need to get them. Multimanager affiliate investment firms that are loath to trim non-performers from their stables and independent traditional investment managers also are on sources' failure-to-thrive lists.

Money managers split roughly into two camps, said Suzanne L. Duncan, senior vice president and global head of research in State Street Corp.'s Center for Applied Research, Boston.

About half of the 200 or so investment company executives Ms. Duncan interviews each year “realize that they are on the losing side and are embracing the trend, making strategic changes to transform themselves into new active managers,” she said.

The other 50% exhibit to a greater or lesser degree the “ostrich effect, not recognizing — consciously or unconsciously — that this asset allocation change is deep and secular rather than cyclical. They think they can just ride the downward cycle and come back when it's over,” she said.

But “strong asset growth is not likely for traditional managers, even traditional hedge fund managers,” Ms. Duncan said. She based that prediction on the center's analysis that over the next 10 years, 60% of institutional investors are likely to invest significantly more in private market investments, such as private equity, private real estate and infrastructure.

A common theme among the firms that can already count themselves among the new active managers is swift, deliberate expansion of investment management capabilities.

For example, The Carlyle Group LP's legacy private equity strategies held $62 billion as of Sept. 30, but newer investment categories are catching up. As of that date, Washington-based Carlyle managed $39 billion in real assets and a combined $35 billion in global market strategies (credit and hedge funds).

Carlyle's client investment solutions unit managed $48 billion as of Sept. 30 using combinations of the three other categories, as well as third-party investment strategies, said Glenn Youngkin, managing director and chief operating officer.

“We are preparing to offer a full complement of alternative strategies,” Mr. Youngkin said, noting Carlyle acquired real estate funds-of-funds manager Metropolitan Real Estate Equity Management LLC, and has made it known that a hedge funds-of-funds business would be of interest.

Standard Life Investments, Edinburgh, “first saw the possibilities in solutions-based investment 10 years ago,” said Colin Clark, director, global client group.

“Institutional investors are steadily moving away from this sort of static asset allocation to a model that is far more focused on matching liability or other outcomes like low volatility, absolute return or inflation protection,” which is what SLI's growing suite of multiasset-class solutions provides, Mr. Clark said.

SLI's prescience paid off. About $50 billion of the firm's total of $300 billion is managed in its global absolute return strategy, the firm's flagship solutions vehicle.

Taking what Mr. Clark called a “conveyor belt” approach in response to client demand, SLI launched a now $1 billion absolute return global bond strategy and will open its global focused solutions strategy in the first quarter of 2014 to offer investors a higher return/higher volatility version of the multiasset-class approach.

“Investors are looking for managers who can do more than one thing in a relationship,” said Robert L. Goldstein, a senior managing director and head of BlackRock's institutional client group and head of BlackRock Solutions in New York.

“BlackRock has been building up its capability for years in all six of Casey Quirk's new active strategies,” Mr. Goldstein said. “Have we been voting with our feet about where the institutional investment world is going? Definitely yes,” he added.

But Mr. Goldstein said the idea that old-style active management will disappear is “naïve. Traditional active management will still have a place in institutional portfolios, but it will be much less of a focus than it is now.”

Sabrina C. Callin, a managing director in PIMCO's Newport Beach, Calif., headquarters, agreed.

“I don't think traditional fixed income will completely go away. Institutional investors are much more willing to think differently about fixed income. More investors are giving PIMCO the latitude to manage their portfolios across the full range of strategies from our traditional total return bond strategy through our unconstrained bond approach to hedge funds and non-traditional credit,” Ms. Callin said. n