Rising rates, political tensions among key challenges for year

Money managers will face a wide range of challenges and opportunities in 2016, from a changing interest-rate environment to geopolitics to more-demanding clients to increasing technology needs.

“The trends we saw in the latter part of 2015 will continue to accelerate in intensity in 2016,” said Stephen Kolano, head of multiasset solutions for the investment strategy and solutions group within BNY Mellon Investment Management, Boston.

One major change for money managers is that we've now entered an environment in which rates have risen for the first time in almost a decade.

Members of the Federal Open Market Committee agreed on Dec. 16 to increase the federal funds rate by 25 basis points, after keeping it at zero to 0.25% for years. FOMC members forecast raising rates one percentage point each year over the next three years, reaching 3.3% by the end of 2018.

“We are going to be coming into the first rate-hiking cycle in a decade. The (Federal Reserve) is going to do that gently and allow the market to acclimatize,” said John Bilton, global head of multiasset strategy at J.P. Morgan Asset Management, London.

Payson Swaffield, chief income officer at Eaton Vance Management, Boston, also noted that rising rates will be “a new start” for fixed-income managers in the year ahead.

In the face of short-term rising rates, Mr. Swaffield suggested that high-yield securities and floating-rate loans, Treasury inflation-protected securities and emerging markets local currencies are areas that might be interesting to investors in 2016.

Mr. Swaffield added that he has also been seeing increasing interest from institutional investors — particularly from pension plans — in municipal bonds.

Despite the rate increase, Erik Knutzen, multiasset-class chief investment officer at Neuberger Berman Group LLC, New York, said it was “going to be difficult to realize long-term returns comparable to historical experiences.”

A couple of managers told Pensions & Investments they believed geopolitics would have a greater effect on the money management industry in 2016 than it did this year.

“Geopolitics is likely to play a very much more important role in 2016 than in 2015,” said Mark McCombe, New York-based senior managing director and global head of BlackRock Inc.'s institutional client business. “I think it will play into the whole issue of having divergent monetary policies around the world. I think we'll be seeing more regional tension and uncertainty.”

BNY Mellon's Mr. Kolano also said he's keen to see how politics is going to affect capital markets in 2016, citing the U.S. presidential election as a prime example.

In addition to geopolitical risks, Mr. Kolano said he's also been noticing more alpha opportunities for active managers. “Investors and asset owners are seeking risk and looking to be compensated. Active managers can start to prove their worth,” he said.

Mr. McCombe agreed, saying “beta will be challenged in 2016. So it's a time for active .” Meanwhile, Timothy J. O'Neill, New York-based global co-head of The Goldman Sachs Group Inc.'s investment management division, which oversees Goldman Sachs Asset Management, said “the ongoing search for alpha on the active side” will continue to be a big challenge in 2016.

“I think actively managed portfolios have a step ahead of passive portfolios, particularly in the equities space. Active managers can adjust the portfolio in the securities selection. This is a dynamic tool that active managers use that isn't available to passive portfolios,” Mr. O'Neill said.

But he added that he thinks the market will reach a balance between active and passive.

“Passive isn't going away, but it also can't take over the market,” Mr. O'Neill said. “Perhaps passive may reach a tipping point, which will open the door for opportunistic active equity managers.”

Weighing in on where active management will be in 2016, Susan Brengle, managing director, institutional, at Eaton Vance Management, said “there's plenty of institutional supporters of active management, large amount of assets still invested in active, so that's certainly not going anywhere.”

“We're still seeing a far greater percentage of fixed-income and international equities allocated to active,” Ms. Brengle added.

Investment trends from asset owners aside, public money managers have faced another problem recently. Although the U.S. stock market is close to an all-time high set earlier in 2015, public money managers have not followed suit.

The stock price of a number of managers, such as BlackRock, Oaktree , AM Gand Invesco, are still vastly underperforming the Standard & Poor's 500 index.

Robert Lee, a managing director and analyst at Keefe, Bruyette & Woods Inc. in New York, said a combination of factors is causing this.

“I think there's this concern from many investors that maybe now's not the time to buy a manager whose value is sensitive to the ups and downs of the market,” Mr. Lee said, noting that low global markets, increased volatility and a difficulty for many traditional money managers to generate organic growth “doesn't create investor excitement.”

Mr. Lee added it was “hard to say” whether this trend is likely to continue in 2016. “You hope at some point (these managers) can do better, assuming they continue to outperform their peers. But investors have to feel better about the direction of asset returns,” Mr. Lee said.

The idea of insourcing — asset owners managing their indexed portfolios and fund-of-funds portfolios internally — will be a bigger topic for money managers in 2016.

“Some of this we've seen. Sovereigns have been pulling back their funds to pay bills. So that's one big thing in 2016 we expect to continue,” said Benjamin Phillips, New York-based partner at money management consultant Casey, Quirk & Associates LLC.

A lot of these sovereign wealth funds are pulling money back because oil prices are dropping.

But globally, as pension funds derisk, they will be pulling back money from managers.

Mr. Phillips said a number of opportunities can come out of this.

“Managers need to focus on providing things pension plans can't do internally,” Mr. Phillips said, citing high-active strategies, highly concentrated equity, liquid alternatives, unconstrained fixed income, and determining how to embed risk management as examples.

Another way money managers can demonstrate value is through services. “More and more, institutions are expecting their fund managers to act as partners. Advice on asset allocation is part of the value add,” Mr. Phillips said. n