Volatility concerns will keep vexing managers
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December 26, 2016 12:00 AM

Volatility concerns will keep vexing managers

Active management resurgence possible while clients look for firms to do more

James Comtois
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    Arnold Adler
    Shawn K. Lytle thinks active management could have a real chance to shine.

    Executives from investment firms are predicting continued market volatility in 2017, which will lead asset owners to reallocate capital to specialized active strategies and demand even more from their money managers.

    “We're going to see volatility in the markets continue to increase for several reasons,” said Mitchell Harris, CEO of BNY Mellon Investment Management, New York. Those reasons include “the uncertainty factor” of President-elect Donald Trump and a significant number of geopolitical events, such as Brexit and the upcoming elections in France and Germany.

    Kevin Jestice, principal and head of institutional investor services at Malvern, Pa.-based Vanguard Group Inc., said in a phone interview that the three dominant trends affecting institutional money managers in 2017 will revolve around skill, conviction and cost.

    With continued fee pressure, dispersion and market volatility, Mr. Jestice argues that active managers will need to prove their worth to clients early and often. “There's an increasing skepticism among institutional investors,” he said. “There's an increased scrutiny on the skill of investment managers they're hiring.”

    Rick Lacaille, executive vice president and global chief investment officer at State Street Global Advisors in Boston, shared the sentiment that managers need to prove their worth now more than ever in a separate interview. “It's all about value for money: "What am I getting and what am I paying for?'”

    Prove their worth

    Other managers agreed that 2017 will be the year for active managers to prove their worth to institutional investors. “We are probably going to see subdued investment returns for the next five years, which will encourage investors to make sure they have the right balance of passive and active in order to meet return targets,” said Shawn K. Lytle, president of Delaware Investments.

    Mr. Lytle added that the lower return environment could be a good opportunity for managers to distinguish themselves.

    Jed Laskowitz, co-head of multiasset solutions at J.P. Morgan Asset Management in New York, also believes that 2017 will be a good year for active management — provided mangers can prove their worth. “Going into the new year, it'll be interesting to see how markets and events unfold, because while there's a lot of optimism — unemployment's low, the economy's healthy — it doesn't change the fact that there's a longer-term challenge here, which is achieving returns,” he said. “Active asset allocation will be critical in achieving those goals.”

    Surveys recently released by Fidelity Investments and Natixis Global Asset Management show that increased market volatility will drive asset owners to significantly reallocate their investment portfolios in 2017 more so than they did in recent years.

    “Institutional investors are confident of generating 2% alpha every year through a combination of manager selection as well as asset allocation,” said Scott E. Couto, president, Fidelity Institutional Asset Management, Smithfield, R.I. “This means they'd have to be pretty active in their management selection.”

    Natixis Global Asset Management's survey released Dec. 13 showed that in anticipation of higher volatility, institutional investors favor active management over passive for 2017. Of the 500 global institutional investors Natixis surveyed, 73% said the current market environment is likely favorable to active management, while 78% are willing to pay a higher fee for potential outperformance. Meanwhile, 64% of respondents to Natixis' survey said active management provides better risk-adjusted returns than passive.

    “These are the types of environments where investors look to partner with firms that can help them get through market volatility,” said Mr. Couto. “We and other (managers) will be trying to figure out implications of the new presidential administration.”

    He added: “There are a lot of people who need our help.”

    More toward alternatives

    Both the surveys found institutional investors plan to shift more toward alternative investments in 2017.

    “Specialist active management, alternatives, even the energy sector are all pretty good opportunities. Direct lending, private debt, the distressed part of the European debt and outcome/multiasset,” BNY Mellon's Mr. Harris said. “We're positioning ourselves in that barbell.”

    Mr. Harris added that institutional investors will need cost-effective passive portfolios to anchor the specialist active strategies such as high-conviction, socially responsible investing, farmland and direct credit.

    Neill Nuttall, co-CIO of the global portfolio solutions group at Goldman Sachs Asset Management, New York, was one of the many managers P&I spoke with who said it's simply too early to tell what trade policies the incoming administration will adopt, and what the effects of Brexit and the electoral cycle in Europe will have on asset flows.

    “We do not yet know what the policies adopted by the new administration will be. Our expectation is (the policies) will be moderately positive, particularly on the deregulation side,” he said.

    Despite this uncertainty, the GSAM executive remains moderately positive on the outlook for 2017 because he believes the country is still within the expansion phase of business cycle.

    “Looking into 2017, we see a moderate pickup in global growth. We expect a moderately positive return to risk assets,” he added.

    Mr. Harris also believes it is likely Mr. Trump will “relax regulations in areas that have been overregulated as it relates to banking.” This could lead to greater liquidity and the freeing up of capital.

    But the BNY Mellon IM chief executive noted it takes time to change regulations and regulators, so this would not really affect 2017. “It's more of a 2018 event,” Mr. Harris said.

    And even though the pool of institutional capital is steadily shrinking — the institutional ex-China flow rate for 2016-2021 is -3.41%, according to money management consulting firm Casey Quirk by Deloitte — that doesn't mean there aren't opportunities to be found within the industry.

    “Defined contribution is going to continue to grow,” said Benjamin F. Phillips, a New York-basedprincipal and investment management lead strategist at Casey Quirk. “Outcome-oriented or multiasset continues to be one of the biggest areas of growth.”

    And despite active management making a comeback, sources said passive management isn't going away anytime soon. Brad Morrow, New York-based head of manager research in the Americas for Willis Towers Watson PLC, said for corporate pension plans still looking to diversify their portfolios with asset classes that have different return drivers, there's “still a move toward passive.”

    "Fair amount of passive'

    Fidelity Institutional's Mr. Couto also noted his firm is still “doing a fair amount of passive.”

    Delaware's Mr. Lytle agreed the structural shift toward passive management within the industry is expected to continue in 2017. “Active managers are still not beating benchmarks. They need to have that top-quartile performance to distinguish (themselves) in order to grow,” he added.

    In addition to the migration toward passive expected to continue in the next year, Messrs. Morrow and Phillips also expect to see continued consolidation within the industry.

    “I think we're at the beginning of a very big wave of M&A,” Mr. Phillips said. “Margins are shrinking. The industry's not as scalable as everyone thought it was.” n

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