Customization key for managers as trillions come off the sidelines in 'biggest jump ball'

Money manager skill in customizing portfolios for clients could prove key to winning back some of the trillions of dollars that institutional and retail clients parked in short-term paper over the past three or four years in search of a safe — albeit increasingly high-yielding — harbor, analysts say.

Ben Phillips, a New York-based partner in Oliver Wyman’s insurance and asset management practice, called that sidelined cash, including a record $6 trillion in money market funds, “the biggest jump ball” in the history of asset management.

A jump ball, moreover, with a highly uncertain outcome amid changes in pension funding levels and demographics which have tended to make clients more outcome-oriented, favoring longer-dated assets, liability management and core fixed income, he said.

With the rise of rates from rock-bottom levels over the past two years swelling the ranks of fully funded U.S. corporate pension plans, leaving sponsors more inclined to trim risk from their portfolios, the money managers best placed to gather those assets are likely to be different from the ones that saw those assets go out the door in the first place, Phillips said.

“Everything that came out of mutual funds, that came out of active equities, that came out of these benchmark-driven portfolios is going back into private markets, more customized vehicles in retail (and) more rate- and credit-focused instruments” - both private credit and fixed income, he said.

In an environment where plan sponsors are focusing on preserving their surpluses, “fixed income wins; private (assets) win…equity is a shrinking pie,” leaving "middling" equity managers vulnerable to getting pushed out and pushed down, said Todd Glickson, head of investment management, North America with financial sector advisory firm Coalition Greenwich.

Increasingly for equity managers, organic growth - the strategic goal for most investment management firms - “probably comes from clawing assets away from a rival,” agreed Phillips, adding “it’s hard to believe that more than a few hundred asset managers can compete effectively” in that space.

Even so, a number of equity managers said they're confident they’ll be able to thrive going forward, even if the U.S. becomes a takeaway market.

Stephanie Braming, William Blair Investment Management’s global head of investment management, said her firm — with $67.1 billion in predominantly U.S. and global growth equity assets as of Dec. 31, up 20% on year — has kept growing despite the broader shift to passive by taking share in the U.S. market while garnering more flows from clients overseas.

When will the Fed act?

Meanwhile, if the timing of the U.S. Federal Reserve Board’s first rate cut — following an aggressive tightening campaign between March 2022 and July 2023 that succeeded in capping runaway inflationary pressures — remains the industry’s favorite guessing game, some market veterans insist investors next year will look back at the current moment as one where they should have been putting money to work.

“In fixed income, it’s right around the corner,” said David Leduc, Boston-based CEO, North America of Insight Investment, BNY Mellon Investment Management’s $826 billion fixed-income affiliate. “Now is the time” and Insight is already seeing a pickup in interest in its active strategies, he added.

But if the top-line conclusion is “more private markets and fixed income, less equity,” it’s a bit more complicated than that, Phillips said. “Equity isn’t gone by a longshot but it will have to really reinvent itself,” with managers, for example, working more with clients to craft custom equity portfolios that complete clients’ desired risk-return profiles for their portfolios, he said.

Money managers used to count on scalability to drive their businesses: “You built the fund, you put it on the shelf, somebody came and took it away as a distributor,” Phillips said. Increasingly now, there’s more of a service dynamic in play, with conversations focused on helping clients achieve their desired outcomes or “solve their problem,” he said.

That emerging “service model” will require managers to have “deeper knowledge of clients, better sense of partnership with key distributors, more custom solutions across the board and … a wider set of advisory skills like tax, downside protection, income generation, Phillips said.

In that world, the relevant benchmark becomes the client’s required cash flows — a more liability-driven approach, he said.

The growing importance of helping clients cover their liabilities and pension payouts is being felt by fixed-income managers as well.

Now that the increase in yields over the last 24 months have left U.S. plans more fully funded, a growing number of those plans are saying, “well, let’s take some of the chips off the casino table,” looking to protect their surpluses and make sure payments to pensioners are more predictable, said Insight’s Leduc.

Instead of the traditional 60/40 approach, combining equities and active fixed income with a duration “that doesn’t meet your liability,” Insight’s team is working to put together portfolios of bonds with cash flows that match clients’ expected payments — leaving them with little if any risk on the bond side, said Leduc.

That reduction in risk, in turn, provides an alternative for clients that might otherwise have felt pressure to do a pension risk transfer, allowing them to consider other ways to use their surpluses to provide benefits to employees, Leduc said.