Money managers under the microscope
By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own.
The evaluation of an investment is measured by its potential performance and risk, and historically, investors have given more importance to the former than the latter. Recent events in the market, however, have challenged the hierarchy, placing risk at the heart of investors’ thinking. It is little short of a revolution in the investment industry.
While performance is associated with opportunities, risk is linked with danger and the switch in thinking is prompting investors to take a more defensive approach.
There have been several factors behind that change. The market is more volatile and given to quicker and more abrupt downturns; there is a polarization of economic growth outside core western economies; demographic change has led to the growing importance of liability management; and regulatory constraints have put extra pressure on institutional players to limit risky investments.
Up to 1996, we enjoyed smooth growth trends in markets, with steady periods of drawdown and recovery. Over the past 15 years, however, the nature of market cycles has changed.
Periods of exponential growth have been followed by deep crises, creating opportunities for hedge-fund style managers but a nightmare for long-only managers trying to protect assets. Both institutional and retail investors have had a hard time during these two crises with significant consequences on their risk appetite. For a chart detailing the recent trends, click: http://r.reuters.com/gef88r
Data from Lipper shows 10.18 percent average annual growth of the MSCI World TR in dollar terms between 1970 and 1980, 16.3 percent the following decade and 15.92 percent in the 1990s. The figure stood at only 1.77 percent during the last decade due to the two major downturns — the bursting of the internet bubble and the credit crisis.
When we look closely how performance was distributed for the past 15 years, we have a cumulative performance of 101.86 percent over the four years to end-1999, followed by a short but severe downturn of -50.74% from 2000 to 2002. From 2003 to 2006, the market rose a cumulative 52.93 percent in 4 years and then dived 37.24 percent in 2008 to emerge again with cumulative growth of 46.9 percent in 2009 and 2010.
Investors cannot time the market, much as they might try.
Strong downturns are prejudicial for portfolios and over the past couple of years, the risk management component has been given a far higher rating in the evaluation of managers before investment mandates are attributed.
Investors are also concerned about the polarization of growth in emerging countries.
Although there are now many brokers offering their services in the region and information is more fluid, investors remain cautious due to the risks — geopolitical, transparency and geographical — associated in investing in emerging countries. They therefore tend to modify their allocations to give more accent to tactical allocation than to strategic, long-term investment.
Indeed, while investors poured $25 billion into emerging market equity funds in 2010, they have removed nearly $2 billion in the first two months of this year.
Another consequence of the aftermath of the credit crisis is an acknowledgement of the inadequacy of investment yields in light of the liabilities faced by insurers and pension schemes as longevity increases.
Asset Liability Management (ALM) is forcing managers to look for alternative ways of increasing yields without taking too much risk. As a consequence of the credit crisis, asset allocation has been largely reshuffled away from equities as investors scrambled to get a handle on their investment risk.
Alternative investment managers running hedge funds or hedge-fund style absolute return funds have been solicited by pension schemes but trustees are conscious that between ex-ante volatility promises and ex-post crisis volatility there is a big difference.
As such, annualized standard deviation for hedge funds from 2004 to 2006 stood at 11.76 percent but this figure almost doubled to 22.77 percent in 2008.
Regulatory measures contained in Basel III and Solvency II will also limit bank and insurers exposures to equities and create a framework where risk is at the centre of investment decisions, helping to foster a top-down approach for risk management.
Institutional players and individual investors alike are putting a premium on protecting assets as well as growing them and are eyeing the market with suspicion. The shift is ubiquitous. And successful fund managers will be those who accept risk criteria are emerging ahead of future returns in post-credit crisis portfolio management.
(Editing by Joel Dimmock) ((email@example.com; +33 1 4949 5009))