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from Global Investing:

US investors prop up emerging equity flows

U.S. mutual fund investors are ploughing on with bets on emerging market equities, according to the latest net flows numbers from our corporate cousins at fund research firm Lipper. Has no one told them there's supposed to be a massive sell-off?

August was the 30th straight month the sector has seen net inflows, and the 9th straight month of net inflows above $1 billion. Sure, there's a downward trend from the February peak, but the resilience of demand is notable given doom-laden headlines about how EM markets will fare once the Fed feels its generosity is no longer required.

Of course, the popular image of mutual fund investors is as a perennial lagging indicator for allocations trends, and the stage may be being set for a sharp turnaround this month. However, U.S. investors have already been offloading their bets on emerging debt, with funds in the sector seeing net outflows of $2.6 billion, or 7.5% of total assets, in the three months to end-August.

It may be that this is part of a trend towards international diversification in the U.S., with investors taking a longer view and a more sanguine approach to risk. But they'll need strong stomachs. Three-month performance at those U.S.-domiciled EM equity funds is at -7.7% (see chart below), while three-month net inflows are at more than $4.5 billion. Juxtapose that with the global EM equity sector over the same period, where  average fund performance is at -8.2% and net outflows are a chunky $7.8 billion. In short, investors elsewhere are pulling cash out of emerging equity funds but U.S. fund buyers seem to be going the other way.

Absolutely Fabulous?

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Among the side-effects of the financial crisis, the importance for European wealth managers and other intermediaries of both managing investors’ expectations and understanding fully what those expectations are, has been underlined.

This is not entirely new. The rise of absolute return products largely reflects intermediaries’ efforts to deal directly with client expectations that, for many, have taken a severe blow. It is worth looking back at the level of inflows to funds seeking absolute returns before and after 2008 (the nadir for the industry in terms of sales activity) to see how this has evolved.

Are marathon runners trying to sprint?

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“The long is short. Investment choice, like other life choices, is being re-tuned to a shorter wave-length.” So stated Andy Haldane of the Bank of England in a speech last month.

If one of the key features of a mutual fund is that it is a long-term investment, then concerns that money is being managed over decreasing time horizons should be treated seriously.

Hedge funds vs mutual funds

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By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own.

Hedge funds took some heat from the credit crisis as liquidity and transparency became critical factors in investment decision-making. It’s fair to say hedge funds continued to deliver decent returns to investors, but how do they compare to mutual funds if we focus on performance and risk alone?

Risk revolution

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By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own. LONDON, April 6 (Reuters) – 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. POLARIZED GROWTH 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) ((dunny.moonesawmy1@thomsonreuters.com; +33 1 4949 5009))

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.

The Naked Truth

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By Ed Moisson, Head of UK & Cross-Border Research at Lipper

Do independent asset managers perform better than bank-run funds?

Lipper was recently approached to analyse the difference in performance between funds operated by broader financial services companies (banks and insurers) and those managed by ‘pure play’ asset managers.

This research came in the wake of comments made by Peter Hargreaves, founder of IFA Hargreaves Lansdown, who said in September that many funds in the UK run by banks were “seriously crap”.

Smith attacks hedge funds’ 2 and 20

Here’s the link to Terry Smith’s blog attacking the “unsupportable” practice of hedge funds charging their clients fees of 2 and 20 (2 percent annual and 20 percent performance).

Smith compares the maths that show a $1,000 investment in Berkshire Hathaway in 1965 (when Buffett began) would last year be worth $4.3 million, with a hedge fund charging 2 and 20.

Hedge fund performers

The top sectors in the year to date.

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RAB fund still paying the price

RAB Capital’s struggling Special Situations fund looks to have recorded a positive return in 2009, but after a bumper year for the industry it is still paying the price for the investments it made in illiquid assets before the credit crisis.

RAB's Philip Richards. REUTERS/Nigel Roddis.

Having seen their investment lose around half its value in 2008 while much of the fund’s money was in hard-to-sell assets, the fund’s investors agreed in autumn ’08 to lock up their money for 3 years in return for a cut in fees.

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