Presentation of the 2010 CFA Monograph authored by Frank
Fabozzi (Yale University), Sergio Focardi (EDHEC Business School,
Nice), Caroline Jonas (The Intertek Group, Paris) Zurich, 25
January 2011 Geneva, 26 January 2011 Investment Management After
the Global Financial Crisis 1
Slide 2
My Objective Here Today Investment Management After the Global
Financial Crisis 2 Present results of the study published by CFA
Institute under the title Investment Management after the Global
Financial Crisis Discuss some of the things asset managers might
want to do differently going forward
Slide 3
Context Leading to the Monograph Investment Management After
the Global Financial Crisis 3 From mid 2007 through Q1 2009,
financial markets were shaken by a series of shocks The summer of
2007 saw liquidity dry up and the beginning of the subprime
mortgage crisis Following the collapse of Lehman Brothers (Sept
2008), the financial markets began a slide which was to see major
indexes such as the S&P 500 and the Morgan Stanley Composite
Index (MSCI) lose more than half of their value compared to their
highs of 2007 By the end of Q1 2009, most investors had suffered
serious losses; asset management firms were in survival mode
Slide 4
2009, 2010 Investment Management After the Global Financial
Crisis 4 Conventional assets under management in the global fund
management industry were estimated to be 71trillion USD end 2009, a
14% increase over 2008 due essentially to the recovery in equity
markets The S&P 500 reached a low of about 680 in Q1 2009, down
55% from its peak of about 1500 in 2007 but rebounded to 1150 by
end 2010 And is now at 1280, the level it had reached five years
ago
Slide 5
Trends and Considerations Still Valid Investment Management
After the Global Financial Crisis 5 Though the equity markets have
rebounded The trends and considerations made remain valid
Essentially because the causes of the crisis have not been removed
And many of the trends are long-term trends that could have been
identified even prior to the crisis
Slide 6
The Objective Investment Management After the Global Financial
Crisis 6 The Research Foundation of CFA Institute asked the authors
to reveal how the financial crisis would impact investment
management decisions and processes and the investment management
industry itself For everyone in asset management managers,
consultants and institutional investors it is vital to do a lessons
learned exercise. The industry failed to do so when the Internet
bubble burst in 2000: everyone said that it was the investment
banks and brushed it off, moved on. This time we need to do a
lessons learned exercise at every level, we need to understand the
10 things that we need to do differently. CIO at a large Northern
European institutional investor
Slide 7
The Research Methodology Investment Management After the Global
Financial Crisis 7 A review of the literature Conversations with 68
industry players, industry observers, executive recruiters, and
academics: 17 institutional investors with a total of 570 billion
in investable assets 15 investment consultants and private wealth
advisors with 5 trillion in assets under advisory 15 asset and
wealth managers with 4.5 trillion assets under management 6
industry observers 6 executive recruiters 9 academics The
geographical breakdown: Europe (roughly 2/3) and North America NB:
Most interviews were realized in H2 2009. Academics contributed
their evaluations in early 2010
Slide 8
Finding #1: Asset Allocation Is Back Investment Management
After the Global Financial Crisis 8 The central role of asset
allocation in generating returns and protecting the downside has
been clearly re-established The events of 2007-2009 highlighted the
need for a top- down approach in which macroeconomics will play a
bigger role One thing that strikes me is the growing client
awareness that asset allocation drives everything. Investment
Consultant
Slide 9
Allocating Assets More Dynamically Investment Management After
the Global Financial Crisis 9 Given the high levels of volatility,
asset allocation is also becoming more dynamic; timing
asset-allocation decisions will play a big role in explaining
returns But: Academics were skeptical as to investment managers
ability to successfully time asset allocation decisions
Nevertheless, academics pointed to evidence that suggests that it
is easier to time parts of the market (for example large cap versus
small cap or individual securities) than to time broad asset
classes
Slide 10
Asset Allocation and Diversification Investment Management
After the Global Financial Crisis 10 Investors are turning to
greater diversification in asset classes to protect assets from
market movements and generate higher returns The investable
universe once centered around two asset classes equities and bonds
has been expanded to include new strategies and asset classes
including real estate, hedge funds, private equity, currencies,
commodities, natural resources such as forests and agricultural
land, infrastructure, and intangibles such as intellectual property
rights The percentage of alternatives in the aggregate asset
allocation of the pension funds in the seven countries with the
largest pensions markets was estimated to be >16% by year-end
2008 (17% year end 2009)
Slide 11
Asset Allocation and Diversification, ctd Investment Management
After the Global Financial Crisis 11 But: Academics we talked to
noted that there is not much history on the (risk-adjusted)
performance of many of these alternative asset classes In
particular, academics were skeptical that private equity should
generate more stable/better (risk-adjusted) returns than public
equity: is it simply a question of lack of pricing
information?
Slide 12
Consequence of the Return of Asset Allocation Investment
Management After the Global Financial Crisis 12 With asset
allocation re-established as the most important factor explaining
returns: Asset-allocation products are expected to have strong
growth In particular, investment products with an element of active
asset allocation are being engineered for defined-contribution plan
members and retail investors Example: lifestyle funds
Slide 13
Finding #2: Focus on Risk Management Investment Management
After the Global Financial Crisis 13 During the 2007-2009 market
turmoil, investors attention shifted from returns to risk Sources
identified risk management as the area that has changed/will change
the most following recent market turmoil
Slide 14
What Is Changing in Risk Management? Investment Management
After the Global Financial Crisis 14 In general, return
expectations will have to be better aligned with the overall
ability of markets and the economy to generate returns In addition
to market risk, we can no longer ignore other risks such as
liquidity risk, counterparty risk, systemic risk, and the effects
of leverage Innovative products, such as the complex structured
products introduced by investment banks, have added a new element
of risk, calling not only for special methodologies for measuring
their risk, but also a greater understanding of the products one is
investing in and how they work in different economic contexts
Slide 15
New Tools for Analyzing Risk Investment Management After the
Global Financial Crisis 15 To gain a better appreciation of risk,
methodologies such as Monte Carlo simulations, stress testing are
being more widely adopted Conditional VaR is being used to measure
risk in the presence of fat tails (i.e., large events such as large
market movements) In the area of systemic risk, aggregation
phenomena are being studied (for the moment by academia and central
banks) using methodologies such as the theories of percolation and
random networks
Slide 16
Not All Risks Can Be Easily Estimated and Hedged Investment
Management After the Global Financial Crisis 16 Academics we talked
to underlined the difficulty in hedging liquidity risk given the
lack of data and the likely non-linear impact of liquidity shocks
As for new risks due to complex structured products a risk
underlined by industry players academics cautioned on their use
given the asymmetry of experience and lack of competition in the
market
Slide 17
Finding #3: Growing Pressure on Costs Investment Management
After the Global Financial Crisis 17 Investors who saw their assets
shrink as major indexes lost around half of their value in the
crash of 2008-2009 are taking a hard look at management fees and
other costs If returns are low, the cost of producing them becomes
more and more important Institutional Investor
Slide 18
Institutional Investors Strategies to Reduce Management Costs
Investment Management After the Global Financial Crisis 18
Renegotiating fees especially, but not only, in the alternatives
arena Investing more assets in index funds Bringing management
(increasingly) in-house Including, for the larger funds, setting up
in-house teams to manage alternative investments, and pooling
assets to wring out layers of intermediaries
Slide 19
Individuals Strategies to Reduce Management Costs Investment
Management After the Global Financial Crisis 19 High-net-worth
individuals are: moving towards simpler, more transparent products
such as ETFs, and towards banks that offer more competitive fees,
more competitive products Retail investors are: reducing management
fees by putting their investable assets into low-cost funds, a
trend already underway for a number of years in some markets (93%
of all new net purchases of S&P500 Index mutual funds
concentrated in least costly funds 2000-2009) Trend towards equity
index funds continued despite recovery of the market (13.7% of all
US equity mutual fund assets year end 2009 up from 13% year end
2008)
Slide 20
Finding # 4: Towards a Redistribution of Roles Investment
Management After the Global Financial Crisis 20 Redistribution of
roles among investors, consultants, and asset and wealth managers
has accelerated Large institutional investors are increasingly
bringing asset allocation and asset management in-house and the
largest are building platforms to service smaller funds Consultants
are moving into implemented or fiduciary management in an attempt
to boost revenues that slumped as the value of assets under
management fell and firms sought to control costs
Slide 21
Finding # 4: Towards a Redistribution of Roles, ctd Investment
Management After the Global Financial Crisis 21 Asset managers are
offering asset allocation advice, both in response to investor
demand and to provide value over and above that added within the
managers asset-class mandate Asset managers are also making inroads
in asset allocation in the defined-contribution (DC) pension arena,
offering all- weather portfolios for DC plan members as plan
sponsors seek to give some sort of downside protection to plan
members
Slide 22
Other Players : Investment Banks, Insurers Investment
Management After the Global Financial Crisis 22 Investment banks
will continue to play an important role in assisting corporate
pension plans, providing hedging of liabilities with interest rate
derivatives and perhaps also, more generally, as a provider of
swap-based exchange-traded funds (ETFs) Insurers will play a bigger
role as small pension funds outsource the management of their
assets, governments try to push down the cost of management, and
retiring baby boomers demand principal-protection and
risk-mitigation products
Slide 23
Finding # 5: A Greater Attention to Ethical Behavior Investment
Management After the Global Financial Crisis 23 Consultants and
investors are stepping up due diligence, especially in alternative
investments Larger consultancies are building up their research
teams, esp. in the area of operational risk Institutional investors
burned by hot money in hedge funds are taking a closer look not
only at who is managing the money and how, but also who the
co-investors are
Slide 24
Finding # 5: A Greater Attention to Ethical Behavior, ctd
Investment Management After the Global Financial Crisis 24 In
addition, continental European funds are taking a closer look at
what activities are behind the profits of the firms in their
portfolios While investors in English-speaking countries are
focusing more closely on governance and other ethical issues that
bear on the value of the firm
Slide 25
Finding # 6: Biggest Challenge for All in the Industry: Regain
Investor Trust Investment Management After the Global Financial
Crisis 25 Will require: More transparency More communication with
investors, especially on risk Better management of expectations
Some help from financial markets Bubbles come and bubbles go and
leave a lot of people angry. Asset managers need a trust
proposition CIO, European asset management firm
Slide 26
The Challenge for Pension Funds Investment Management After the
Global Financial Crisis 26 The challenge: pay the pension promise
in what many investors expect to be a highly uncertain,
low-interest-rate, low-return environment Among the strategies: Get
costs down Move more assets into in-house management wherever
possible Try to increase returns with greater diversification and
more opportunistic, active asset allocation, While paying more
attention to the macro environment
Slide 27
The Challenge for Consultants Investment Management After the
Global Financial Crisis 27 The challenge: add value as investment
strategies pursued by institutional investors become more complex
Will require: A bolstering of competencies in risk budgeting, asset
allocation, and new asset classes Might include enlarging the
service offerings to include, for example, fiduciary management Or
merging (ex Towers Perrin/Watson Wyatt) or considering alliances
with asset managers or institutional investors
Slide 28
The Challenge for Investment Managers Investment Management
After the Global Financial Crisis 28 The challenge: redefine the
offering, aligning the promise with the ability to deliver
Strategies: Play a bigger role in asset allocation advising
institutional investors and engineering products for retail
investors and in risk and liquidity management Restructure: As
investors move their assets increasingly into index funds on the
one side and alternatives on the other, the industry is expected to
restructure, with a few large firms with a comprehensive product
offering including alternatives and advice, and a large number of
specialized boutiques Separation of production and distribution: As
the industry consolidates and the pensions market undergoes
retailization, the industry is moving towards a separation of
production and distribution in which revenue- sharing will be a
major issue
Slide 29
Employment Trends Investment Management After the Global
Financial Crisis 29 Mid 2009: 20-55% drop in overall recruitment
mandates due to downsizing at large asset management firms as they
tried to control costs in the face of falling assets under
management and investors preference for lower-margin products By
end 2010 recruitment firms reported that dramatic cost cutting was
over and recruiting was up again though still not up to 2007
levels
Slide 30
Compensation Trends Investment Management After the Global
Financial Crisis 30 Compensation in the industry was down 20-40% in
2009 compared to 2008, due essentially to a reduction of bonuses
Compensation bounced back 10-15% in 2010 but it is still below 2007
levels Compensation structures are also being reviewed, with a
larger percentage of compensation being deferred, performance
evaluated over several years, and incentives aligned with the
long-term performance of the firm
Slide 31
Recruited Most / Least in 2009 Investment Management After the
Global Financial Crisis 31 Demand up for: Asset-allocation
specialists and persons with multi-asset experience and
quantitative skills Risk managers, including counterparty and
operational risk managers Global and emerging markets specialists
Credit specialists Demand down for: Stock pickers, as investors
moved assets into index funds Equity portfolio managers for
developed countries Retail wholesaling staff, with the decline of
the open-architecture model
Slide 32
What We Might Do Differently Investment Management After the
Global Financial Crisis 32 For everyone in asset management
managers, consultants and institutional investors it is vital to do
a lessons learned exercise. The industry failed to do so when the
Internet bubble burst in 2000: everyone said that it was the
investment banks and brushed it off, moved on. This time we need to
do a lessons learned exercise at every level, we need to understand
the 10 things that we need to do differently. CIO at a large
Northern European institutional investor
Slide 33
#1 : More Effective Diversification Investment Management After
the Global Financial Crisis 33 Consider correlations at the
relevant time horizons Instantaneous correlation between the
returns of different assets and asset classes does not fully
reflect the behavior of the returns of assets or asset classes in
times of crisis Diversification based on correlations at short time
horizon does not protect against crises One needs to understand
trends at intermediate times and diversify trends Or equivalently
diversify at the relevant time horizons and Understand
cointegration that is the clustering of price processes around a
small number of key trends
Slide 34
# 2 : Review Asset Allocation More Frequently Investment
Management After the Global Financial Crisis 34 Todays markets
experience more large swings in valuations and change behavior in
fundamental ways that affect the forecasts of entire asset classes
and require dynamic asset allocation But: while dynamic asset
allocation holds the promise of higher returns, it is a source of
risk given that it shifts assets dynamically from entire asset
classes, leaving little margin for mistakes in the difficult task
of timing Therefore the need to understand what asset subclasses
can be forecasted most accurately
Slide 35
#3 : Consider Extreme Events Investment Management After the
Global Financial Crisis 35 Extreme events do occur more frequently
than todays risk models forecast Empirically, we know that returns
distributions are fat-tailed In addition, there are hidden sources
of extreme risk that have to be accounted for, e.g., 6 May2010
flash crash The presence of fat tails implies that linear
correlations do not reflect co-movement between asset returns But
we still have to separate fat tails of short-term returns from
prolonged market slides And understand when extreme events are
triggers of crises
Slide 36
#4 : Consider Liquidity Risk Investment Management After the
Global Financial Crisis 36 Consider carefully the magnitude of
losses should one need to unwind positions rapidly Recent events
have demonstrated that a sudden withdrawal of liquidity from
markets might occur, leading to potentially very large losses on
leveraged strategies But liquidity is difficult to understand
Because it is a non linear phenomenon only partially explained by
standard asset pricing theories
Slide 37
#5 : Consider the Complexity of the Web of Relationships
Between Agents, Investment Products Investment Management After the
Global Financial Crisis 37 The structure of market links has come
to the forefront as a source of risk as complex derivative products
might propagate losses throughout the economy well beyond what was
believed realistic before the 2007-2009 crisis The Bank of Englands
Executive Director of Financial Stability Andy Haldane has proposed
measures of market connectedness
Slide 38
#6 : Consider Macroeconomic Quantities Investment Management
After the Global Financial Crisis 38 The real economy does matter
Though macroeconomic variables move slowly, they are important
insofar as they can signal the building up of situations that might
lead to large losses For example, the progressive building up of
excessive mortgage exposure is a fact that could have been revealed
by economic analysis
Slide 39
#6 : Look at Macroeconomic Quantities, ctd Investment
Management After the Global Financial Crisis 39 Financial returns
must have an economic basis One has to understand the sources of
returns And their sustainability The economy, markets are finite,
While classical finance theory essentially assumes infinite
markets
Slide 40
#6 : Look at Macroeconomic Quantities, ctd Investment
Management After the Global Financial Crisis 40 We know a lot about
crises, in particular about the links between crises and the excess
of money and credit Studies have underlined common characteristics
of the economy in periods preceding a crisis (e.g., Minsky,
Reinhart & Rogoff) But these forewarnings are often interpreted
as signs of a favorable situation for generating returns
Slide 41
#6 : Look at Macroeconomic Quantities, ctd Investment
Management After the Global Financial Crisis 41 The injection of
money in the economy will have to be closely monitored It might be
profitable to split inflation into an inflation vector with many
components including asset inflation In order to understand if the
realignment of different sources of returns is likely to happen
smoothly or through more frequent boom-bust cycles
Slide 42
#7: Consider the Risk that Hedging Strategies Can Fail
Investment Management After the Global Financial Crisis 42 The
failure of Lehman Brothers demonstrated that apparently solid
counterparties can and do fail With the crisis that started in
2007, hedging has acquired a new dimension as the possibility of
failure of counterparties such as major banks and insurance firms
has increased beyond what was considered likely before the crisis
Need to care not only about the reliability of counterparties but
also of their environment, interconnectivity
Slide 43
#8 : Build up Multi-asset and Multinational Capability
Investment Management After the Global Financial Crisis 43 Exposure
to alternative asset classes among the seven largest pension
markets has gone from 6% to 17% in the last ten years Markets are
global and investors increasingly expect those who manage their
money to have a global view on the investment environment
Slide 44
#9 : Build up the Quantitative Capability Investment Management
After the Global Financial Crisis 44 The size and complexity of
todays (equity) market is enormous By yearend 2010, worldwide
regulated exchanges listed over 45,000 firms with a total market
capitalization of 55 trillion USD Optimal execution increasingly
calls for automation and quantitative capabilities
Slide 45
# 10 : Align the Promise with What the Investment Management
Industry Can Deliver Investment Management After the Global
Financial Crisis 45 Investors have been stunned by large swings in
market valuations three times in the past 10 years (1997-1998,
2000- 2002, 2007-2009) years The industry needs to regain investors
confidence More transparency will be needed Investor confidence
cannot withstand another crisis, markets cannot function correctly
in the absence of a minimum level of trust
Slide 46
A Final Word from Academics: Investment Management After the
Global Financial Crisis 46 Dont forget that there really is a
risk-return trade-off. If something looks too good to be true, it
probably is. Professor John Finnerty, Professor & Director of
the MS in Quantitative Finance Program, Fordham Graduate School of
Business