“My expectations are not being met, I cannot keep the commitments to my stakeholders and it is challenging to find very good external manager talent. What do I do? Well, I am going to ACT and start doing it myself”.
This is what is going on with the Institutional asset owners. They are reducing how much they outsource to asset managers. In fact, they are finding that this is the perfect storm driven by low performance, increased regulation and talent getting commoditized especially with the addition of AI/Big Data and machine learning to the suite of tools managers have at their disposal.
Similar thoughts resonated through my conversation with a senior executive of a large pension fund. Until recently they used various managers to get exposure to different asset classes and instruments. Creating similar processes in-house was much more complicated as they trade everything from equities, fixed income to structured credit, private equity, real estate, commodities and all kinds of direct investments. As a pension fund their time frame is much longer than most asset managers, more like 20 years plus and hence they wanted to be engaged with the companies and markets of the future. Managing all the requirements of a pension fund calls for a very complex infrastructure. The senior executive of the pension fund however believed that recent developments presented an opportunity for asset owners to build complex infrastructures from scratch. In fact, this pension fund is building an operating environment very like what asset managers did in the past. This includes an integrated front to back platform as well as implementing AI, machine learning and blockchain where it makes sense.
Although historically, asset owners have preferred outsourcing to both traditional and alternative asset managers, this trend is beginning to shift. The key catalysts that are also fueling asset owners’ interest in managing investments in house include cost savings, improved access to better internal portfolio and risk management systems and availability of middle and back-office administrative solutions. A study in 2015 revealed that pension funds spent, on average, 46 basis points on external management compared with 8 basis points on internal investment capabilities1. Another major road block to bringing management in house had been the lack of talent. Well, that is now being solved as two key trends are emerging:
i) Asset owners are able to pay better than what they would pay a manager of a public utility for active management
ii) More investment professionals are willing to move to locations other than New York, London and Hong Kong for better lifestyle.
In October 2016, California State Teachers’ Retirement System (CalSTRS), the third-largest pension plan in the US planned to pull around $20 Billion from its external fund managers. Similarly in Europe, Denmark’s biggest pension fund ATP group halved (as of December 2016) the amount of money it outsourced to external asset managers over the past two years, due to higher costs and transparency that made outsourcing uneconomical. Railpen, the £25 Billion UK pension scheme saved £50 million in 2015 by cutting its external equity managers from 17 to two, by managing more money internally. 3
I believe pension and endowments funds are adapting to the new normal by being more self-reliant. While we are very far away (5 years plus) from any kind of mass change, the wheels are in motion and over time I anticipate asset owners in-sourcing more of the investment functions and a partnership developing between asset owners and asset managers. In many ways they are facing the same challenges as an asset manager, reduced performance fees as well as a large cost burden. Many of them are also trying to transform their operations to be leaner and to be able to scale smartly.
1 Slattery, William. “Cost cutting is behind pension insourcing trend” Financial Times, Financial Times, 15 Feb. 2015, https://www.ft.com/content/41480ce8-b153-11e4-a830-00144feab7de?mhq5j=e3.
2Ram, Aliya. “Calstrs to pull $20bn from external fund managers” Financial Times, Financial Times, 16 Oct. 2016, www.ft.com/content/1f1e396c-9162-11e6-a72e-b428cb934b78.
3 Ram, Aliya. “Danish pension fund halves outsourced money” Financial Times, Financial Times, 11 Dec. 2016, www.ft.com/content/32ecd494-be26-11e6-8b45-b8b81dd5d080.
ABOUT THE AUTHOR
Linedata Gravitas a leading provider of middle office and technology services to the asset management industry, combining dedicated professionals, industry standard processes and world-class technology to create smart scale and reduce operational risk and overall costs.
Linedata Gravitas was most recently named “Best Alternative Investment Outsourcing Platform” in the 2016 Wealth & Finance International Awards and “Most Innovative Hedge Fund Solutions Provider, US” in the 2016 Acquisition International Awards. The company has also been recognized as “Best Middle Office Solution” in the 2015 HFM US Hedge Fund Services Awards and “Best Outsourced Solution” in the 2015 HFM US Technology Awards.