The World is Changing: Also in Asset Management

By Erik L. van Dijk

The world is changing. On the one hand, we see that the relative importance of Emerging Markets is growing. When looking at the relative market value of stock markets of these nations, we see that the percentage went up to some 10-15 percent in 2006-07. True, due to the credit crisis this percentage dropped back to about 7-8 percent recently. And although that number is more or less in line with percentages seen in the decade before, one thing is totally different since 2003. Market values of stocks represent the price of economic activity in a country (albeit as a rude proxy). But the gross domestic product (GDP) of a country is an indicator of the underlying asset base / fair value of that economy. Robert Shiller’s excellent book on Market Volatility contains a few papers that clearly indicate that prices are far more volatile than fair value. Result: we move from periods in which prices are far too high to periods when they are more or less in line with fair value to periods when prices are way too low, et cetera. With the GDP weight of the Emerging Markets now being close to 30-35 percent of world GDP, it is obvious that the market value weight underestimates their current importance. More than ever so. We do therefore believe that the bulk of conclusions drawn by Jim O’Neil and his Goldman Sachs economic research team in their book ‘Brics and Beyond’ do still hold. This is going to be the era of Emerging Markets. Sooner or later China and maybe India will be bigger economies than the US one.

But it is not just the economic world that is changing geographically. A similar phenomenon is going on in the asset management world. As an asset manager selection specialist, I would say that up until the beginning of this century the bulk of real best-of-breed asset managers was Anglo-Saxon. Within that group, the US asset managers got the lion’s share. This was especially true when looking at so-called quantitative asset managers. In the fundamental zone there were some good British asset managers active as well. Local parties in other nations were mainly of interest to local end-investors to the extent that the local factors were of importance. Be it legally, or because of the local presence. In terms of performance track record they couldn’t keep up with the best-of-breed specialists from the UK and US.

Now, with the world getting smaller due to globalization, the number of products growing and international complexities increasing, something has happened. The dominance of the Anglo-Saxons in the best-of-breed major league is far less prominent than it used to be. In the case of the Americans part of this is understandable. The Americans were always best in domestic products, and I would still be more than surprised to see a top-notch US equities or bonds manager not being from the States. It can be done, but it is hard. But their attitude to label products elsewhere as ‘International’ and put them alltogether in one mandate/fund was illustrative of how the US saw the world: us, the US, versus the rest. In terms of a world divided by market cap this was actually quite understandable. The US’s relative weight in terms of market cap was indeed about 40-50 percent for many years. If you add to that the fact that the Wall Street stock markets were the best-regulated and most-liquid ones, this approach was more than OK.

But with the shift in economic activity, and with the world becoming a more equally-weighted place with the US now being approximately 30-35 percent of the total pie, Europe and other developed nations (JAP, CAN, AUS, NZL, SING, HKG) representing a similar percentage and the Emerging Markets also, things are changing. And not just that, it is also clear that with this shift in economic power two important trends have helped to change the balance of power in asset management:

1. The increasing role of London as center for international asset management. With Americans being less internationally-oriented than the Brits, major banks, insurance firms and asset managers from all over the world realized that London was an excellent alternative as world hub for international mandates. Not just in terms of available knowledge, but also in terms of time zone, being neatly placed between Asian time zones and the US time zones. The UK also followed an active strategy to grow the London Stock Exchange and attract as much as it could this type of new business. And with it came the shift of knowledge to this market. Even big American institutional investors and financial services firms accepted it and the growth in the City of London was to a large extent caused by American institutions understanding that ‘London was the place to be’ for non-US asset management. It was not surprising that the brightest talents in the asset management community followed this trend. Sure, when thinking in terms of academic study in Finance or Investments the US was still the hottest place to be, although levels in European schools like the London Business School, London School of Economics, INSEAD or even Asian ones like the Indian Institutes of Technology, top universities in Israel, Hong Kong and Singapore are definitely not considered much lower by recruiters anymore.
2. And not just that. With the economic balance of power shifting, it became clear that there were areas of the market in which foreigners could do at least as good a job as their American colleagues. The ‘investment game’ is not the same in every asset class. Equities, Fixed Income, Hedge Funds are different games. And that is definitely true when looking at running portfolios of securities in these markets in different countries. This has led to the rise of excellent asset managers in other nations as well, also on a performance basis.

Examples: the top-level French asset managers are true specialists in Fixed Income. Somehow the French specialists, often relatively quant-oriented play a ‘game’ in Fixed Income that makes it very hard for the big Americans to compete. Germans also are strong in Fixed Income. Good quantitative managers are now also not a rare thing in the UK anymore, albeit that it is mainly in boutiques (with the exception of large powerhouse Barclays Global Investors, albeit that BGI is especially strong in index products). Average knowledge levels in the Netherlands and Scandinavia have gone up spectacularly.

This increased competition between a growing number of international players with far more knowledge dissemination than before has led to:

a) growing numbers of strong asset management boutiques, that exploit a specific, specialized skill set on a relatively narrow market segment;

b) finally (!), some downward price pressure on asset management fees, with unfortunately brokerage fees still not following quickly enough

c) the demise of parties that didn’t really add value, but simply leveraged their ‘brand name’ image / ‘size’

d) a growing interest in manager selection, because – with the non-existence of reliable ratings similar to what we described about rating systems in the Chess World in a previous entry – a larger number of providers in a growing number of sub-categories of asset management made things less overseeable for the average investor.

That is where we stand. An industry getting more mature at a time when the financial world seems to be burning. Investors do not just have to analyze carefully which asset manager has products in a specific category that are truly outperforming on the basis of skill, no, he/she also has to make sure that the provider itself will be there one year from now. Especially asset managers that are part of large banks or insurance firms have to be analyzed carefully. Before you know the asset management operation is sold as part of the restructuring operation, with all the turmoil that goes with it. What will that do to the team of specialists that you think you are hiring when opting for a specific product that you like? Will they stay with the entity? Leave to another one? Start their own?

Asset management in a grown-up financial world is more important than ever, but separating the good guys from the bad ones will itself prove to be a new, specialized quality as well. A quality that can make or break overall portfolio results. Those of you that were hurt by investments in the Madoffs of this world, or in asset management products that underperformed indices by 100s of basis points know what I talk about.

The end result of this new development is of course good: they are all signs of maturing. But as long as end-investors do not realize what is going on and think that the old world is still there, it will take quite some time before end-users – be they pension plans or private investors – will be provided with a full opportunity set of good products, with bad products having no chance at all. In the mean time the grey zone will continue to make victims, because penny-wise, pound-foolish market participants might continue to follow a DIY strategy of selection without realizing that it is really true that results in the past are not necessarily in-and-of-itself indicators of success in the future.