PwC Survey: Volcker Rule Creates Uncertainty Around Alternatives Divestment

(May 4, 2011) — According to a report by PricewaterhouseCoopers (PwC), US financial firms are awaiting Volcker Rule clarity before they reevaluate their existing relationships and divest hedge funds and private equity funds.

“The rule is that banks will be prohibited from certain activities, so there’s a lot of uncertainty,” PwC’s John Marra told aiCIO. “As with any business, banks want to divest as slowly as possible to preserve value.”

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Volcker Rule limits proprietary trading and hedge fund and private equity fund sponsorships by banks and their affiliates and holding companies. While some divesture activity may result as firms seek to avoid the restrictions imposed by the legislation, the report asserts that US banks and financial firms will await Volcker Rule interpretation before they make major divestments. “US banks and broker dealers are unlikely to make hasty moves to divest their hedge fund and private equity businesses until there is further clarity regarding the impact of this rule,” according to the report.

“The Volcker Rule, while expected to be effective in 2012, will provide a transition period for the new regulations that can be extended a number of years with regulatory approval, especially for holdings of illiquid funds,” the report states.

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Investment banks such as Goldman Sachs and Citigroup have already indicated their intentions to divest their hedge fund and private equity holdings as they will be directly affected by this rule.

According to Marra, there will be greater growth in M&A activity within the asset management space, with the finalization of regulatory changes likely spurring the growth of activity. “The post-financial crisis recovery in the equity markets has driven significant increases in management and performance fee income, pushing valuations higher and fostering greater M&A activity in the asset management space,” the report indicates. “We expect to see continued M&A activity in the asset management space driven largely by small to medium-sized asset managers, albeit at a slower pace than has been observed recently. Changes in the regulatory landscape resulting in the need for greater cost efficiencies, scale, and also the need for broader product offerings, will drive much of the consolidation in this market.”

Additionally, PwC says that foreign buyers, particularly those in Asia, will continue to explore the US markets for acquisitions.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

The manager of the world’s largest bond fund, who sold out of all his holdings in US Treasury bonds in March of this year, is pushing investors to move away from Treasuries and seek global investments for better yield opportunities.

(May 4, 2011) — In the face of rising inflation, Bill Gross, founder and co-chief investment officer of Pacific Investment Management Co. (PIMCO), is urging investors to embrace local-currency emerging market debt.

Expressing PIMCO’s belief in the strength of developing and emerging markets, Gross wrote, in his usual colorful language: “Bond – and stock – investors have been sailing on the ‘Good Ship Lollipop’ for over 30 years following the Volcker Revolution and the return of high real interest rates to investment markets. Now, however, with governments attempting to impose financial repression, bond investors should revolt.”

Gross’s departure from Treasuries has been widely reported. Earlier this year, his $237 billion Total Return Fund said it would hold no government debt for the first time in over two years while also cutting its exposure to mortgage-backed securities from 42% to 34% of holdings. Instead, the fund is upping its exposure to emerging-market debt to 10% of its total assets. In his latest report, Gross wrote that investors in Treasuries are being ‘shortchanged’ and are ‘abdicating their responsibility’. According to Gross, the current high inflationary environment presents immediate threats to portfolios as Treasuries are set to be “overvalued for decades,” even following the end of the Federal Reserve’s QE2 stimulus in June.

“The argument over whether the end of QE2 on 30 June will result in higher yields and lower Treasury bond prices is, in a sense, a secondary one. Even if 10-year Treasuries stay where they are at 3.3%, and Fed funds close to 0%, savers and financial intermediaries are being shortchanged by both of these yields and everything in between,” Gross wrote. “An investor should expect these overvaluations to be with us for years if not decades. While that still leaves open the question of price behavior following QE2, there should be little doubt simply holding Treasuries at these yield levels for an extended period of time represents an abdication of responsibility.”

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Despite PIMCO’s confidence in the sector, pensions remain cautious about fully embracing emerging market debt, according to a March survey by Aberdeen Asset Management. Aberdeen, the global investment management group overseeing more than $287 billion of assets for institutions and private individuals, reported that limited knowledge about emerging market debt was perceived as the most popular roadblock to investing. Nevertheless, the firm acknowledged the significant value of investing in the asset class. “Emerging Market Debt (EMD) has generally remained one of the best performing asset classes for over 10 years, despite high-profile crises,” the firm stated. “In our view EMD has the potential to enhance returns, providing diversification benefits for investors. We believe that most investors should at least allocate a modest holding to emerging debt, while investors more tolerant of risk should consider a more significant holding.”

Click here to read Gross’s full letter.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742