Marketing as Spy-Craft | Chief Investment Officer

View this article in digital magazine format.

“We’re not established enough to be ‘dangerous’.”

That was the feedback I received from an institutional marketer when we announced the launch of our Summit of Dangerous Ideas—an event set to coincide with aiCIO’s five-year anniversary in June, which will showcase the most aggressive ideas from the preeminent minds in asset management.

I quickly disagreed with her. How could her relatively small business grow by huddling with the pack? In return, she accused me of not understanding marketing—perhaps a fair critique. She also censured me for having a cloistered view because I’d only ever worked for this magazine—not a fair critique.

For more stories like this, sign up for the CIO Alert newsletter. 

Here’s why: I have the pleasure, and access, to speak with hundreds of end-users of the asset management system every quarter. I also have the pleasure, and access, to speak with the most successful asset managers serving them, as well as some not-so-successful providers. It is through these interactions that my opinions are formed.

Take our Forty Under Forty, for example. Over the past three months, we’ve sifted through hundreds of nominations and emerged with 40 of the most dynamic and influential young asset owners around. While the interviews with them span more than 17,500 words, the two comments below are germane to the idea that marketing and sales in this industry are lacking.

“The industry is way larger than it makes any sense to be,” Leo Svoboda of the UPS pension system told me. “You see that in the number of mediocre managers you meet. But maybe I shouldn’t be so cynical.”

An even more damning critique came from Kevin Kenneally of DTE Energy: “The disparity among firms that have great relationship models—Bridgewater, PIMCO—and those that are lacking is cavernous.”

The overwhelming sentiment of asset owners is that few managers are truly adding long-term value to their portfolios, and even fewer understand how to gather and maintain assets. So why are firms (like the one staffed by the critical marketer mentioned above) still content to do exactly what hasn’t been working for them? To find out, I went right to the source—people who had worked for successful asset gatherers/maintainers (including some who have worked within the bowels of Bridgewater’s client service group), and who knew the secret sauce.

“Bridgewater, first and foremost, really understands the job that the person on the other side is trying to do,” one former insider told me. “They understand the types of constraints—political, organizational, investment—that they face. When they are talking to the head of absolute return at some place, they are trying to arm them to successfully advocate internally, both up and down the spectrum of stakeholders. They understand that person, they understand the CIO, and they understand the board of trustees.”

“It’s not exactly spy-craft,” another insider continued. “Call it ‘trade-craft’. If you’re a case officer in the CIA, you have to understand people’s motivations—their interests, their strengths, their weaknesses. When you understand that, you can tailor what you do with them. And remember: These top firms are genuinely trying to help. They believe that their ideas are genuinely going to help asset owners succeed.”

Who was the Godfather of this approach, I asked one former employee? “It really came from Ray [Dalio],” he said. “Bill Mahoney”—the former Bridgewater marketer during its years of unprecedented growth, who passed away last year—“added a lot and rounded out the rougher edges.

At its core, though, it’s that Ray really understands people, their different motivations and perspectives. The returns Ray has produced are very good, of course, but the firm really excels at partnerships. A lot of people are focused on new names—but Bridgewater has always wanted fewer, deeper, bigger clients.”

“These partnerships form a mosaic,” a former marketer at another asset management firm said—a mosaic, he noted, that sits at the core of strategic partnerships between asset owners and private equity firms, among others. “For many clients, it’s a 15-year relationship at this point,” he said. “It’s a constant, continuous delivery of value.” I asked for an example. “I’ve seen some asset managers tell clients that they had too much allocated to the firm,” he responded. “‘We’re too big a portion of your portfolio, you need to reduce us and diversify,’ they have said. That kind of thing—caring about their business, but also understanding that if their clients are not managing their portfolios well, the manager will eventually suffer—shows clients that you are genuinely a partner. That’s how the mosaic endures.”

Why hasn’t this spread? “It’s a choice,” he continued. “First, you have to decide if you want to deal with the demands of institutional capital. Many investors don’t. They’re happy managing $2 billion, not growing, and still making a lot of money off of that.”

“If you do want to manage institutional money, there isn’t any single way that’s been successful,” he continued. “The returns-plus-service model, that’s one way. But some managers—think Renaissance, D.E. Shaw historically—rarely wanted to meet with clients, instead wanting to just focus on producing stellar returns. Allocators know they’re smart—and their client service sucks—and they put up with it. Firms starting to gather assets need to decide: Do they want a returns-only model or a returns-plus-service model? There isn’t a right answer.”

“Look,” one insider concluded: “In any population, there will be 80% in the middle that are mediocre. They do just fine, on average. In this space, they deliver mediocre returns with mediocre service, and can eke out a good living for a very long time. That’s not likely to change, despite the success of firms like PIMCO and a few large hedge funds.”

Before I let them go back to their day jobs, I asked everyone about the comment that sparked it all: The idea that marketers could feel that they weren’t established enough to do anything “dangerous.” “I think they’re probably caught up on the word ‘dangerous’,” one noted. “Is ‘dangerous’ the best word? Or do they mean ‘not established enough to be at the vanguard’, ‘not established enough to push for the right thing’? Either way, that’s a challenging approach in asset management.”

It will continue to be so. Nothing in this industry suggests that relationships are becoming more commoditized. Despite the excessive jargon (“It’s a necessary evil, but I find the industry jargon nauseating at times,” Forty Under Forty member Andrew Parks told me), what asset management firms are trying to emphasize with their endless talk of “solutions” is the idea that, in this industry, one size fits one. After paying lip service for so long, they’re out to prove they actually, finally, grasp it. The real test will be whether their pledged allegiance leads to truly different models of client service, asset gathering, and marketing.

I’d like to think it will eventually, even for the 80% in the middle—but first, they’ll have to overcome this fear of being dangerous.

View this article in digital magazine format.

“Most of our real estate investments today are made directly in individual properties, rather than via participation in commingled funds,” says Joe Fazzino, senior manager for the $43 billion retirement fund for United Technologies (UTC), a Connecticut-based company for aerospace products and services. Interestingly, he says the financial crisis awakened UTC to the risks of not going direct: Those heavily invested in real estate via funds or fund-of-funds took a hit from dislocated prices and liquidity problems.

“Commingled funds were reluctant to sell properties in a soft market, while at the same time, there were fewer new investors whose investments could have been used to provide liquidity for those wanting to exit,” Fazzino recounts. UTC overhauled its strategy after that experience, in an effort to rectify liquidity restrictions.

Sizable direct investments are particularly well suited to corporate pension plans, which enjoy increasing liquidity as they de-risk.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

UTC, with the help of real estate management firm AEW Capital Management, invests primarily in multifamily properties, aiming to capitalize on demographic shifts, urbanization, and trends around home affordability in urban centers—a successful strategy so far, Fazzino says. Although still slightly underweight its 6% target allocation—largely due to portfolio repositioning—UTC committed $200 million last year to three urban multifamily development programs through a separate account with AEW. New, large-scale residential buildings are planned for Jersey City, Boston, and Seattle.

“We believe that the primary benefit of direct investing is the ownership control that it provides,” Fazzino explains. “As a direct owner, we can customize investment strategy, guidelines, debt levels, and the pace of investments and property sales.” By actively choosing where and what to invest in, asset owners may be able to stack their portfolio more dynamically and better hedge against inflation—often a key function of real estate assets. Specific and targeted decisions land with the investor, not a general partner.

But targeted direct investments don’t come easy, says Tim Walsh, president and COO of real estate fund manager GAW Capital Partners USA, and former investment director of New Jersey’s $74 billion pension plan. Typically, investors can save on expenses through direct investing, he says—if all the proper staffing, infrastructure, and governance are in place. Without these features, the cost-benefit prospect of going direct can be tricky to reconcile. “It’s a lot easier—and somewhat cheaper—to make an investment in a fund as a limited partner [LP] than it is to actually buy a specific commercial building,” Walsh explains, speaking as one who has done both. “These direct investments, or separate accounts, require more staff and consulting support. There’s a lot more work to set up at the onset than you would face as a traditional LP. There is more legal detail and generally no cookie-cutter format to follow. It takes a lot more time.” This is time—and resource drain—that many investors who lack UTC’s size simply do not have.

A 2012 paper by German researchers reinforces this position: Direct acquisitions and closed-end funds may not be effective for small- and medium-sized institutional investors. “The professional and in-depth knowledge of economic, legal, and technical relationships with real estate investments and the relevant markets can only be generated by larger institutions,” authors Steffen Sebastian, Melanie Wagner-Hauber, and Bertram Steininger wrote. Direct investments should only be made when savings made in due diligence processes in-house could offset high transaction costs. Instead, the authors argue that indirect investments such as listed property shares and real estate investment trusts are likely the most efficient vehicle for smaller funds. Accessing the asset class indirectly optimizes transaction costs, risk diversification, and the highest possible liquidity, they explain, by trading on the stock market.

On the opposite end of the spectrum, then, stands the giant Ontario Municipal Employees Retirement System (OMERS). “Three of the Canadian pension funds decided to play real estate through a direct platform,” says Eric Plesman, senior vice president of investments at Oxford Properties. “We think it’s been the right decision—absolutely.”

For Oxford, it undoubtedly has been. In 2001, OMERS acquired the commercial real estate firm Oxford Properties for $1.5 billion, transforming it into the $65 billion fund’s real estate arm. Today, it invests more than $24 billion on behalf of OMERS in a portfolio of “high-quality income-producing properties in world-class cities” in Canada, the US, and the UK. According to OMERS’ 2013 annual report, Oxford Properties slayed its 7.25% benchmark with a return of 14.3%.

The direct model also offers greater potential capital appreciation, says Plesman, which translates into alpha from above average gains on equity, or at least below average costs. “The general and administrative expense is more than offset by fees that we receive from tenants—and fees that we would otherwise have to pay a third-party manager,” he argues. Direct investments maximize returns through prospective increased property values, adding cash upon payout.

Still, Walsh points out that few institutions outside of the top-tier—OMERS, New Jersey, UTC—possess the “professionalism on the outside that you have on the inside with experienced general partners.” And this dilemma demands the question: Is it worth it? The answer, as it so often does with institutional investing, depends to an extraordinary degree on your priorities.