The Cynics Have Their Say

“It’s a clever name, if nothing else, right?” Joe Nankof, co-founder and partner of consulting firm Rocaton, says.

Since the end of the financial crisis, myriad trends have taken over the asset management industry—some of which may permanently change the game, and others that are simply buzzwords fated to be “overused and with murky meanings at best.” Asking which was which appealed to Nankof, and to many others.

In an informal online survey conducted by Chief Investment Officer (CIO), asset owners, managers, consultants, and other industry experts were asked to share their thoughts on 10 primary trends that seem to permeate not only the language, but also the direction, of institutional asset management.

The results were striking, yet not entirely surprising. Asset owners, compared with other respondents, were more pessimistic towards the big trends. Only three were voted secular shifts, two split down the middle, and five qualified as passing fads. Asset managers, consultants, and other service providers were evenly divided—five permanent changes and five transient “solutions.”

Despite such discrepancies, both asset owners and managers agreed on three major secular shifts in the institutional investing realm—all of which happen to be within the pension space—in the past five years: the transition from defined benefit (DB) to defined contribution (DC) plans, liability-driven investing (LDI), and pension-risk transfer (PRT).

“DC plans are becoming the primary source for retirement income,” Scott Brooks, head of DC at SEI, says. “It’s been a long-term trend that began more than two decades ago when DC plans were offered to provide supplemental retirement income, but it’s definitely taken a stronger hold more recently.” According to the firm’s data, less than half of 285 corporate plan sponsors surveyed still operate a DB plan—and more than half of those organizations have closed their DB plans to new hires. In addition, 34% said they have taken steps to freeze benefit accruals for existing participants as a preparation for termination. As such, 82% of asset owners and 96% of asset managers said the shift from DB to DC plans is here to stay.

On the other end of the spectrum, for fiduciaries of open DB plans the paradigm has now swung to de-risking, liability control, and an abundance of endgame options and service providers. “The nature of the management of pension assets is now more tied to liabilities,” Nankof says. “Investment committees are more focused on strategic de-risking goals, undoubtedly using LDI as a dynamic component to asset allocation.” The data agreed: Close to 95% of asset owners surveyed by CIO said LDI is an integral part of corporate pension investing strategies; asset managers and consultants followed suit with 92% in agreement.

Nankof and the data are not alone in this opinion. “If you grant that we can turn the burners down on risk exposure and have a commensurate effect on lowering funded-state volatility, there is a flexibility that is maintained in a LDI portfolio,” Jess Yawitz, CEO at NISA Investment Advisors, told CIO last year.

There exists another—and newer—option for plan sponsors to take risk off their balance sheets. Pension-risk transfer, prominently brought to the industry’s attention through mega-deals by General Motors and Verizon in 2012, could be an interesting strategy to watch, Nankof says. “It hasn’t taken up momentum just yet. I think currently, PRT is where LDI was five or seven years ago. There’s a lot of discussion, but not a lot of movement. It’s market-dependent. Corporate plans, especially at the edge of full funding, are questioning today’s rate environment. It may not be the best time for an annuity purchase with lower interest rates. When rates rise and plans are fully funded, I think we may see a slow trickle of plan sponsors taking the PRT approach.” Instead, lump-sum payouts have begun to take hold as a popular de-risking strategy, Nankof says, as plan sponsors pay out in an attempt to beat out mortality table changes due in 2016, which may add 5% to 10% to lump-sum valuations. 

Disagreements

Surveyed asset owners and managers were split on the issue of investment outsourcing. More than half of asset owners voted outsourced-CIO (OCIO) as a passing fad, while a staggering 79% of asset managers and consultants named it a permanent game-changer. “I’m surprised to see that OCIO was viewed as a fad,” Craig Russell, head of institutional business at Goldman Sachs Asset Management (GSAM), says. “From the asset management perspective, we think that OCIOs offer their clients a breadth of insight of managers.”

SEI’s Brooks agrees: “I like to think of OCIOs as the Henry Fords of asset management. They take something complex and are able to offer efficiency and specialization by breaking it down. Perhaps because of the trend of smaller to intermediate-sized investment committees closing shop and going to an OCIO, asset owners may feel their job securities are in trouble and hoping OCIOs are a fad.” Of course, both men’s businesses depend on them being correct—just as asset owners who label OCIO a fad have an incentive not to see their roles outsourced to the likes of GSAM or SEI. 

“It’s a clever name, if nothing else, right? Maybe if you don’t adopt smart beta, it implies that you’re not… smart.”

Opinions on strategic partnerships were evenly split, at least for asset owners. Asset managers and consultants leaned towards a secular shift. However, Rocaton’s Nankof is skeptical. “It’s something we talk about regularly, every five to seven years. In my memory of fiduciaries that have engaged in strategic partnerships, none have succeeded or lasted. And when it fails, the topic is taken off the table until another conversation seven years on. It’s really not that popular.” The consultant says the reason why strategic partnerships have failed to take hold in the industry is their tendency to concentrate responsibility with one firm for manifold asset classes—a task only a few can master. As for other value-add services a strategic partner offers to its clients, Nankof says any consultant or manager can act as a sounding board of ideas without being designated that role. “The objectives of a strategic partnership become murky as mandates expand. Fiduciaries become more and more unsure of what they are looking for the managers to do.” As with OCIO, of course, Nankof has an interest in seeing consultants—not strategic partners—as the continued go-to for ideas.

Murky objectives and definitions proved key to identifying fads among a variety of other industry trends. Smart beta, a “solution” with a clever name, is one that has been on the lips of asset owners and managers. “Honestly, I’m at a loss as to what smart beta really means,” Nankof says. Whether it’s confusion or disinterest, the industry seems to agree with his cynicism: Asset owners, managers, and consultants were all in agreement that smart beta was a passing fad. Only 25% had voted it a secular change.

And yet, words and deeds may not entirely match here: According to a Towers Watson client survey, institutional investors allocated more than double the amount of assets to smart beta strategies in 2013 than the year before—$11 billion across 180 portfolios. “It’s not really a fad,” Lynn Blake, CIO of global equity beta solutions at State Street, said in February. “Investors have been disappointed with active managers’ performance since the financial crisis, and [are] discovering great value in advanced beta’s transparency and its ability to help them achieve long-term goals.”

Nankof argues that the terminology of smart beta doesn’t quite make sense. “Essentially, every exposure you have in a portfolio is either a beta or a manager exposure we may call alpha, and I’m not sure if there is any beta that is smarter than any other beta. Maybe some people are guilted into trying it. Maybe if you don’t adopt smart beta, it implies that you’re not… smart.”

—Sage Um