28 November 2005

"Assessing the Legacy of the Last Great Bear Market"  

By AMIN RAJAN

"Too soon to say" replied the former premier of Communist China Chou en-Lai, when asked about his views on the French Revolution two centuries previously. Such an answer would not do for those fund managers rethinking their business strategy in response to the worst bear market in living memory.

For sure, the bear market has unleashed no less than 12 clearly identifiable shifts. At surface level, it is easy to conclude that together they will radically alter the face of fund management in this decade.

" But never underestimate the power of inertia. We live in a world where we may wake up 10 years from now and nothing major might have happened. Nor should we expect everything to be fine and dandy because unforeseen events can create major tipping points," cautions Edward Bonham Carter, joint chief executive of Jupiter Asset Management, owned by CommerzBank.

It therefore makes sense to group the recent shifts into three categories: structural, covering those most likely to outlast the bear market; cyclical, covering those most likely to reverse as markets improve; and parallel, covering those where the old and the new will continue to co-exist to the extent that it is "too soon to say".

The structural shifts (see graph) are inter-related. In the emerging business models, agility has definitely replaced rigidity: there is an ever stronger focus on core capabilities, backed by willingness to form alliances with the best of breed product and service providers across the value chain. Liability driven products are now firmly established as pension funds tackle the deficits looming on the foreseeable horizon. Most critically, as the ascendancy of distribution has continued apace, funds are no longer "sold", they are "bought".

We are witnessing a very profound shift, which has significant implications for the future of managers, distributors and end-clients. Intermediaries are increasingly employing institutional-quality analysis to engineer best-of-breed packaged solutions.

"The era of one-off fund purchase with high front-end commissions is dying and giving way to asset-based fees on packaged portfolios," according to Todd Ruppert, president and chief executive of T Rowe Price Global Investment Services.

"Approximately 70 per cent of fund purchases in the US are through some type of professional overlay solution. In Australia it is probably higher. It's inevitable that Europe will move further in this direction," he says.

At the other extreme, the cyclical shifts are disparate and weakening. The much publicised shift from relative to absolute returns is running out of steam, as it has become all too clear in 2005 that alternative products, too, can be long on promises and short on deliverables. Investors now chase returns, not asset classes.

"Clients are questioning the quality of absolute return products; they are not the only way of having capital protection and income upside. Besides, why pay such high fees when beta is so respectable and cheap?" questions Angelien Kemna, chief executive of ING Investments.

The other cyclical shifts that are fizzling seek to change staff behaviours. They aim to promote personal accountability, cost cutting and teamwork. As fund managers have tried to emulate hedge fund type structures and strategies, two unintended consequences have ensued: loose cost disciplines and a reinforced star culture.

This is unsurprising: in other cyclical industries, it has taken at least two recessions to affect behavioural shifts.

Yet there are other areas where the old and the new co-exist. Medium-sized businesses are scaling the business while global ones are widening the scope of their offerings; European firms are aggressively growing funds under management to create a critical mass while their US peers are concentrating on performance; quant houses are aggressively marketing white label products while the active ones are developing proprietary brands; many in Asia-Pacific are developing absolute returns capability while their European peers are moving towards liability-driven investments.

These parallel developments reflect the extreme diversity of strategic approaches in global fund management. The industry is too young to produce rapid convergence. Equally, the longer the current low return environment persists, the weaker the innate tendency to revert to the old ways.

In any event, the bear market has doubtless changed the prevailing business models. There is a sombre realisation that the next wave of pension reforms will create as huge opportunities as the last one, except in one crucial sense: the new money will no longer be mesmerised by the old mumbo jumbo of relative returns, benchmark hugging and equity premium. Accumulation rather than speculation is now the name of the game.

Those who can deliver it will thrive. Those who can't, will wither: bifurcation will be the most enduring legacy of the bear market.

Professor Amin Rajan is the CEO of CREATE, a research consultancy: amin.rajan@create-research.co.uk.

.