18 September 2006

"Managers miss pension funds' needs More talk needed to bridge the gap between what's on offer and what funds want"

By Pauline Skypala

"Asset managers and their pension fund customers must talk more, to close the gap between what pension funds want and what managers think they need, according to a new report on innovation in the asset management industry.

Managers expect liability driven investment, portable alpha, hedge funds, structured products and private equity, in that order, to be the top five products in demand by defined benefit pension funds.

Most of these aren't even in the top 10 for pension funds. They agree on private equity in fifth place but otherwise focus on global equities, emerging market equities, real estate and manager of manager mandates.

There were two ways to look at this, said Todd Ruppert, chief executive ofT. Rowe Price, which with Citigroup sponsored the publication of the report* by UK consultancy Create.

"You could say asset managers are right and pension funds haven't caught up yet, or that asset managers are just trying to push new products without taking account of what customers want. It is probably a bit of both," said Mr Ruppert.

However, the report*, which is based on information from 300 asset managers and pension funds in 38 countries, found pension funds do want absolute returns and liability-matching products. They just aren't ready to invest in them.

"Pension funds say they want to go back to basics," said Amin Rajan, author of the report and chief executive of Create. "They want capital protection and income growth, plus money for a rainy day, or in other words, liability matching. So the products the managers are talking about are the ones they want."

But they will not invest until innovation has made these products easier to understand, more transparent, less risky and more liquid.

There are geographical differences in attitudes, with European pension funds likely to be more cautious and North American ones more adventurous. But the report found that, regardless of nationality, pension funds have become more cautious in their investment choices as a result of under funding, regulatory changes and mark-to-market valuations.

There were three distinct attitudes to new products, divided 25/50/25 between believers, who understand the products and are keen to use them; pragmatists, who want to see a longer track record; and sceptics, suspicious about hidden charges and doubtful that genuinely new products could be produced that quickly.

This did not surpriseasset managers, who recognise they are moving into new territory, and seeinnovation as a priority.

But the report found managers would also have to pay attention to the basics of investment management, to rebuild client confidence. "There is a lack of trust and asset managers will have a hard time regaining it, particularly in Europe," said Mr Rajan.

The basic business factors needed for success were seen as much the same by both asset managers and pension funds. Pension funds put investment process ahead of performance and organisational stability, while managers set greater store on performance.

It boils down to a simple equation said the report: trust = credibility + synchronicity + stability.

Credibility is about track record and delivering what it says on the tin; synchronicity concerns alignment of interests between asset managers and their clients; and stability is about the ability to repeat past successes.

"Trust will become synonymous with brand. Either successful managers will have it, or they will have to acquire it," said Mr Rajan.

*Tomorrow's products for tomorrow's clients: innovation imperatives in global asset management, available at www.create-research.co.uk"