After a few years of abysmal markets, the Top 40 money managers pulled off a solid return of 6.6% for 2010, following 2009’s terrific market rally. There were even a few stellar jumps on the list as some players clocked double-digit increases. Yet despite the good news, no one’s celebrating. Managers aren’t yet ready to call an end to the troubles that have plagued the industry since the 2007/08 financial crisis—and they’re certainly not ready to pop any champagne corks. In fact, the mood is decidedly gloomy as the industry feels the pain of plan sponsors grappling with mounting liabilities—low funding ratios that even the strongest market performance can’t erase. As one manager put it, 2010 won’t be remembered as a year of asset growth—it will be remembered for the liabilities.
In this year’s Top 40 report, we ask managers how they’re faring in such an environment. What are plan sponsors demanding from them? How has global economic uncertainty hit the business? And, more importantly, is it time to let go of the doomsday talk and just…cheer up?
When Returns Aren’t Enough
Clearly, plan sponsors and managers alike seem faced with some major challenges—and a bit of doom and gloom. “This is the year that was supposed to be the recovery, and yet it doesn’t feel like that,” says Bill Chinery, managing director with BlackRock (No. 2 on the Top 40). “You can’t really have a non-consumer lead recovery with no increase in jobs and employment. Yet that’s the kind of recovery we’re having. So while capital markets were reasonably good, people are still concerned if this recovery has legs or not.”
True, managers did start the year stoked by the great market rally of 2009. The mood didn’t last, though. “Managers started 2010 with a lot of optimism,” says Kevin Barber, senior vice-president with Pyramis Canada (No. 18) in Toronto. “But 2010 put the reality lights back on. Managers started to realize they weren’t going to come out of this immediately. There are still systemic issues here in Canada and globally that need to be addressed before we can get to something more sustainable.”
Bruce Curwood agrees. He is director of investment strategy with one of this year’s top performers, Russell Investments Canada Ltd. (No. 28) in Toronto. Even though his firm experienced a big leap forward on the list, Curwood says that now is not the time to celebrate or rest on laurels. “People are cautious,” he explains, adding that top concerns of clients and prospects these days are governance and risk management—not big returns. “The name of the game right now is not just optimizing returns,” he says. “Investors aren’t sure where markets are going. They are looking for advice and risk management solutions.”
That’s a story we heard again and again this year—strong investment returns aren’t going to fix the problems facing many plan sponsors. Peter Lindley, president and head of investments with State Street Global Advisors Canada (No. 4) in Montreal, says, “The challenge for plan sponsors has been declining ratios, which have made it much harder for them to achieve their overall funding rate over time—especially those that are underfunded.” Even double-digit returns can’t fix the problems for an underfunded plan: “Once you’re under 100% funded, you need more returns just to stand still,” he explains.
From the client sponsor perspective, Calvin Jordan, CEO of the NSAHO Pension Plan in Halifax, sees defined benefit plan sponsors facing “fantastically very difficult times” right now, with even the biggest and most sophisticated funds walking a tough road. “Today, the really big issue is that despite a year of really good post-2008 rates of return, most DB pension fund plans are not materially better off than they were at the end of 2008, by and large,” he notes. Jordan stresses the fact that even though returns have been decent, liabilities have skyrocketed due to declining interest rates. “A lot of this has happened in 2010, so this may not yet be broadly appreciated.” And that’s not going to go away any time soon. “Nominal rates, real return bonds—everything has come way down, and that just pushes your liabilities way up,” Jordan says. “Everyone’s DB pension plans are still in miserable, tough shape.”
At the same time, managers and plan sponsors aren’t all that resilient anymore in the face of market volatility. “The industry today is much more fragile than it used to be,” Lindley says. “Its ability to bear losses and risks is lower than it was. So plan sponsors are going to demand returns from their managers without taking much risk.”
John Akkerman, senior managing director, head of North American institutions, with AllianceBernstein (No. 12) in New York, says 2010 really brought home a new reality that took hold in 2007 and 2008. “We really see now that those years were not cyclical,” he explains. “There was a secular change that is occurring, and this understanding was reinforced in 2010.” That means, the way people look at risk management and asset allocation, and even the way they view their relationship with the investment industry, has changed dramatically—and permanently.
| 2010 in numbers: Top 40 at a Glance It’s hard not to be gloomy about 2010. The year was marked by unsettling events, from the unrest caused by the unfolding Greek debt crisis to the May flash crash that gave already jittery investors an unwelcome and sudden jolt. Against this backdrop, the With all the big jumps in assets under management, where is the money going? Most of the dollars are sitting here at home—Canadian bonds and Canadian equity are still far and above the biggest asset class on our list ($451.6 billion and $314.7 billion, respectively). Outside Canada, global equities and U.S. equities are drawing some of the Top 40 money ($89.5 billion and $72.1 billion, respectively), although nowhere near their domestic counterparts. Clearly, there’s lots of room for growth as Canadians seek global diversification. The list also shows other areas |
It’s the Economy
While 2010 will be remembered as a year of challenges, the global economy was perhaps the biggest—and it’s likely to remain front and centre for a while. What’s difficult is, no one appears to know quite what to expect going forward—from interest rates to inflation, to the impact of unprecedented austerity measures, few can agree on where the global economy is headed and what the outcome of all this turmoil will be. As a result, say managers, that uncertainty is taking its toll on investors.
“It’s unprecedented,” says J-F Courville, president and CEO of MFC Global Investment Management (No. 32) in Toronto. “Never in my career have I seen a time where there is so little consensus around what will happen over the next few years,” he notes. “It’s a different story every day,” says Courville, and that makes for an unsettling investor climate.
Chinery agrees that uncertainty has been a huge issue in recent months. “I think everybody is of the view that we’re not going to have inflation right away. In fact, we might even see some deflation.” But that’s where the consensus ends, he says. “After the next year or two, all bets are off. People now diverge in opinion on whether growth is going to continue to languish in a low inflationary environment or if governments will have to get out of debt and we’ll have deflation as a result.”
And while a level of debate is always healthy, managers note that uncertainty and a lack of consensus have made for a really tough—and negative—business environment. Barber says the uncertainty and volatility have been especially hard for plan sponsors dealing with solvency ratio issues. “The markets are in a better spot, but there is still a lot of anxiety among plan sponsors,” he says. “For the most part, they are only about 85% to 95% funded, on average. So it’s been a good time for them to pause and go back to their investment strategy—to make policy changes so their portfolio supports some of the volatility that’s in the marketplace.”
The De-risking Continues…Slowly
Given the volatile backdrop we’re operating in right now, plan sponsors do want a level of knowledge and clarity from their managers. Courville believes plan sponsors are looking to their managers for clear guidance on what is happening in the markets—and they also want to understand how investment firms are managing risk. “Investors want to understand what the risk drivers are,” he says. “They want to know that you are someone who can demonstrate an ability to add value in a sustainable way in these markets.”
“Straight talk” is what Terri Troy, CEO of the HRM Pension Plan in Halifax, says plan sponsors are looking for—that, and ways to improve the funded status of their plans. Plan sponsors, she says, want “good ideas to improve risk-adjusted returns net of fees, and open and transparent discussions about the challenging market environment.”
The demand for good ideas rather than product pitches is a message we heard from a lot of managers. Roger Beauchemin, president and CEO of McLean Budden (No. 6) in Toronto, says managers have seen a change in the kinds of conversations they are having with clients and prospects. “It’s shifted from a product conversation to a solution conversation,” he says. One solution Beauchemin sees plan sponsors looking at very closely is liability driven investing (LDI). “The starting point for us is to get plan sponsors to extend duration and get their asset side to match their interest rate risk.”
In light of that, it’s not surprising that many managers say plan sponsors continue to embrace de-risking strategies like LDI in greater numbers. But for many, it’s not going to happen overnight. Those plans are now asking for a gradual, planned move into LDI, with plenty of time to play catch-up on the returns front. “Some plan sponsors want to boost their funding levels first before de-risking,” says Chinery. “So a plan at 80% will continue to see returns before locking in through an LDI solution.” Chinery says this has led to what’s called “journey management,” which maps out a gradual shift toward LDI while plan sponsors also realize the additional returns they need to make it happen.
However, at the same time as they de-risk, the hunt for alpha appears to be on again. “I don’t think simple market returns will be able to offset the necessary funding rates,” says Lindley. “Alpha will be more important. If you can only expect 2% or 3% from your overall market level returns, then you are going to need alpha to get you up to your funding rate that is 6% to 8%.”
Blinded by the Gloom
While the mood seems really low-key this year, some managers see bright spots. In fact, some think it’s time for investors to be more optimistic. Moreover, all that negativity can be downright risky. “The world is overwhelmed by doom,” says Akkerman. “There’s a chronic lack of optimism and an oversupply of doom.” He believes that all this negativity is blocking people’s ability to follow opportunities—and it could be driving them to risky behaviour.
He argues that emerging markets in particular are a lot stronger than they were 18 months ago. “They aren’t suffering from the same debt problems, there has been some growth, and stock markets are attractively priced,” Akkerman explains. “I think people take a risk in overreacting post-2008 and anchoring themselves in the idea that it’s leading to a permanently impaired set of opportunities.” Fixed income is one area that plan sponsors have been driving to this year as they de-risk. However, he thinks that segments of this asset class are on the verge of a bubble as a result.
Edinburgh-based Scott Nisbet, a partner with Baillie Gifford Overseas Ltd. (No. 37), also thinks that the whole doomsday scenario has been overblown and that it’s blinding investors to the reality of where growth is coming from. Nisbet has been dismayed by the negativity. For example, he says, “Canadian investors are worried about Europe because of two tiny economies—Greece, Ireland—or domestic underweights in a potash company or a few gold stocks. And yet the really big story is growth—growth that has been coming from emerging markets.”
“There was no uncertainty last year,” he says. “Instead, 2010 clarified the direction in which the world is going. It’s being led by emerging markets.” And yet he points out that allocations remain on the low side, as investors talk about risks in such markets—risks, Nisbet says, that are overblown. “Investors are still steeped in the mantra that these places are risky,” he explains. “And yet the biggest risks you could have taken in the last 10 years have been right under your nose, in the United States (and U.K.) with the tech and housing bubbles and the ensuing banking disasters.”
For Montreal-based manager Robert Brunelle, senior vice-president with Hexavest in Montreal, the past few years have been great for his firm’s top-down approach—an investment strategy that has typically been overshadowed by the many bottom-up managers on the street. “This environment has been a great playing ground for top-down managers,” he says. “Since late 2008, we have seen pension funds seeking managers with a top-down component—this is very new and strange for us, but it makes sense.”
Real estate has been another strong area in 2010 as it recovered from a tough 2009. Malcolm Leitch, chief operating officer with Bentall Investment Management (No. 17) in Vancouver, says the commercial sector has been stable, and plan sponsors spent the year on the hunt for places to invest. The problem remains that there isn’t enough product out there to meet demand. “People are being very selective about what they sell today, even though investment activity has improved,” he says. “So there is not enough real estate out there to meet demand—and that has driven prices up.”
Zelick Altman, managing director with LaSalle Investment Management Canada, says even though rising prices mean lower yields, real estate is still attractive for plan sponsors dealing with low inflation and low interest rates. “Real estate looks good in a lower-yield environment, since the risk-adjusted returns are still decent,” he says. And since it looks like low rates are going to be around for a while, real estate will continue to draw interest. Leitch also sees more plan sponsors looking for real estate outside of Canada to add value. “The Canadian real estate market hasn’t suffered as much as the U.S., so investors are looking there to possibly get higher returns.”
Looking Ahead
Whether or not the industry will embrace these bright spots remains to be seen in future Top 40 reports. In the meantime, we hope that the gloom lifts and that better times settle on the Canadian money management industry soon. If indeed we are facing a new reality in the global economy, no doubt new opportunities will continue to arise in the years ahead. And as plan sponsors seek solutions to their own funding woes—both within the money management industry and at the policy level within their own plans—the future of the industry could be in for continued transformation as risk trumps returns in the years ahead. While no one can be certain about where the economic future lies, one thing remains—2011 is another year. Here’s hoping it’s a good one. BC
Caroline Cakebread is editor of Canadian Investment Review. caroline.cakebread@rogers.com
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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the November 2010 edition of BENEFITS CANADA magazine.