2009 Top 40 Money Managers Report: Positive Energy

Smith also observes that there has been a steady movement toward foreign equities at the expense of their Canadian counterparts, despite the fact that the former have underperformed over the last couple of years. The reason, he says, is that the Canadian market is relatively small and—due to its reliance on financials and natural resources—not overly diversified.

Williams says he’s seen some movement with regard to asset allocation, but nothing dramatic. “Short term, we saw some movement related to rebalancing, particularly as equity markets got hit hard,” he says. “We saw some trade out of fixed income into equities, as equity allocations had fallen far below what their policy targets had been. As the crisis has stretched out, clients have been thinking about whether the allocations have been suitable, such as funds that have been betting on high equity returns, which have been hurt in this environment.”

However, some institutional investors—with a firm eye to reducing their risk exposure—are making drastic cuts to their allocations to equities, says Rabovsky.

“We already had clients that were 50/50 [equities to fixed income], and we have some clients that are moving to the 20% to 30% range, but they’re correspondingly increasing their allocation to other asset classes, such as alternatives,” she says. “I’m hoping that what happened in 2008 made people realize that reliance on equity risk premium and interest rates (the bond/equity split) can lead to outcomes you just don’t want to live through. The problem is that many of these other asset classes come with increased monitoring and compliance, and not everybody can do it.”

Risk management
No conversation about today’s money management industry would be complete without mentioning risk management, and with many clients putting a premium on it, managers are drawing whatever lessons they can in order to prepare for a lengthy discussion.

Benoît Durocher, executive vice-president and chief economic strategist with Addenda Capital in Montreal, says the main lesson from the crisis is that it brought awareness to the dangers of complacency. “You can’t necessarily plan for the worst, but you have to be aware that the worst may arise,” he says. “Managers, in general, were complacent with regard to risk, and you may find a hint of that again today. Bond yields are down, interest rates are down, and that hurts pension plans a lot. They still have a hunger for returns and for yield.”

There’s more than a hint of the old attitudes toward risk, according to David Mather, executive vice-president with Integrated Asset Management in Toronto. “Plan sponsors learned some really hard lessons last year, and I’ve heard that some of them have already begun to forget,” he says. “The trading volume in collateralized debt obligations and collateralized loan obligations is going up sharply. They were a principal contributor to the crisis, and hedge funds are now trading Lehman bankruptcy claims with each other.”

On the whole, however, Mather says the past 12 months have been instructive in fundamental lessons on investing that had largely escaped the industry. “It’s less about learning something new and more of a powerful reinforcement of principles we already understood. What we know for sure is that there’s no such thing as adequate risk management. You have to work hard to build the very best risk management systems that you can, as opposed to building them and saying, ‘I’m glad we’re finished that—we should be in good shape now.’ You can never afford to be satisfied. They can always be better.”

In terms of actual strategies, de-risking is manifesting itself in different ways, says Rabovsky. “It could be, ‘I want to reduce my overall level of risk and therefore I’m moving more to bonds, perhaps with more matching types of bonds.’ Or it could be, ‘I want to reduce the amount of risk, but I want to take it where I’m best compensated,’ and that’s why you’re seeing people move in to things like infrastructure and emerging markets,” she says. “In other words, giving your manager a little more breadth to add value.”

“But I think the general view is, ‘I’d like to de-risk, especially as a mature defined benefit plan, but we can’t afford to go all the way right now.’ So how do you get there? What’s the path you’re going to take to de-risk over time?”

Black swans
By far the hottest metaphor to take the financial world by storm in recent memory, Nassim Taleb’s theory of black swan events is occupying a new place in the world of risk management. Defined as events that are unpredictable with massive repercussions—and, with the benefit of hindsight, appear more predictable than they actually were—the global financial crisis and its effect on capital markets has delivered a stark example of a previously obscure and poorly understood theory. So what effect has it had on the industry’s concept of risk management?

“The value of the black swan movement is that it has shown that the one-in-a-million probability event happens every day,” says Quigley. “That being said, you can’t really model for a black swan event. If you did, you’d never invest in anything.”

The point, he explains, is to focus on low-probability, high-impact events, now known as outliers. He says the whole debate on black swan events will have served the industry well but cautions against attributing too much to the theory. “We have to be careful not to start seeing black swans everywhere.”

Mather suggests that the terminology is less important than the lessons learned. “If the global financial crisis was a black swan, there will be another one,” he says. “We don’t know how or when, or what form it will take, but you have to reasonably conclude that there will be another one.” At the very least, he says the industry needs to learn to recognize deteriorating situations sooner, react faster and construct portfolios with lower correlations to each other.

“One of the things that made the collapse of the fourth quarter [of 2008] so devastating for plan sponsors is that some of the things they owned, which were supposed to be uncorrelated, all fell together,” says Mather. “The good securities got marked down with the bad. There’s a saying: the greater the stress, the greater the tendency for the correlations of the different asset classes to move toward one, and that happened. Everything they owned went down at the same time.”

Such lessons are all well and good, says Williams, except that the likelihood of the next event resembling the experience of late 2008 is almost nil. “The industry will certainly be better prepared to deal with risks associated with credit quality and investments dependent on easy liquidity, but that’s not the next problem,” he says. “The next problem is going to be something else.”

Good times, bad times
Coming out of the worst economic period in a generation, with record declines in asset values and restless clients, there’s not much to be happy about, and one would expect to find an industry in crisis. While the bad news is that increased search activity means many firms will likely lose clients, the good news is that many firms will likely gain clients, which is the brass ring for the time being.

“This is a very good time to be a money manager,” says Smith. “There are tremendous opportunities for thought leadership and for strategic partnership with plan sponsors and consultants. Plan sponsors are looking for not only tailored solutions but also trusted advisors they can work closely with.”

“It depends on the asset class,” adds Rabovsky. “Is it a good time to be an infrastructure manager? Absolutely. But a hedge fund, not so much.”

According to Mather, the question of whether these are good or bad times for money managers is beside the point. “This is a new reality,” he says. “Past market cycles have always been based on the assumption that we’ll return to normal, but the question many of us are quietly asking ourselves now is, What if we don’t return to normal? To work in this business you have to be a natural optimist.”

Jody White is associate editor of benefitscanada.com.
jody.white@rci.rogers.com

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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the November 2009 edition of BENEFITS CANADA magazine.