Canada Versus the U.S.
Wendy Brodkin, director of Canadian business development and client service, with U.S. firm T. Rowe Price in Toronto, says one of the main things U.S. firms are bringing to Canada is choice—a wider pool of managers for plan sponsors. That’s something that just didn’t exist a few years ago, she notes. “I was talking to a plan sponsor recently who said she would run through the list of Top 40 money managers in Canada,” Brodkin explains. “After taking out the managers she already had and striking off the ones she wouldn’t hire, she was left with only small managers.”
Today, with a host of new U.S. money managers on the scene ready to do business, there are a lot more options for plan sponsors to choose from. Zainul Ali, senior asset consultant, with Towers Perrin asset consulting in Toronto, agrees that U.S. managers have brought muchneeded choice to the Canadian market. And, he says, plan sponsors are hiring them. “U.S. managers are faring very well,” Ali says. “They’re winning mandates, and are proactive with new strategies and solutions.”
Just how well are they doing? A quick glance at last year’s Top 40 Money Managers Report (see the November 2007 issue of Benefits Canada by clicking here) shows some of the big U.S. players moving up the list. For example, Fidelity Investments Canada ULC, which wasn’t even on the list five years ago, now holds the 25th spot and boosted its assets by 30.9% during 2007. Another U.S. giant, AllianceBernstein, has also seen its Canadian pension assets grow substantially—it ranked 27th back in 2002, but 2007 shows it in the No. 7 spot. It also placed second on the 2007 ranking of the Top 10 fastest growing assets in dollars, a list that also includes U.S.-based Bank of New York/Mellon Asset Management and Goldman Sachs Asset Management.
Why the steady growth? Ali believes that U.S. managers bring a few key attributes to the table. “They bring a depth of research and resources that Canadian managers do not have,” he explains, noting that, as a result, “foreign managers have raised the level of quality on the products that Canadian plan sponsors are getting.” U.S.-based money managers also tend to have a global perspective, something that’s becoming increasingly important in Canada. “A firm like AllianceBernstein is global and doesn’t look at Canada in isolation,” he says. “The global focus has forced Canadian managers to do the same, which means raising the quality of the research and the people you have working for you.” All this, says Ali, is a huge win for Canadian plan sponsors, and it has raised the bar in terms of the quality of service and products available here in Canada.
John Montalbano, president, Phillips, Hager & North Investment Management Ltd. in Toronto, agrees that, as more U.S.-based and global managers move into Canada, it’s altering the competitive landscape in a positive way. “This has been good for plan sponsors,” he says, noting that the new range of choice available means that they now “have an increasing number of alternatives.” The trend has also turned up the heat on managers to maintain a competitive edge. “This trend reinforces the maxim that to retain clients and win new clients, you have to compare favourably on a global basis,” Montalbano explains. “Maintaining a competitive edge is about hiring and retaining talented people—Canadian money managers have to continue to compete for the best professionals in a North American and global context.”
Local Still Matters
At the same time, global doesn’t necessarily mean better, and U.S. managers can’t expect to win business based on a big global brand. Gary Grad, vice-president, consultant relations, with Fidelity in Toronto, is well aware that non-Canadian managers have their work cut out for them when it comes to proving what they can do here. “I don’t think you can show up and use your name to get business,” he says. “You have to earn your stripes in the Canadian market and earn the respect of consultants and plan sponsors.” Montalbano notes that you can’t succeed in Canada without a sound knowledge of how the marketplace works—an attribute, he says, that still gives many Canadian firms an edge in the domestic market. “One significant advantage that Canadian firms have is the breadth and depth of our working knowledge of the domestic pension marketplace,” he explains.
But as plan sponsors eye global assets, are Canadian product offerings still essential for managers looking to win Canadian business? According to Grad, they are. “We started out offering international products,” he explains, speaking of Fidelity’s first foray into Canada. “But after initial success in that area, we felt that, to be considered a serious participant in the institutional market in Canada, we really needed Canadian offerings.” At that time, he says, foreign content was capped at 30%—so if you didn’t play in the Canadian space, you could only capture 30% of the market. To compete, it launched two Canadian equity products. “Looking back, the launch of those products was essential to us becoming a legitimate market force here,” Grad says.
But with no limit in place, that could change. Kevin Martino, Canadian director for AXA Rosenberg (a U.S.-based firm that has been in the Canadian market for the past few years), isn’t so sure that Canadian products will give foreign money managers an edge in the future. When it comes to global managers, many already have Canadian experience within a different context. As he says, “It’s worth noting that some foreign investment managers have a longer track record in Canadian equity as components of a global equity strategy—so they might well have the expertise needed.” At the same time, he’s not convinced that Canadian managers have the advantage when it comes to knowledge of the local market. “Canada is a unique animal,” he admits. “However, many large and global firms have learned to deal with the peculiarities of many unique markets. To be sensitive to the features of a local equity market is part of the basic skill of an investment manager, no matter where they are based.”
Searching for Better Beta
In addition to global equities and fixed income, U.S.-based managers are also tapping into a growing appetite for new and emerging products that haven’t previously been available in Canada. Traditional pension fund mainstays, such as Canadian equity and Canadian fixed income, are slowly being replaced by more global products as plan sponsors seek to manage risk, generate alpha and meet their liabilities. Brodkin says that much of the shift is also due to pure necessity, as plan sponsors seek to cope with the realities of global markets. “Interest rates are so low, the equity risk premium is so low; people are looking for ways to get higher returns,” she explains. “They are looking for better beta or other sorts of beta, such as regional or sector beta. And they’re looking for alpha.” That also means that they need a broader opportunity set to choose from, she says, and this is something that U.S. managers can offer. “U.S. managers with a global platform can undertake proprietary research around the world, which can give them an alpha edge in security selection.”
Mark Doyle, vice-president, JP Morgan Asset Management (Canada) Inc., believes that U.S.-based managers are positioned to help Canadian plan sponsors go beyond some of the traditional asset classes in ways that many Canadian firms can’t. “Back in the 1980s, it was all about U.S. equity and maybe some global equity,” says Doyle. “When we first started out in Canada, Canadian plans didn’t want to waste their foreign content on U.S. fixed income, for example.” That has changed dramatically. “They’re getting into hedge fund of funds, private equity and infrastructure. Small plans now have more choice,” he notes. “The opportunities are broader in these areas for U.S. managers. It’s like a lot of industries,” he explains. “The U.S. has got the marketplace to get economies of scale in whatever they’re doing, while Canada has always been a niche market looking out into the world.”
The Long and the Short of It
At the same time, the type of investments that plan sponsors are looking at right now involve a very different skill set that not all managers can bring to the table: the ability to short sell. Grad says that Canadian plan sponsors are keeping an eye on products such as 130/30 strategies, which are, for the most part, coming from U.S. and global managers. “They’re looking to people with experience in those products, since they do require a different skill set,” he notes. “Shorting is a different skill than long-only investing. People need to be discriminating; they can’t take a leap of faith. Not only is the skill set different, but there’s also a different infrastructure necessary to properly support shorting, and not every shop is in a position to spend the resources on establishing that infrastructure.”
This is where U.S.-based managers with experience in the area of quantitative investing might make their biggest leap into Canada. Omar Aguilar, head of quantitative equity, with ING investment management in New York, says that most of the action in the “quant” arena is happening outside of Canada. “There are not too many quant managers based in Canada,” he says. “In the quantitative space, it’s all about talent. You don’t necessarily need the home bias; you just need people with strong backgrounds in research who can translate it into product.” The U.S. is a major hub for the kind of academic research that is so central to quantitative investing—from Harvard to MIT, the U.S. is where much of the thinking is being done. “When it comes to quant,” Aguilar says, “you look for strength of research, and that means constant contact between academics in the field and the street to get a sense of what’s happening in the market and how it links to the academic world.” At the same time, says Aguilar, the sheer size of the derivatives market in the U.S. has helped fuel the strategies and experience that have shaped the growth of the hedge fund space.
Ali agrees that the length of time that U.S. managers have been working in the quant space, along with the number of professionals they have, give them an edge. But he’s not so sure that Canadian plan sponsors are ready to fully embrace 130/30 quite yet. “I’m not sure plan sponsors are quite ready for it,” he notes. “You have to convince plan sponsors and trustees, and right now, they are questioning whether the additional risk of shorting stocks is worth the marginal added value derived. Many corporate pension plans in Canada are reasonably well funded, and their focus is on reducing risk rather than boosting returns…but that could change with one or two bad years in equity markets.”
Ready or Not
Whether or not plan sponsors are prepared to bite, the new products are starting to roll out, and many are geared specifically to the needs of the Canadian marketplace. Doyle says that his firm is in the process of launching a 130/30 strategy that’s based on the S&P 500 benchmark but is aimed at Canadian plan sponsors—it’s a pooled fund based on the 130/30 concept, and it’s built for small and mid-size Canadian pension plans. Doyle believes that, once it’s launched, it will be the first U.S. 130/30 based in Canada that is only available to Canadian clients.
As new products roll out to meet the evolving needs of the Canadian marketplace, it looks as if U.S. managers will continue to shake up the game here at home. And there will be some clear winners and losers down the road. Ali believes that, for Canadian equity managers in particular, it will be challenging to compete. “The whole idea of being a Canadian equity manager is coming under fire,” he notes. “It’s a declining business.” As people look to diversify their product lines, more and more Canadian managers are going global, looking for partners and alliances with U.S. and global firms to help them maintain an international focus, he says.
But as the Canadian space continues to shift and become more global, one thing is clear—the players are going to change and so are their strategies. And with any luck, the big winners will be Canadian plan sponsors.
Caroline Cakebread is the editor of Canadian Investment Review. caroline.cakebread@rogers.com
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