As the credit crunch spreads, giant financial institutions evaporate and governments struggle to intervene effectively, the spectre of a global recession is looming. And all of this has had a tremendous impact on the money management industry in Canada.
Total pension assets under management on the 2008 Top 40 list have shrunk for the first time ever, down 4.1% overall. And while this report is admittedly a snapshot of the industry taken at an unflattering time when volatile markets were down, this year’s Top 40 managers agree that these are tough times—and they’re going to stay tough. Plan sponsors and money managers alike are holding their breath, waiting to see what surprises the markets have in store for them.
But thankfully, no one is panicking. Instead, the report finds Canadian money managers working hard to communicate with clients, assessing the situation as it unfolds and learning some hard lessons from what they all agree is an unprecedented time in the global financial markets.
Ups and Downs
To see just how low some of these numbers are, let’s compare them to the results in 2001—the worst year in the history of Benefits Canada’s Top 40 Money Managers report. Back then, as the tech bubble continued to burst and the industry felt the severe impact of the 9/11 terrorist attacks, the report showed a large drop in the growth of pension assets. While the heady days of 2000 had resulted in a major jump of 17.3% year over year, 2001 saw that number shrink to just 2.9% growth.
That was a bad year—but this one is worse. Pension assets under management have dipped overall, with a -4.1% showing. All told, only 17 of the managers on our list clocked any growth at all. In total, 23 managers experienced losses, outstripping the 19 managers that saw their Canadian pension assets shrink in the post-tech bubble, post-9/11 environment of 2001.
Those losses didn’t make a huge dent in the top 10 (note that the Caisse de dépôt et placement du Québec and Bimcor were removed from the list for other reasons unrelated to market conditions). Barclays Global Investors Canada Ltd. took the top spot, with $51.6 billion in Canadian pension assets under management and a small gain of 0.1%. In the No. 2 spot, TD Asset Management showed assets under management of $38.7 billion and a gain of 2.8%.
However, broad losses on the list also extended to the top 10 managers, with pension assets for five of them sliding south. One of the biggest gainers in 2007, global player AllianceBernstein Institutional Investments, experienced a 9.0% drop in the value of pension assets under management but still managed to move up to the No. 5 spot.
The market volatility had a severe impact on many of the Top 40, with managers of all types and strategies moving up and down. Alternative manager Northwater Capital Management Inc. (No. 36) saw a 32.8% dip in pension assets under management, while global manager Natcan Investment Management’s (No. 31) assets fell by 31.8%.
The rare gainers included Addenda Capital Inc. (No. 9, up 22.6%), real estate manager Bentall (No. 16, up 13.2%) and CIBC Global Asset Management (No. 14, up 10.2%). GE Asset Management Canada Company appeared on the list this year (No. 38) with a gain of 1.7%.
Addenda Capital Inc. also led the fastest-growing list (by dollar amount), followed by Connor, Clark & Lunn Financial Group (No. 2) and Bentall (No. 3). Alternative managers Integra Capital Management Corp. (No. 8) and Integrated Asset Management Corp. (No. 9) also made it onto the fastest-growing list this year, boosting their assets by $982.8 million and $950.0 million, respectively.
Steady As She Goes
So how are managers reacting in these unprecedented times? Michael Barnett, executive vice-president, institutional retirement services, with Fidelity Investments Canada ULC (No. 20) in Toronto, says things haven’t changed all that much on the business side. “We’ve got a busy October ahead of us,” he says, noting that plan sponsors are still pressing ahead with their investment plans and decisions for the year. “These are challenging times for everyone but what we’ve seen is, if plan sponsors made decisions, they are moving forward with them. You just can’t freeze,” he explains, adding that he expects to see this activity continue.
Brendan George, senior vice-president with Aon Consulting in Vancouver, agrees that plan sponsors are holding steady to see what happens. “Almost all are staying the course,” he says. “They feel it’s a shortterm thing, although it will take awhile to recover. As a result, they are avoiding knee-jerk reactions.” At any rate, trying to get out of equities now would be a mistake, he says. “It’s too late.”
Malcolm Hamilton, worldwide partner with Mercer in Toronto, shares that sentiment. “You have to worry and be concerned, but there’s not a lot you can do,” he says. “It’s late in the game to be doing significant repositioning, so people are going to have to cross their fingers and try to ride it out.”
Duncan Webster, chief investment officer and head of CIBC Global Asset Management, says that his firm is working hard to keep in touch with clients. “There has been an intensification of contact with clients to keep them informed. They’re wondering what has changed structurally in the markets—that is a distinction from previous market episodes,” he adds. Webster says his firm always looks closely at its portfolios from a liquidity standpoint. “We are giving them a good scrub,” he explains. “We’re ensuring that we have a good deal of liquidity in our portfolios, focusing on very high-quality credits in our bond portfolios and looking for solid-value stocks in our equity portfolios.”
Neil Matheson, vice-president, economics and portfolio management, with Standard Life Investments Inc. (No. 17) in Montreal, says his firm has been shifting assets in anticipation of the coming crisis. “We’ve been moving our clients more defensively over a period of 18 months,” he adds, noting that Standard Life shifted to one of the lowest equity allocations among Canadian managers in favour of cash and bonds. It also made a move to reduce exposure to energy and materials, and reduced exposure to credit.
Stunning Times
Many believe that today’s market events mark a new era in the money management industry, and all admit they’ve never seen anything quite like this in their careers. “Stunning is the word everyone is using,” says Nereo Piticco, president and chief investment officer of PCJ Investment Counsel (part of Connor, Clark & Lunn Financial Group) in Toronto. “Even decades-long veterans in the investment industry are using that word. And we’re only starting to see the rising defaults,” he says, adding that more will happen in the next six to 12 months.
Webster notes that the massive coordinated intervention on the part of central banks and governments is also unprecedented. “In previous times and in a normal cycle, you have some combination of monetary and standard fiscal policy,” he explains. However, this time around is very different. “We are seeing a change, potentially in entire regimes, in terms of who owns capital. Government intervention is changing the rules of the game.”
For his part, Hamilton believes that the current level of government intervention represents the biggest test of monetary policy since the Depression. “There has never been a depression in my lifetime,” he notes. “However, the official view is that the bankers and governments made mistakes in the late 1920s and early 1930s that exacerbated the downturn and turned it into a depression.” According to Hamilton, economists generally believe that policy-makers learned a lesson from their inaction during that time.
Today’s economic situation is providing governments with an opportunity to prove that they can do better this time around. This is the “thing that nags,” says Hamilton. “They won’t make the same mistake, that’s true. But with all the debt lying around, it’s hard not to make a mistake. I think there’s a risk you could inadvertently stumble into the thing you were trying to avoid.”
Indeed, says Hamilton, governments have already done a lot—but to no avail. “If you make a list of everything the government can throw at this, it’s just about all been done. Interest rate cuts, tax cutting, bigger deficits…we’re getting near the end of the list, and nothing has really worked.” As U.S. consumers tighten their belts and the psychology of despair spreads across world economies, things could get a lot worse. “The American consumer has been the wonder of our time,” says Hamilton. But now, without consumer spending power fuelling global growth, it’s tough to say when things will get better.
Is there any light on the horizon, or are we in for a long haul?
Harold Scheer, president and chief investment officer with Baker Gilmore & Associates (part of Connor, Clark & Lunn Financial Group) in Montreal, says it’s going to take some time for conditions to improve. “The buildup in excess leverage before was so extreme. We’re working through all this de-leveraging, and banks are afraid to lend to other banks. It will take time. The U.S. consumer has to rebuild their savings—70% of the U.S. economy was based on consumption, so it’s going to be contracting,” he says, adding that we haven’t seen the end of defaults. “There are going to be more defaults—not just among homeowners, but in the broader economy as a result of the slowdown.”
He also sees the leveraged buyout market taking a hit. “Those deals were being done in the frenzied financial markets into the summer of last year.” And that party on Wall Street is definitely over. Fortunately, the monetary and fiscal stimulus by U.S. policy-makers is very impressive and should prevent a severe economic recession, although the recovery period will be long.
Shifting Ground
Although plan sponsors are staying the course today, there will likely be some changes on the horizon when things settle down. But that will take time, says George. “Even those who are thinking of changing money managers are holding off to see what happens. It’s going to take another six to 12 months to see how it all unfolds. Markets are so volatile and extreme that switching managers during this turmoil is risky.”
In particular, he thinks that some bond managers are likely to take a hit, with plan sponsors making changes down the road. “There were big differences in performance,” says George. “Some [fixed income managers] have done really well. They preserved capital and stayed out of credit.” However, he says, others had big credit exposure. “Not now, but maybe next year, we’ll see some musical chairs on the fixed income side—you’ll see some winners and losers.”
Barnett also sees shifting ground ahead in the form of further consolidation of money managers in the Canadian space. “I think this type of market environment accelerates it further,” he says. George sees a future made up of mega players that can offer products across most asset classes. “The middle ground will disappear, and the bulk of assets will be with the big players,” he says.
Warren Stoddart, co-chief executive officer of Connor, Clark & Lunn Financial Group, also sees more consolidation on the horizon, although he’s watched it happen for a few years now. “It’s not new,” he notes, but he does see pressure on the smaller managers due to the big drops in the market. As infrastructure costs go up and assets go down, Stoddart believes that some smaller players will ultimately get squeezed by falling revenues, and that could lead to the disappearance of smaller names in the money manager landscape in Canada.
Benefits and Opportunities
While some in the industry are going to feel the squeeze, others are set to benefit from the market turmoil. George says that value managers are snapping up bargains. “They are taking advantage of some of the stock that’s dropped precipitously.” Indeed, Marcel Leroux, vice-president, marketing, with value-focused Sprucegrove Investment Management Ltd. in Toronto, has seen a move away from value in recent years. However, this market is bringing value back in style. “Prior to the third quarter, the value investing style was out of favour,” he explains. “Now it’s back, relatively speaking. We see that as a positive development for the future.”
George also says that alternatives are going to get more attention from plan sponsors concerned about heavy correlations between equity markets and the volatility they’re seeing. While he says that the mega funds have embraced alternative investments in a big way, other plan sponsors are lagging behind. “Our client base has been looking at alternative strategies for two to three years,” he says. “Some of them have done better in the current market environment. Real estate has held up well so far—particularly Canadian real estate.” Infrastructure and certain hedge funds have also managed to perform better than equities in the turmoil.
As these alternatives continue to outperform, plan sponsors could start to pull further out of equity markets. “Different equity markets don’t offer a diversification benefit anymore,” says George. And just how well plan sponsors do in these tough times depends on their asset allocations. “It boils down to what our exposure was to equities versus alternatives,” he notes. “Allocating 10% to alternatives hasn’t helped enough.”
Tristram Lett, managing director, alpha beta strategies, with Toronto-based Integra Capital Management Ltd., says that while newspaper headlines are pointing to hedge funds as the culprit in the current market volatility, they are already coming out on top when it comes to performance. “When you sit down and analyze the data, hedge funds are going to be the big winners,” he says, looking ahead to when markets calm down in the months ahead. “They’ve outperformed long-only investors,” he adds, and you only have to look at the hit taken by the Toronto Stock Exchange to see that. “It’s down 40%. There aren’t many hedge funds that are down that much, and many are up. I don’t know a single equity fund that is up.” Lett sees the big winners as global macro and managed futures, followed by short bias strategies as of the end of September.
Other alternatives will also provide a hiding place for gun-shy investors. One of the gainers on the list this year is Vancouver real estate firm Bentall. Malcolm Leitch, Bentall Investment Management’s chief operating officer, says that while it’s still considered an alternative, real estate has moved into the mainstream in pension portfolios. And it’s faring well so far, particularly in Canada.
“For 24 months, we’ve seen plan sponsors taking a more serious look at real estate—particularly those plan sponsors that have never been in it before,” says Leitch. Except during the early 1990s, real estate has managed to weather most market challenges, including the tech wreck. “Income returns have been stable for 20 years or so, and pension funds find that attractive,” he adds. However, investors looking for more of the double-digit capital appreciation that real estate experienced in the last few years need to temper their expectations going forward. “We keep telling plan sponsors that it’s not the norm and [not to] expect the returns of the past few years to repeat themselves,” notes Leitch.
And there are some challenges ahead for real estate. Leitch says this business houses the economy and the businesses that drive it. “As the economy goes down, leasing markets slow down,” he explains. “Although Canada is stronger relative to the U.S., people read the papers and are delaying new leasing decisions. People are being cautious in their real estate decisions, at least in the short term, and they aren’t committing to new space.” Alberta is a province to watch—after years of booming real estate growth, shrinking oil prices will take their toll on space. “That’s likely to hurt,” he says, but on balance, Canada is in much better shape than the rest of the world.
There are also some good opportunities on the bond side, according to Webster. Corporate bonds are in decent shape on an absolute yield basis, he says. Which is good because, according to him, “investors are looking for yield in any form they can get it.” Yields on corporate bonds are becoming attractive as everyone piles into government and sovereign markets, pushing down yields in those areas and creating opportunities in other parts of the fixed income market.
Another Perfect Storm?
It’s an unprecedented series of events, to be sure, but what lessons are we learning as it all unfolds? According to Hamilton, there is a fundamental lack of understanding when it comes to risk and how to manage it. “I don’t think people should say ‘perfect storm’ anymore,” he says. “Because when a perfect storm comes along every four years, it’s not that rare anymore—and people have to ask why the perfect storm is coming along so regularly.” Hamilton says the industry needs to get serious about risk management. “Risk is real. It’s not a matter of making bold predictions or being patient and waiting two years for it to blow over.”
Piticco points out that risk management tools weren’t able to predict the calamities facing the markets today. “Everyone had the same bet, and when it went wrong, the ability to forecast it was abysmal. You can’t rely on the black box or sophisticated modelling,” he says. As a result, he sees a swing to simpler investments and approaches. “The days of complex securities are over; it’s back to basics in portfolio management,” he says. At the same time, “clients need to better understand their liabilities. Liability driven investing is going to be important going forward.”
Matheson agrees that, in the future, plan sponsors are going to be shifting to liability-focused approaches such as LDI and absolute return strategies. He sees a pullback on the horizon for some traditional products. “Going forward, there will be less interest in classic straight equity products—rather, you need to find asset classes that are going to work in a wider variety of economic cycles.”
However, risk management alone isn’t enough. George says there’s a limit to what risk management can do, although he admits that “many plan sponsors and fund managers aren’t doing enough on risk management, and many got caught up in the equity downdraft.” But what risk management system could have predicted the demise of AIG? “Most of those tools do not capture extreme unforeseen events,” George adds.
Although there will likely be more time and energy than ever spent on risk management as a result of this crisis, he cautions that these systems aren’t foolproof. Instead, diversification is key. Webster agrees that asset allocation and diversification will determine who comes out on top and, as a result, managers that can offer products across many asset classes on a global basis are going to be the big winners in the years ahead.
In the meantime, it seems that everyone can agree that tough markets will persist. Just how red next year’s list is will depend on how long and painful the de-leveraging process is, and what surprises pop up as it unwinds. Suffice it to say that it will be monumental. And there will be many lessons learned, for better or for worse, in the months ahead.
Caroline Cakebread is the editor of Canadian Investment Review. caroline.cakebread@rogers.com
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