What is the winning formula for asset managers and institutional investors in the coming year? The 2016 eVestment Institutional Investment Intelligence (EI3) client conference set out to answer exactly this question. With over 200 attendees, the conference provided institutional investment professionals with the latest trends and actionable items from a great line of speakers. Here are some of the key takeaways from a few of the sessions.
Consultant Panel: Asset Allocation 20/20
The panel represented consultants from firms of various different sizes and geographies. One of the topics discussed regarding asset allocation focused on the future of active management. “There’s certainly a lot of headwinds,” said one of the panelists. “There are a lot of clients bringing money in house and insourcing of assets. Passive equity is another issue. There is a lot more competition. If you look back just a few years ago, there were under 500 global equity products in the investment database. Now there’s over 700. There are fewer assets to go around, more competition and pressure on fees, but more managers out there vying for assets.”
While many investors tend to be more comfortable with large managers, consultants acknowledge the potential of smaller managers from an alpha generation perspective. The key to opting for a smaller manager is that “you need to get everybody on board so they understand the manager very well.”
Many institutional investors are limited in how quickly they can change allocations in alternatives. The panel discussed how consultants are taking a more active approach to real assets and building out their research teams to meet those needs. Within traditional allocations, consultants are recommending investors go into more concentrated strategies with higher conviction to capture alpha. There is also an increased focus in emerging markets and small caps. The consensus of the panel was that many trends in the industry are fads, especially if some area of the market gets “too hot.”
As of late, the panelists have seen this phenomenon in both low volatility strategies and smart beta. In the case of low volatility, consultants are seeing that, regarding many of these strategies, “the risk of the low volatility segment of the market exceeds the S&P 500.” Managing investor behavior is one of consultants’ most important attributes – especially around popular options. Panelists agreed that passive strategies have taken a stronghold in some of the more efficient markets, such as U.S. Large Cap.
“I think the concern there is yes, you’ve got 15% absolute return on large growth, but only 10% of active managers are beating the benchmark quota here. That’s a really tough benchmark to beat. Again, I think these things are cyclical.” Another panelist added that “you need to give [active] managers a lot more leash to try to beat the benchmark in a very efficient market.”
Private Equity Panel: The Problem of Dry Powder Within PE
The private equity panel included experienced investors, consultants and fund managers. A key point of discussion was the asset class’ record levels of dry powder and what that means for both sides of the table.
Private equity has attracted increasing amounts of capital from investors over recent years thanks to its ability to deliver, on average, double-digit returns in an otherwise low return environment. However, this influx of capital, combined with record distributions in recent years, has created unprecedented levels of dry powder – a primary concern for investors in the asset class. “It certainly makes you wonder if all that dry powder is going to be disciplined in putting itself to use, and if there are enough opportunities at the right price to get it put to use. It’s very, very concerning.”
Members of the panel said they are looking to diversify their investments into the increasingly popular sub-asset classes to “act as a hedge” in the event dry powder conditions continue to inflate valuations and flatten returns. For those looking to maintain allocations to private equity, they are mitigating risk by applying more scrutiny to manager selection.
One panelist offered his advice to LPs on best practices for robust due diligence: “This is both an art and a science. You need to look at things from both sides. A lot of LPs are getting into trouble because they don’t have the qualitative skillset. They’re simply investing off of a quantitative skillset at the peak of a market. You need to have the experience or the background to be able to qualitatively assess the managers. You need to know the right questions to ask to be able to really dig in and understand what makes one return different than the other – even though the IRRs could be exactly the same. It’s about finding out how they got there.”
Trends Briefing: Obstacles and Opportunities to Thrive
In this session, speakers from eVestment explored asset flows and database viewership trends from the eVestment platform, touching on active/passive trends, the importance of fees and the characteristics of winning strategies.
How important are fees in terms of their relationship with flows? After analyzing high level data from eVestment, it turned out that the least expensive products (in the lowest fee quartile) were 1.7x as likely to experience positive flows as those in the most expensive fee quartile. So that means low fees versus high fees translates to a 1.7x opportunity of growing a strategy.
U.S. active equity has been seeing about 20 consecutive quarters of outflows. How important are fees in this space? US active equity products are 2.2x more likely to experience positive flows if they have bottom quartile fees versus top quartile fees. In light of all of this, what is the state of fees and what are managers doing about this? It turns out most managers are not decreasing fees at all. 4.5% of active products had some change in fee structure this year and only 5.8% of managers charging the highest fees have changed, decreased their fees so far this year.
Active products are losing money at an increasing velocity while the shift to passive is actually slowing down. Diving in specifically by asset class, U.S. equity has seen a net loss in active and passive strategies. This asset class makes up almost 44% of all active outflows at $177B from the first half of 2016 and 17% of passive. On a brighter note, some of the universes winning include: U.S. fixed income, ACWI ex-US equity, Europe fixed income and EAFE equity.
One of the most exciting things to come out of EI3 was the announcement of eVestment’s acquisition of Public Plan IQ. This searchable database of public plan board materials, agendas and presentations adds a huge benefit for managers looking to do business with public plan investors. Using information aggregated from Public Plan IQ regarding searches so far in 2016, there was an obvious trend favoring alternatives, namely private equity and real assets which accounted for almost half of all searches.
Are there commonalities among the best performing strategies also winning flows from a strategic perspective? Not surprising, products with top quartile three-year performers win more today than ever before (2.4x as likely to see top quartile flows). Another interesting characteristic of winners was around how often and how quickly managers populate performance data (good or bad) into the eVestment database. Managers in the top quartile of providing this data were 1.5x as likely to have top quartile flows and products with top quartile fees (lowest) were 2.1x as likely to see positive flows.