CLO Newsletter

In-sourcing of Asset Management. Are Institutional Investors ready Part 1

[] Posted by Vikas Verma on Sun, Oct 21, 2012 @ 10:17 PM Last week, I spoke about the structural shifts happening in the Asset Management industry. This week I will focus on one of the most recent and prominent trends In-sourcing of Assets Under Management. One of the key questions occupying the minds of Financial Institutions (Pension Funds, Insurance Companies, Central Banks, Endowments, etc.) today is which form of Asset Management is optimal for the beneficiaries (be it Institutional investors, trusts or plan beneficiaries) Professional Asset Management, in-house Asset Management by the Institutions themselves, or a combination thereof. For those who believe in numbers a recent survey by Sutherland Global Services of 40 Institutional Investors - Insurance companies, corporate defined benefit plan sponsors, as well as endowments and foundations showed that only 21% of the firms that have external asset managers were satisfied with the asset managers investment performance. Another research study by Sutherland conducted between June and Sept 2012 showed that of the top pension funds in Australia, UK, US, and Canada approximately 21 of them brought more than $65Bn AuM back in-house in the last twelve months.

Some of the large Institutional Investors taking the plunge to in-source Asset Management (partly or fully) in the last six months included: CalPERS approx. $1bn AMP, Australia's largest retail and corporate superannuation provider, brought back ~$6bn of their fixedincome assets in-house to AMP Capital AustralianSuper brought close to $3bn of equity investments in-house The State of Wisconsin Investment Board is moving $3.9bn of externally managed international equity assets in-house

Why is this trend critical? In-sourcing of Asset Management is not new but the rate at which it is increasing has never been higher and the value of Assets brought in-house has never been so massive. Institutional Investors realization of cost adjusted returns heightened when they saw their portfolios dwindle in the wake of the financial markets collapse in 2008. Also, Institutional Investors today know that fund management is largely a fixed-cost business while their current fees structure rises even when costs do not. Case in point -- The Teachers Retirement System (TRS) of Illinois paid more than $1.3 billion for money managers and brokerage firms to handle its $30 billion-plus in financial assets during a 10-year period ending in fiscal 2010. Despite this high fee - TRS 10-year average rate of return during this span was ~ 3.7 percent excluding fees, far below its 8.5 percent annual target return (Source: http://news.heartland.org/newspaperarticle/2012/04/20/big-fees-small-returns-illinois-teachers-retirement-system). Part of this dismal performance is attributed to the market crash of 2008 even though the portfolio recovered in 2010 and 2011. Another example - Australian superannuation fund, AustralianSuper, brought $3 Bn in-house (http://investmentmagazine.com.au/2012/09/australiansuper-brings-it-in-house/). Its head of investment operations stated in September 2012 that the fund spent about $200 million a year in external investment-management costs and predicts that if this was to continue they will end up paying about $500 million a year in a few years. AustralianSuper plans to cut their projected costs by about two-thirds by managing internally. Bottom-line Economics is in force. The differential between the external asset management fees vs. the cost of managing it in-house is driving the latest structural shift. Control over investments as well as governance around the investment management process are also key factors. In part II and III of the series I will cover topics in a 'New Normal' Asset Management industry, including: Factors that the Institutional Investors need to take in to account for the decision to in-source. Which asset classes are most optimal for in-house Asset Management? How to leverage the recent developments in global shared services models (not only for middle office / back office but for Investment Research, Investment decision support and monitoring) to succeed in your in-sourcing strategy.

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Comments Great information and analysis. Institutional investors are becoming smarter about the cost of Money Management and the next 5 years will change the economics completely. Writing is on the wall - the share of profits must be fairly distributed between the players over a longer term. It's a matter of next 4-5 years and every large pension fund and Sov. fund will copy the business model, especially with the right support partners / providers in the entire value chain from Custodian, Fund Accounting, Trade settlements, Reporting to Research, etc. Posted @ Wednesday, October 24, 2012 4:57 PM by Anthony Goldman