Financial crisis turning point in investment approach
Jim McCaughan, Principal Global Investors
Conventional investing, which failed in 2008 and its aftermath, has been replaced by the rise of passive vehicles and multi-asset strategies
New ways of investing, which emerged in the aftermath of the 2008 financial crisis, have gained ground and will continue to advance over the next few years, according to a new study by Create-Research, backed by Principal Global Investors.
The financial crisis was a turning point, as diversification failed when it was most needed. Unconventional monetary policies, by hugely inflating asset values, disconnected those assets from fundamentals, explains Amin Rajan, CEO of Create-Research.
“The search for new ways of investing has intensified because conventional investment wisdom has been sidelined by negative real yields and extreme levels of volatility. For investors, being risk-averse became the biggest risk,” says Mr Rajan.
By necessity, investment approaches have evolved and will continue to do so for the rest of the decade, aimed at finding superior returns through improved asset allocation and better investment vehicles.
The most “pervasive trend” across all investor segments relates to the rise of multi-asset investing. A key benefit is that it can ‘net out fees’, as it charges fees on the net performance of all the strategies covered by each vehicle, unlike single strategy funds.
It also promotes a deeper understanding of changing correlations between different asset classes and offers risk allocation. Multi-asset funds are the fastest growing sector in Europe, and “outcome oriented” strategies are the most rapidly expanding.
Other investment approaches, which “may well outlast the crisis that catapulted their rise in the first place”, include risk-factor diversification, absolute return investing, thematic funds, alternatives – especially liquid alternatives and institutional loans – and exchange traded funds (ETFs).
Having grown each consecutive year since 2008, reaching $2.879tn globally at the end of last year, ETFs are cheap, easy to use, liquid, and quick to access ways of “slicing and dicing the investment universe following specific themes”. These passive vehicles are increasingly replacing active funds in core portfolios, with satellite assets pursuing alpha. Satellite ETFs can also be used to access specific asset classes, such as synthetic hedge funds.
Smart beta – a subset of ETFs – is also gaining traction, although the size of their AuM remains relatively small, and mostly skewed towards the US and Canada (see chart). Seeking to minimise risk by controlling factor exposure, and aiming to deliver alpha by seeking to beat cap-weighted indices, “smart beta is the investor’s Holy Grail: getting additional alpha, at beta fees and beta risks,” adds Mr Rajan.
The big shift to passive has put a huge downward pressure on fees and explains declining revenues of global asset managers year to date, even those who have experienced large inflows, observes Jim McCaughan, CEO at Principal Global Investors.
“At a time when expenses are rising because of globalisation and compliance, there is a tough squeeze going on, a re-pricing of a lot of products, which is most extreme in passive funds themselves,” he says.
$2.879tn
The size of the global ETF universe had expanded to $2.879tn by the end of 2015
These factors are leading to a change in leadership in the industry. “This has become a much tougher environment and anyone who gets it right is going to do very well relative to others.”
The size of assets under management is no longer as good an indicator as it used to be, given the commoditisation of certain products. “We are very much more driven by the added value we can provide for clients through active strategies,” claims Mr McCaughan.
The US firm – the asset management arm of the Principal Financial Group – runs $418bn through a multi-boutique model approach, and enjoyed positive financial results in 2016 thanks to “good inflows” in multi-asset strategies and yield-based funds.
The firm’s specialised approaches in high yield, preferred real estate, preferred securities and emerging market bonds, are “resonating well” with investors, especially those in Europe. The asset manager – which will soon be launching a Ucits platform for multi-asset income funds – also entered the smart beta market last year, launching strategies such as the Healthcare Innovators ETF, and the Millennials ETF.
“ETFs are an efficient way to provide active and smart beta investing too, and that’s why we got started in this space,” says Mr McCaughan. However, the firm has no intention of getting into the purely passive arena and competing with big players who are “very well entrenched”.
