EXPERT OPINION
MAY 2017
MEETING TODAY’S ASSET
MANAGEMENT CHALLENGES
Lionel Paquin
CEO
Lyxor Asset Management
Active management is under pressure as never before as a result of macroeconomic, competitive
and regulatory challenges. But active input into clients’ organisational set-up, fund structures and
investment decision-making remains vital.
The successful active manager of the future is likely to be defined as something more than a provider of
superior performance. Instead, a successful manager will be a partner with the ability both to enhance
returns and to avoid unnecessary costs on behalf of its clients. In practice, this will mean the provision
of a full fiduciary, open architecture service, covering all the elements of the investment value chain.
THE TRIPLE CHALLENGE FOR ACTIVE MANAGERS
SPEED READ
Active managers are facing three existential challenges.
Asset managers face a triple challenge as a
result of macroeconomic, competitive and
regulatory challenges.
The first is macroeconomic and results from the
emergency measures put in place by central banks
after the 2008/09 financial crisis.
Active asset management should be seen as
complementary to passive management, not in
opposition to it.
Alternative funds offer an important additional
source of returns in an environment of
depressed interest rates and low nominal return
expectations from traditional asset classes.
Clients are looking for an investment partner
who can offer a full fiduciary service.
Reductions in official interest rates to near-zero levels,
combined with the quantitative easing policies in
place across major economies, have provided an
unsurprising boost to equity and bond prices. But a
side-effect of these unconventional monetary policies
has been an unwelcome reduction in the dispersion of
global markets.
Dispersion is a mathematical measure of how differently
individual asset classes perform with respect to the
global average, and it has been around a third lower
post-crisis than pre-2008.
In other words, the benefits of diversification, an
important tool for the global asset allocator, have been
reduced by quantitative easing policies. If diversification
has accurately been described as the only free lunch in
investment, the portion sizes have now been reduced.
REDUCED DIVERSIFICATION BENEFITS ACROSS ASSET CLASSES
Fed total assets ($ Tr)
5.0
Cross asset dispersion
2.5
2.0
4.0
1.5
3.0
Average dispersion 2000- 2007
1.0
2.0
0.5
0
2000
1.0
Average dispersion
June 2009- 2015
2002
2004
2006
2008
2010
2012
2014
2016
0
Note: 3-months pair-wise average absolute correlation between daily
returns of Equity EM & DM, DM Govies, EM Bonds, Corporate Credit,
Commodities & FX Carry trade, 1-month moving average.
Source: Macrobond, Bloomberg, Lyxor AM
The second challenge facing active managers is the
widespread shift into index-tracking, passive funds, a trend
that lasted two decades and shows no sign of decelerating.
With an increasing range of market exposures now available
via low-cost, index-tracking exchange-traded funds (ETFs),
many investors have decided to track indices, rather than
try to beat them.
Global ETF assets approached US$3.5 trillion in value by
the end of 2016, with assets growing at an average 25
percent a year since 2007.
And, within the passive fund segment, so-called smart
beta funds are growing particularly strongly. These indextracking vehicles replicate non-standard benchmarks, with
the objective of producing specific risk or return outcomes.
A type of smart beta generating special interest among
institutional clients is factor investing. Academic research
has shown that equity portfolios’ exposure to factors such
as low beta, size, value, momentum, quality and liquidity
helps explain the majority of past portfolio performance.
Many institutions are engaging passive managers to run
factor mandates, while there’s also a widening range of
ETFs offering exposure to factors. Lyxor calculates that
European smart beta ETF assets under management
reached €27 billion by the end of 2016, ten times the level
of four years earlier.
A third consideration for active managers is the growing
impact of regulation on their business models. Initiatives
such as the Financial Conduct Authority’s Asset
Management Market Study have put pressure on active
managers to justify the link between the services they offer
2
and the charges they levy. Cost transparency is also one
of the central themes of the revised Markets in Financial
Instruments Directive (MiFID II).
Lyxor has long believed in an important role for low-cost
passive funds: we are a leading player in the European ETF
market and were one of the pioneers of European ETFs
nearly two decades ago. But we are also firm advocates
of active and alternative asset management. All three
approaches—passive, long-only active and alternative—
have a vital role to play in clients’ portfolios.
ACTIVE MANAGEMENT SHOULD BE COMPLEMENTARY TO
PASSIVE MANAGEMENT
Although many industry observers tend to present
passive and active portfolio management approaches
as diametrically opposing and in competition, Lyxor
believes that active management should operate in a
complementary way to its passive counterpart.
Clearly, there’s an important difference between the two
approaches: active managers aim to outperform their
benchmarks, while passive managers aim to track them.
But active and passive often share a common quantitative
framework, particularly in the realm of smart beta and factor
investing. By definition, the indices underlying passive funds
follow systematic, transparent rules. But active funds run
according to quantitative models, as at Lyxor, operate in a
not dissimilar way.
A quantitative approach to investment offers clear benefits:
by mining and analysing the ever-growing seam of opensource data in a thoughtful and standardised way, we
provide an important logical framework for our investment
policies and help measure the risk exposures of the assets
we hold. A non emotional approach also helps reduce the
influence of the behavioural biases to which we are all prone.
But a purely data-driven approach often misses structural
changes and may be inefficient in a changing market
environment. Factor models also tend to have very limited
reliance on the macroeconomic data that drive shorter-term
market trends.
In Lyxor’s view, active views are therefore often required
when it comes to the selection, timing and weighting of
portfolio allocations.
Our quantitative fund management team, which numbers
40 experts, is responsible for €30 billion in client assets,
therefore makes use of factor scoring models to provide
an objective basis for its investment approach. We then
apply a discretionary overlay to take account of changing
market conditions.
For example, in our active clients’ equity portfolios we
marked the recent shift away from quality and lowbeta factors and towards more cyclical, value stocks in
two ways: via an asset allocation change, reweighting
portfolios towards more economically sensitive stocks
like financials; and, within the financial sector, via a
discretionary move to overweight banks vis-à-vis other
financial stocks like insurance companies.
However, a UCITS multi-strategy structure can benefit from
the mutualisation of risk exposures, enabling a broader
range of alternative strategies to be put in place.
ALTERNATIVES AS AN ADDITIONAL SOURCE OF
PERFORMANCE
Lyxor’s managed account platform, which draws from the
expertise of one of Europe’s largest open architecture fund
selection teams, advising or managing on €28 billion in
assets, is continuing to grow in size. Within this total, multistrategy alternative UCITS have gained increasing traction
in the last two years.
In an environment of depressed nominal returns from
traditional asset classes, alternative funds can provide a
valuable additional source of portfolio performance.
For example, the current low level of bond yields presents
long-only asset managers with a major challenge. Several
conventional means of generating returns from a bond
portfolio—extending duration, accepting lower-quality
credit or lower liquidity bonds—have arguably reached a
limit in terms of the risk-return trade-off involved.
OPTIMISING COSTS CREATES VALUE
Most asset managers have always relied largely on a
promise of value creation that investment skill will help
generate future portfolio performance.
But alternative funds can exploit strategies that are simply
unavailable to traditional, long-only fixed income managers.
These include long-short credit and other arbitrage
strategies, as well as trend-following (CTA) approaches.
In Lyxor’s opinion, the successful asset manager of
the future will be one that helps clients to avoid value
diluters as much as being able to identify and exploit
value creators. The potential value diluters in a fund
structure can include a duplication of efforts among
fund managers, administrators and consultants.
With rising concerns about a possible bond bear market,
these alternative portfolio management approaches are
much less exposed than traditional strategies to a market
reversal.
In turn, this can generate excessive investment
management and administration costs, lead to poor tax
management and result in an unwieldy decision-making
process for fund trustees and CIOs, resulting in missed
tactical asset allocation opportunities.
In an era where so much information is available in
real time, it’s not acceptable for the CIO of a pension
fund to have to wait a year or more to implement an
asset allocation change simply because of an unwieldy
decision-making process.
Another benefit for alternative fund investors comes
from Europe’s UCITS fund framework. UCITS funds
have important inbuilt investor protection rules, covering
leverage, concentration, counterparty risk and liquidity.
There’s an additional benefit that comes from providing
multiple alternative strategies via a single fund platform,
such as Lyxor’s. At an individual fund level, the UCITS rules
constrain the size of positions that a long-short credit fund,
for example, would be able to exploit.
VALUE DILUTERS AND VALUE CREATORS
LDI
TACTICAL ASSET
ALLOCATION
STRATEGIC ASSET
ALLOCATION
VALUE
CREATORS
MARKET
EFFECT
SECURITY
SELECTION
VALUE
DILUTERS
INVESTMENT
MANAGEMENT
COSTS
MISSED TAA
OPPORTUNITIES
Historically focus of
pension funds was on
value creators
In new reality of low yield
environment we see
increasing attention to
value diluters
WITHHOLDING
TAXES
ADMINISTRATION
COSTS
CONSULTING
COSTS
3
In a 2015 OECD study of pension fund operating expenses
relative to total assets, the top quartile of pension funds
had expenses of 18 basis points relative to their assets
and the second quartile expenses of 33 basis points. But
the third quartile had an expense/asset ratio of 69 basis
points and the fourth quartile 122 basis points.
For the average fund, there is therefore a substantial
opportunity to reduce investment management and
administration costs, as well as rationalising the operational
set-up to avoid missing out on important opportunities.
A recent project for a Lyxor pension fund client involved
the streamlining of its operational and fiscal structure. Any
duplication amongst consultants, custodians and overlay
providers was minimised and client assets were placed
into three pooled vehicles, covering equities, fixed income
and alternatives, with significantly enhanced reporting
capabilities.
A single fiduciary manager, working closely with the
pension fund CIO, was put in place to oversee the new
set-up. The restructuring resulted in an estimated 40%
saving in operational costs, a saving that feeds directly
into the future benefits enjoyed by fund beneficiaries.
A FULL FIDUCIARY SERVICE
Today, an increasing number of clients are looking for an
investment partner who can offer a full fiduciary service:
this means open-source access to a selection of the best
internally and externally managed strategies in a regulated,
liquid format. This should cover the full spectrum of asset
classes, investment approaches and fund liquidity structures.
Such a fiduciary service can encompass the range of asset
management approaches — traditional long-only active
funds, passive funds and alternative funds — as long as
they are designed to function in a complementary manner.
And in an environment of intensifying cost-consciousness,
the active manager needs to focus on generating value along
the full chain of investment services, from front to middle
and back office. A fund infrastructure should guarantee the
full transparency of client holdings, enabling asset owners
to form a real-time, top-down view of risk exposures and to
move nimbly when circumstances change.
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of Lyxor Asset Management (“Lyxor AM”). This material has been prepared solely for informational purposes only and it is not intended
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