(Part two of two) In my previous blog, The Era of Investment Solutions, we envisaged an evolution of the role of active managers from product to solution providers. Here, I will continue with that idea. If we look at flow data in the period 2011-2015, we see that the “era of solutions” has already begun with most of the flows (more than 1 trillion euro) going to multi-asset, fund of funds and liquid alternatives. The growing appetite for income products we have seen in the last five years is also part of this trend towards solutions.
Global Mutual Funds and ETFs (ex-Money Market) Net Flows in 2011-2015 (Mln)
Source: Pioneer Investments on Strategic Insights data. All long-term mutual funds including index and ETFs sold in the world excluding Australia and Canada. Data as at 31 December 2015. Liquid Alternatives include absolute return and liquid alternative products. Other (commodities, real estate and other not classified) not included.
In our view, the era of solutions will require a rethinking of product design, risk management and portfolio construction, and distribution models to deliver the investment experience that investors demand.
We see four major success criteria for solution providers:
- Pursuing effective risk-management, to mitigate the impact of extreme events
- Searching for “true” diversification, with uncorrelated asset classes
- Achieving a clearer separation between alpha and beta
- Looking for “true” alpha to compensate for lower beta
In the solutions era, we believe that the focus on risk should evolve, shifting from traditional market measures (i.e., volatility versus a market index), to innovative client-tailored risk management.
Hence, risk management should be conceived of as the need to limit the expected drawdown (1) of an investment to an acceptable level, reducing the risk of failing to meet investor objectives rather than merely reflecting market volatility.
Looking Ahead to A New Environment
When we look into the future, we see exciting opportunities for asset managers who adopt a solution-driven approach as well as compelling benefits for investors, both retail and institutional, around the world.
In this new environment it will be even more important for managers to strengthen their investment processes and transition to a “solutions” business model. This means, to us, enhancing high conviction idea generation through research, both bottom-up and macro, investing in effective portfolio construction and risk management and engaging in an ongoing dialogue with investors.
In this new era of investment solutions, all investment decisions will become active choices, including the one to add a passive product to a portfolio designed to reach a predefined goal. Hence, in our view, the asset manager’s role is set to evolve from pure product provider to a solution provider. For a more in-depth discussion of the four investment criteria outlined here, see my latest CIO Letter, The Era of Investment Solutions.
Alpha — Measures risk-adjusted performance, representing excess return relative to the return of the benchmark. A positive alpha suggests risk-adjusted value added by the money manager versus the index. Beta — A statistical measurement of an investment’s sensitivity to market movements in relation to an index. A beta of 1 indicates that the security’s price will move with the market. Betas of less than 1 or greater than 1 indicate that the security will be less volatile or more volatile than the market, respectively
Drawdown – The peak-to-trough decline during a specific record period of an investment, fund or commodity, usually quoted as the percentage between the peak and the trough.