Asia’s asset owners will likely outsource a further $1.2 trillion of their assets to third-party managers in the next three to five years, even as these institutional investors continue to build out their internal capabilities, according to the lead author of a new industry study.

And that outsourcing will be driven mainly by rising institutional demand for specialist skills in alternative assets and more sophisticated forms of investing, McKinsey and Co's Anu Sahai told AsianInvestor, ahead of the publication on Wednesday of the report by the consultancy.

There has been a noticeable shift in institutional demand from traditional to more thematic or specialised products from external managers and that trend has become more visible in the past two years, senior expert Sahai said.

Almost 70% of institutional mandates for third-party managers in 2017 were driven by increased allocations to multi-asset and alternatives investing, coupled with the lack of in-house investment know-how, says the report entitled 'Will the good times keep rolling for Asia’s asset managers?'

Multi-assets include traditional balanced, target date and target-risk strategies, global tactical asset allocation and retirement income strategies, while alternatives include investments in infrastructure, real estate, hedge funds and private equity. 

As it stands, passives make up between 20% and 22% of the mandates from institutional investors, with a good portion of that demand coming from environmental, social and governance factors, Sahai said. The balance comprises traditional mandates in fixed income and equities.

In all, that institutional business in Asia accounts for some $11 trillion of assets under management. By 2023 or less expect this figure to grow by an additional $1.2 trillion, Sahai said

"We believe that this could be achieved in the next three years itself but, yes, definitely by the next five years," she told AsianInvestor.

Driving those institutional flows is growing demand for retirement products in the region – the result of ageing populations, especially in developed Asia, which is forcing institutions to seek higher risk-adjusted returns to match their rising liabilities.

Most of the asset management industry’s institutional clients consist of pension funds, both defined benefit (DB) and defined contribution (DC), and insurers. It is the fastest growing institutional segment due in large measure to regulations in many countries to create new retirement programmes, according to the McKinsey report.

Currently, North Asian institutions account for nearly 80% of the total institutional market, but opportunities for retirement products are growing in both developed and emerging Asian markets, the report added.

Within retirement, the fastest growth in Asia in the past five years has been in DC at 23%, followed by insurance at 17%. DB has been losing prominence; its contribution to total institutional AUM has dropped from 32% to 23%.

TALENT CONTEST

The McKinsey report says institutions have been outsourcing more of their investment management in the quest for diversification and to fill gaps in their in-house capabilities.

“This trend to outsource includes expanding the geographic remit as well as expanding into newer strategies such as global and regional equities and fixed income, multi-asset, absolute return and alternatives,” it notes.

And while asset owners are making efforts to build their internal investment capabilities, fierce competition for talent and remuneration challenges mean they are likely to continue outsourcing.

In the near term the talent shortage is expected to continue, Sahai said, noting the difficulties asset owners face to build their expertise in alternative investment segments where there are a limited number of professionals.

“It’s tough, for instance, to hire the best-in-class private equity expert to a government-driven organisation that will likely have caps on compensation,” she said.

Retaining such professionals can also be a challenge, she added, since many private equity specialists break away from large houses to retain a larger share of performance fees, which might not be possible with government-driven entities.

A lack of scale can be a hindrance too for institutional investors; unless they have a sizeable commitment within their portfolio to private equity – say 10% or so – you are not going to have the scale that large private equity players already have.

“Certainly talent development is happening at the local level, but will that talent development be able to keep up the pace of growth in demand? That is the bigger question,” Sahai said.