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These execs should have stuck around during some of the dead zones of the day, particularly yesterdayÆs presentation just before lunch featuring Fortis InvestmentsÆ CIO for Asian equities, Alex Ng (who held the same role at ABN Amro Asset Management before its acquisition by Fortis).
His message, delivered in an extremely polite, somewhat understated cadence, was the philosophical equivalent of hurling a grenade at a wedding reception. His message: the funds industry (including both manufacturers and distributors) has failed retail investors in Asia, and it risks losing out to rival investment products if it canÆt do better by its end clients.
Conventional wisdom has fund managers and their distributors reciting a mantra about their retail clients, suggesting ôputting clients firstö means telling them to be long-term and fully invested in a diversified portfolio that measures performance relative to a benchmark. Underlying this wisdom is the belief that equity markets will always trend upwards û just look at the charts!
While over the very long term this is true, Ng says, it may not hold true for certain periods û lengthy periods û of time. For example, the US stock market was caught in volatile range-trading throughout most of the 1960s and 1970s. Clients facing nearly two decades of sideways markets are going to be better off being told (early on) to redeem û something that no fund house or distributor would say.
ôOur received wisdom has been the catalyst for hedge funds,ö Ng says, noting that the religion of relative out-performance that still loses investors money has spurred the growth of absolute-return alternatives, as well as structured products or simply cheap beta products like exchange-traded funds. Often these products can produce similar returns at lower costs or at lower levels of tracking error.
ôHedge funds have emerged as serious competitors to mutual funds because weÆre not meeting client needs,ö Ng says.
The mutual-funds industry is perfectly capable of competing, but this may require a new mantra. The growing adoption of Ucits-3 funds in Asia, which allows fund managers to use derivatives, offers better technology for fund managers seeking high-conviction portfolio strategies.
Two ideas need to be amended. First, faith in diversification needs to be reinterpreted from meaning ôinvest in everything all the timeö to ôlet us invest your money anywhere we think we can make moneyö.
This has already taken place among sophisticated institutional investors such as US endowments (the oft-cited Yale University among them), which have given their managers discretion across many types of assets. Ng says this model must be transferred to the retail side by weaning investors off global balanced products into global multi-asset class funds or tactical asset-allocation funds that give managers lots of freedom, including the ability to go to cash when necessary.
Secondly, fund housesÆ business models need to adjust. Today the dominant structure is a ôclient-led multi-boutiqueö platform. This puts the emphasis on picking best-of-breed managers. But the truly important decision, for retail or institutions, is not picking the manager, but deciding the asset allocation.
ôWhile asset allocation accounts for something like 80% of your return, most fund-management companies are dedicated 10% of their resources into this, mostly just to create something for clients to read,ö Ng says. ôItÆs not been a real driver for advice.ö
So far these failings havenÆt appeared to hurt the funds industry. The fact that most active fund managers regularly under-perform their benchmarks is well known in America, yet the industry has enjoyed solid growth.
Ng takes the example of Hong Kong to show that it may not enjoy similar success in Asia over the long run. Data from the Investment Funds Association of Hong Kong shows that from early 2000 to early 2008, gross sales of mutual funds have soared, but 80% suffer redemptions, on average. Net sales have been roughly flat over that time. Great for salespeoples' commissions, but not so great for the industry at large.
Moreover, structured funds were heavily sold at exactly the wrong time for investors û when underlying markets were poised to take off û and stopped when markets peaked (exactly the best time to lock in principal protection). Funds tend to be focused too much on just equity, rather than on products that blend asset classes or set target-return dates.
The fund houses, distributors and retail investors share responsibility. The three parties are locked in a mutually reinforcing spiral based on the assumption that clients will only buy hot, sexy products, which by definition are those which have already realized their upside.
For example, Ng wonders, what fund-house or distribution salesperson is going to recommend a customer buy a fund of US financial stocks? None û but now is probably a terrific time to do so. Were an investor putting money into a multi-asset class fund with manager discretion, however, the portfolio manager who has confidence that financial stocks are very cheap can make that decision without being second-guessed.
Can the industry escape this trap? It will require fund houses to argue the case for TAA or multi-asset class products, including target-return dated funds. It will also require a big change in how distributors operate, however. One suggestion from Ng: reward salespeople on the basis of NAV performance, not just for a front-end load.
ItÆs a great idea, but unfortunately an oligopoly of consumer banks has such a throttlehold on the market, it wonÆt feel obliged to reform. These banks can always switch to selling ETFs, structured notes and absolute-return schemes to boost their fee income, should investors grow disenchanted with mutual funds.
AsiaÆs markets are not like AmericaÆs. Mutual fund penetration remains relatively low, with real estate, not funds, the preferred vehicle for long-term financial security. Industry execs were in a back-slapping mood this week, buoyed by the recent, bull-market fuelled success, and dazzled by the enormous potential the region offers. If they donÆt improve their ways, that potential may prove illusory.
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