Schroders faces a post-equities world

Fund managers must abandon vanilla asset classes for those in which they have a chance to outperform if they are to impress institutional investors.
Institutional investors worldwide have grown disillusioned with equities as a growth asset. They want alternatives that provide equity-like returns, but hopefully without experiencing high correlations to equity performance, says John Troiano, head of global institutional business at Schroder Investment Management in London.

This is a huge challenge for fund houses like Schroders, which throughout its 200-year plus history has built a name for itself managing UK and global equities for pension funds.

This equities revulsion is a result of the credit crisis, but is one of several other big trends hitting the funds industry. In America, Britain and the Netherlands, the move by pension schemes to liability-driven investments is one, although this trend seems unlikely to matter in Asia. Second is the rise of sovereign wealth funds as new pools of strategic savings, a trend where Asia plays a starring role. Third is the increasing use of third-party asset managers by large insurance companies û a trend that has begun in America, is growing in Europe, and emerging in Asia.

Although appetites vary around the world û for example, Asian institutions tend to prefer absolute returns and inflation-protected strategies, whereas accounting rules force many Western institutions to focus on LDI û the demise of equity investing seems to be happening everywhere.

SchrodersÆ response has been to remain an active fund manager but in a growing array of asset classes. It has bulked up on funds of hedge funds, real estate and commodities (although it has no capability in some areas such as infrastructure).

Beyond this, it is putting more resources into its ænew balancedÆ strategy, a multi-asset portfolio. Troiano says the difference between this and TAA (tactical asset allocation) is the timeframe: TAA implied investment decisions that would last three to 18 months, chasing alpha; while the traditional idea of a pension fundÆs long-term asset allocation (plain old strategic AA) was meant to be at least five years. æNew balancedÆ falls in between.

But ænew balancedÆ still has its work cut out, because the credit crisis has shown that, in times of stress, asset classes thought to be uncorrelated in fact move in line with one another û downward.

Troiano says good fund management must, more than ever, be about mixing sources of alpha and beta. He says pension funds and other long-term investors spend too much time obsessing over picking fund managers for a particular asset class, rather than understanding alpha/beta separation; the beta part goes especially overlooked.

For example, he doubts pension funds will find much value in trying to pick an active manager for US large-cap equities, where indexing makes more sense. On the other hand, due diligence can make a difference when picking a hedge-fund manager or a private-equity fund û not only because the differences in performance are much greater, but because an investor cannot get cheap, broad exposure to these asset classes.

ôWhere itÆs not worth the time, investors can look at indexed funds or ETFs,ö Troiano says.

But investors need to specialise more. For example, when looking at managers for fixed income, pension funds wonÆt find much value in seeing which ones beat the Lehman Aggregate Index. Instead they need to assess which ones excel at credit or high-yield.

By choosing a handful of value-adding fund managers, institutions can either assemble their own portfolio or package individual sources of alpha. ôAnd then investors can demand more from their alpha investors, they can tell us to be more aggressive,ö Troiano explains.

Although it can be painful to be a traditional active fund manager trying to compete with either cheap passive/ETF providers for beta mandates, or boutique active players including hedge funds for aggressive alpha ones, Troiano says this is actually a good time to be a fund manager. Provided you can develop high-performance strategies, you can then charge higher fees than you ever could before.

So while the likes of Schroders feels keen competition in standard asset classes such as G3 sovereign bonds or US large-cap equities, it can thrive in more niche strategies or those requiring more skill û assuming, of course, its performance holds up.

ôOur institutional business is driven now by innovative products,ö Troiano says, citing a diversified growth fund that allows it to pursue a ænew balancedÆ strategy, splitting alpha and beta sources; or unconstrained, global investment mandates that are quantitatively managed but not against an index benchmark. Schroders is also developing new real-estate investment strategies in this high-conviction mould.

This is coupled with going after new sources of business, such as sovereign wealth funds and insurance companies, as well as maintaining a culture that continues to value entrepreneurialism and reward clever portfolio managers, regardless of the strategy.
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