After a mass firing and a cease in hiring of external managers during the recent crisis, Asian institutions are again looking to outsource asset management, while at the same time making a long-term decision to boost their internal capabilities, finds a Greenwich Associates report* published this week.

Not surprisingly, the level of outsourcing varies among institutions, size being one driver of the decision-making process, says the US research house. But a growing trend towards internal management among smaller organisations could be cause for concern.

Central banks and large government-affiliated institutions in the research group manage most assets in-house, with only 12% of their total assets accessible to external managers. Likewise, corporate pension plans and other private-sector institutions allocate a relatively low share -- although more than the government agencies -- of assets to external managers. (In the UK and US, 90-95% of assets are outsourced, while in continental Europe, the number is around 50%.)

As many as 92% of institutions expected to increase their level of externally managed offshore assets in 2008 -- that figure dropped heavily to 15% in 2009, but has rebounded to 30% this year. Interestingly, the proportion of respondents that expect to increase the amount of onshore assets they outsource has rebounded more strongly, to 40%, up from 18% last year and not far off the 2008 figure of 46%.

Meanwhile, almost two-thirds (64%) of institutions plan to expand their internal management capabilities. Indeed, 30% say the performance of external managers during the crisis has caused them to alter long-term plans in favour of internal management, while only 3% report long-term plans to increase their use of external managers.  

Interestingly, whereas Western institutions tend to focus their in-house resources on passive strategies, two-third of those in Asia are using their internal teams to generate alpha. In some cases, says Greenwich, they are running portfolios in parallel to those of external managers to learn and develop better skills in specific asset classes.

Specifically one-third of Asian institutions use exchange-traded funds, as compared to just 14% of those in the US, even though institutions there contribute about half the total assets invested in ETFs.

In terms of asset class and function, Asian institutions are looking above all to increase their internal capabilities in domestic fixed income, strategic asset allocation and risk management (see graph below). As for areas they are looking to outsource, the most cited are international/global fixed income and international/global equities.

However, while in-house management may be a good bet for some organisations, others should exercise caution when considering it, advises Greenwich Associates.

Larger institutions such as sovereign wealth funds can often deploy resources on a par with those of local or indeed global financial services firms. But smaller organisations should move more cautiously.

Six in 10 institutions with less than $5 billion in assets plan to significantly expand their internal management capabilities in the next year, but they should take note of other organisations that have done so around the world. Many, especially in Europe, committed a lot of capital to the task, but found they had "severely underestimated" the challenges of active management.

Markus Ohlig, a Singapore-based consultant at Greenwich, notes that institutions building internal capabilities are entering into direct competition with external managers, and therefore need to pay comparable salaries to portfolio managers, analysts and so on. "For some public funds and small institutions, that is just never going to be an achievable goal," he says.

Another issue for smaller Asian institutions is that they make far less use of investment consultants than their counterparts in the West. Only 27% of Asian institutions overall use consultants, compared to 85% in the US.

This is partly down to the fact that there are fewer pension funds -- the most common users of consultants -- in Asia than in markets such as the UK, US, Japan and Australia. In addition, SWFs, central banks and the like have internal resources to make investment decisions and select managers.

When it comes to the reasons why Asian institutions hire and fire external managers, Greenwich points to an interesting finding: when hiring managers, investment performance over the previous two to three years was cited as a relatively unimportant factor, yet when firing managers it is cited as the most important (see graph below). 

That may not be the best approach, particularly since the recent crisis will have significantly skewed performance figures, argues Ohlig. "For that period, as always, institutions should employ the same rigorous and forward-looking assessment process used in hiring new managers to assess the performance of existing managers," he says.

The study also covered asset allocation among Asian institutions. It found that equity exposure is gradually falling in favour of fixed income and alternatives, despite them expressing intentions to boost equity allocations. Asian institutional portfolios contain 13% equities and 73% fixed income now, as compared to 69% and 18% last year and 63% and 25% in 2008. Alternative asset allocations increased to 7% in 2010 from 6% in 2009 and 4% in 2008, and look set to rise further, according to other reports.

* Greenwich Associates' 2010 Asian Investment Management Study, for which 84 of the biggest institutional investors in the region were interviewed from January to March. The organisations manage around $5 trillion in assets between them.