Fund managers ignore industry shift towards passive 'at their own peril'

GLOBAL – Investment managers who ignore the shift in interest away from traditional active bond and equity products do so at their own peril, the global chief executive of Principal Global Investors has warned.

Discussing institutional investors’ increasing interest in non-traditional assets, such as emerging market products and infrastructure, Jim McCaughan said that, as these asset classes had hardly been of note only 20 years ago, it reinforced the idea that the investment management industry was “going through a period of very rapid change”.

“Most industries go through some kind of convulsion every 10 or 20 years,” he said. “Investment management has been an extraordinarily stable industry, but that’s all coming to an end.”

He warned that ignoring the shift in interest by pension investors – both defined contribution (DC) and defined benefit (DB) – away from core products that used to be the “mainstay” of industry income was risky.

“Anyone in the investment management business who ignores that does so at their peril,” he said.

However, he added that a report by CREATE-Research and sponsored by Principal Global Investors – Investing in a debt-fuelled world – found that investors, including DB funds, nonetheless believed managers could provide alpha and added value with the help of products other than the active core products of pre-2007 days.

“Those kinds of products are really not in demand at all,” McCaughan said. “In fact, they are seeing outflows to the extent they still exist and being substituted by passive [strategies], including ETFs, and, in the case of corporate pension plans in the US and the UK, by liability-driven investing.”

Discussing the increasing interest in passive indexed funds and ETFs, the survey noted: “Both are seen as avenues of low-cost market exposures. Both are also amenable to tilts towards specific risk factors within a smart-beta framework.”

A respondent to the survey added that, for every five active mandates up for renewal, three ended up in passive or ETF mandates.

The survey also found widespread dissatisfaction with the shape of DC markets in a number of countries, but noted that similar investment trends could be found across both DB and DC.

“As in DB plans, so in DC plans, beta and lower fees are now seen as the main source of returns,” it said. “ETFs are, thus, seen as low-cost liquid options to source cheap beta.”

More than 40% of DC respondents cited ETFs as the next step for opportunistic investment, followed by actively managed and diversified growth fund options.

The survey added: “There is ample recognition that DC investors need an intelligent approach to risk that can deliver better outcomes on the one hand and minimise investor foibles on the other.”

McCaughan said the US market had already accepted a more innovative investment approach in DC through target-date funds.

“I expect to see similar product evolution happening in the European market, even though the markets are fragmented and somewhat smaller than the US market,” he said.