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A Return to the Age of Conservative Investing?

by Lindsay

While investors' quest for alpha, and subsequent interest in alternative investments, has been widely chronicled, there is another opposing force that will likely drive innovation in product development over the next several years: concerns about inflation and longevity risk pushing investors toward more conservative long-term investment strategies.

As reported by the Bureau of Labor Statistics last week, the Consumer Price Index rose at an astounding 7.9% seasonally-adjusted annual rate (SAAR) in 2Q08, and a 5.0% unadjusted rate for the 12 months ended June 2008.

The typical investor response to rising inflation, more aggressive investing, has also become a dangerous proposition, at least in the short term, as the Dow Jones Industrial Average has continued to bounce around over the past year, peaking at 14,279 in October 2007 and then plummeting to 10,731 just last week.

As reported by Ignites, several firms are taking a cue from the DB space and developing target date funds that use the principles of liability-driven investing (LDI). Essentially, these funds place greater emphasis on protecting investors against longevity, inflation, and currency risk to protect retirement income -- often at the expense of higher potential returns.

Is this trend enough to shift firms' focus from chasing alpha by developing the most obscure alternative investment vehicles to touting their safest, most-likely-to-protect-your-initial-investment funds? Will we all eventually go back to investing in utilities, like our grandparents did? It's hard to believe, but we might be going down that road...

"Do not try too hard, I may pay you too much" - Another Reason Why Gross Sales Compensation Has To Go

by Mike Ma

Later this week, I am meeting with a firm that has done extraordinarily well, so well that they would have had to pay several of their wholesalers over 7 figures at plan.

They didn't pay it. They cite the fact that the wholesalers didn't earn all of it. Surely, they couldn't have raised all that money.

To be honest, we've been saying that for years. However, I don't want to indict them directly, they are not alone. I've heard dozens upon dozens of national sales managers and distribution heads say similar things. Does this sound familiar?

"We are an outcome driven sales organization."
"People eat what they kill."
"Our team needs clear motivation."

Here's the hidden asterisk to all of these -- as long as it falls within an acceptable band (say, $250K-$500K) of compensation.

I think the way out of this is paying on sales activity. We have to deem the actions that we think are valuable, and then pay for their execution. This type of compensation is typically called "discretionary" which I think has been too small, and misnamed. Discretionary sounds optional. I think of it as non-commission variable. Not great, but we are working on it.

And I think that there is more to be gained managerially rather than lost -- we want loyalty from our employees, we want them to be "good soldiers." Then we owe it to them to have a better battle plan. The two prerequisites to making this a bigger part of your game plan are segmentation and metrics.

Think about what this would garner. In a bad year, if you think that you are going to lose 10% of assets due to performance, you could be excited that you only lost 5% with good wholesaling? In a good year, if wholesalers are just riding a performance wave, you could help concentrate that momentum to the advisors that matter most.

A greater slice of the compensation pie is going to be based on valuable, quantifiable metrics such as:

• Team based touches between sales and marketing
• Cross selling advisors to new, more stable, or profitable products
• Cross selling strategies to different product wrappers
• Penetration of new advisors at key firms
• Identification and development of top advisors
• Increasing usage of known loyalty, sales-correlating activities such as the Web

These are just a few things that come to the top of my mind. Two things stand in the way ... the ability to think of new metrics and courage to push this in your sales organization.

I would be up to help anyone in the business that is up for the challenge.

The Northeast is a Beer Desert

"The Northeast is a Beer Desert."

...Fred Eckhart

By Sean

On a recent trip to Portland, Oregon, I drank some of the finest beer made in the world. There, the beer community embraces the virtues of innovation, collaboration, and exclusivity. Imaginative brewers salute the area with commemorative beers for restaurateurs (Hair of the Dog's "Greg" brewed for Higgins' Greg Higgins), barkeeps (Rogue's "Younger's Special Bitter" brewed for Horse Brass Pub's Don Younger), and notable critics (Hair of the Dog's "Fred" brewed for Fred Eckhart). Like all good things, supply is limited. So is distribution. Seldom, if ever, are these beers found outside of the Northwest. In some cases, this is due to a lack of a scale, but in most, it is by choice.

Consultants love to draw parallels between the distribution of investment management and pharmaceutical products. Both industries are faced with increased competition and slowly-declining margins. The response, in our industry, has been to create more products with broader distribution. In the beer industry, still dominant players like Budweiser and Coors are employing the same strategy, but to limited avail. With sales growing at more than 30% over the last three years, craft breweries, like those scattered throughout Oregon, are chipping away at the market share of the major brewers, which now hovers around 77%, down from over 90% almost ten years ago.

Firms would be wise to take a page from the Oregonian craft brewers' playbook: innovative products in shorter supply and more targeted distribution channels.

All Around the World, Same Price

by Lee

Last month, Steven wrote about the emerging trend among global distributors of consolidating their global research functions. Since that time, I've had conversations with four large asset management firms that they have begun to consolidate their global National Accounts function in response. These initiatives are typically focused on a small number of large distribution partners, often some combination of Citigroup, Goldman Sachs, HSBC, JPMorgan, and Merrill Lynch.

As firms look to centralize their distribution discussions, a number of questions arise, such as where to find qualified individuals to manage global distribution relationships. Perhaps most importantly, firms are faced with questions about pricing. For example, should sub-advisory fees in different countries be based on the same schedule or vary from region to region?

While many firms fear that distributors will try to squeeze them on pricing in exchange for shelf space around the world, the opposite effect may start to come into play. With increasing competition for limited product capacity (from global distributors as well as from sovereign wealth funds), product manufacturers may be able to command a premium in exchange for capacity in truly alpha-generating strategies. Pricing decisions will need to be made on a case-by-case basis, but firms must recognize that these choices are becoming ever more complex in a global environment.

How Big Will 130/30 Be?

by Mike Trapanese

Today, around $100 billion in assets are held in 130/30 strategies. Merrill Lynch envisions the worldwide market for 130/30 funds at $1 trillion in just five years time. More ambitious, the TABB Group doubles the estimate to $2 trillion and claims that 2 years should do the trick. Looking at recent growth, neither of these figures sounds outright unrealistic.

Research from Macquarie Capital Markets (Empirical Analysis on Active Extension Strategies, April 2008) shows that relaxing the long-only restriction can raise the transfer coefficient of a fund, thus increasing its information ratio and boosting excess returns. In an alpha-crazed environment, this helps to explain the 130/30 hype. As mainstream investors pour into long/short strategies, however, the cost profile of short trading is bound to change.

Short positions require borrowed securities. For an asset manager, a prime broker will locate lenders and facilitate an exchange. There is a natural limit to the number of shares on short offer, however, and this quantity is necessarily far less than the number of long shares on the market. Growth in 130/30, along with other long/short hedge fund strategies, will increase demand for borrowed shares and drive up the cost of borrowing them. Scarcity will enable both lenders and prime brokers to increase fees, eating away net returns.

At a recent NICSA conference, I heard a prime broker put a great deal of faith in his firm's ability to rehypothecate shares, effectively stretching the number of short shares currently available. When he was asked if $1 trillion was realistic, his answer was telling: "maybe."

Short trading will undoubtedly play a role in future fund innovations. In estimating the future market, however, we must be cognizant of the limitations of our current one.

Morningstar Takeaways

by Tricia

Back from the Morningstar conference in Chicago: The consensus from veterans of the Asian market is that Asian markets have re-priced themselves correctly following five years of unsustainable growth. Japan is interesting for the first time in a long time. Experienced managers continue to buy firms with long-term production capability, not short-term value, and advise others to hedge against Asian currency inflation. The main threat to global growth? Unredressed inflation. In other words, too much money chasing too few goods.

An interesting tactical note: In a room of about 150 financial advisors, about 2/3 held ETFs. Of those, one half said ETFs were a key part of their strategy. My question is, how can ETFs be so cutting-edge and innovative if so many people are already using them?

Overall, what I got out of the conference was this: The biggest challenge to globalizing your strategy is rarely operational; instead, the challenge usually lies in persuading people to see themselves as competitors in an increasingly complex global economy, and not to rest on their laurels -- a profound, and profoundly humbling, paradigm shift.

Wholesaling Darwinism

by Mike Mc

The lead story in Ignites from Monday, Wholesalers Face Scary Scenario as Advisor Ranks Fall (subscription), paints a grim, challenge-laden picture for today's sales organizations. The advisor population is shrinking; the average wholesaler lacks experience; the sky is falling.

It seems that rarely a day passes now where one wholesaling apocalypse or another isn't upon us. We sometimes dabble in it ourselves.

But lost amidst the constant rhetoric -- if I never read another article about product pushing externals, it'll be too soon -- is the fact that wholesaling is entrenched as part of distribution. It's here to stay.

What's more important (and more interesting) is how wholesaling is evolving. One such evolution, hybrid wholesaling, continues to be a dominant topic with our clients.

Like a fund reaching its 3-year anniversary, hybrid implementations industry-wide are finally establishing an identifiable track record. So, are hybrids here to stay, too?

We'll be releasing a full report on this later in the month, but early returns indicate that the answer is a resounding 'yes'. Based on our analysis, here are three key reasons why:

• Profits: for the vast majority of firms, hybrids have enhanced the profitability of their sales efforts, in some cases by more than 5%. In our research, no firms have indicated a decline in financial efficiency.
• Reach: where hybrids are placed and who they target varies dramatically across firms, but they are almost always focused on unexploited pockets of advisors (by channel, by geography, by behavior). With 300,000 advisors out there, wholesaling has elements of a numbers game, making it increasingly critical to find those shadowy corners of the advisor universe.
• Lifestyle: as hybrid positions have become established, they have become an important alternative for individuals who want middle ground when it comes to travel, and for firms who want to offer careers to salespeople that do not require endless time on the road. With field time ranging anywhere from 20% up to 70%, a hybrid role can provide a range of lifestyle options.

Given costs that are roughly 1/3 as much as a traditional external, hybrids will continue to play a key role in wholesaling evolution.

The landscape is changing, but the sky is staying right where it is.

The U.S. as a "Dying Proposition"

by Johanna

At a presentation on global trends in the mutual fund market I recently attended, I heard an interesting statement made about the U.S. asset management industry:

"The U.S. is a dying proposition."

Indeed, the U.S. financial markets are suffering a crisis, but the U.S. still has far and away the largest share of the global mutual fund pie. For example, in Q407 the Americas had 51% of worldwide mutual fund assets, whereas Europe had 34% and Africa/Asia Pacific had 14%. However, one of the factors mentioned got me thinking that such a morbid statement might have some truth to it. The idea centered on product innovation, and how it has moved overseas.

It's no surprise that the amount of regulatory hurdles in the US, which makes it difficult to bring innovative products to the market, puts this country at a disadvantage, so it's also no surprise that today many new product types are introduced abroad and then appear in a 40 Act version in the states a few years later. One recent trend that began overseas and is making its way to the U.S. marketplace is thematic investing -- such as funds centered on agriculture, climate change and anti-global warming, and financial global infrastructure.

Missing out on product innovation is one sign that the U.S. is falling behind other countries in the asset management market. Despite regulatory constraints and hassles, U.S. product providers must break from style boxes to remain competitive. The first step is to rethink product development processes and move further towards a "market needs" approach. As kasina posited in the report "Rethinking Product Development," instead of getting most product concepts from wholesalers or creating line extensions of current products, firms should do due diligence with advisors and investors to understand true market needs. The firms that succeed in translating those needs into new products (that likely won't fall in the style boxes) will have a chance of staying in the global fund game.

The Global Outlook: What to Watch For

by Tricia

Here in Chicago at the Morningstar Conference, the watchword is complexity. If I had to pick the most important thing to talk over with our clients, it would be the convulsive global environment.

The operating environment is almost completely reversed from what anybody would have dared to say even a year ago. The emerging markets are net creditors, and the US is a net debtor. The $350 billion dollars of market recapitalization came from the Asian central banks, not from the G-7. So did 60% of all global growth. Brazil's sovereign debt rating is higher than that of Citi's. The expectation is that the next massive recapitalization need will be that of the American consumer, whose resilience carried the global economy through the 1997-98 contagion.

That's nerve-racking. Consumer spending is about 70% of the American economy, and the American economy is about 1/3 the global output. In the last twenty years, Americans have had most of their equity stored in the value of their homes. We are right on top of the point where it will make sense for some people to drop off their keys and walk away from their mortgages. Certainly, for the first time in American history, homeowners are falling behind on their mortgage payments before they fall behind on other payments.

As we said in "Future of Distribution," the ongoing erosion to investible assets as well as to margins, makes a more compelling argument for global diversification (as if you needed another one) -- not just geographically, into the BRICs or "developing" (we're going to have to come up with a different nomenclature soon) Asia, but across commodities and industries as well.

Redemptions a Problem? Internals, the Cure

by Mike Ma

"We are beating benchmark by 1300 bps and we are suffering net outflows!"
"How do we stem redemptions from products that have good performance?"

This first statement was said by a good friend of mine I am vacationing with who happens to be a portfolio analyst of a high-profile asset management firm. The second question was also brought up in a call today with the head of marketing from one of the top 10 asset managers in the industry (I am on a working vacation ... lovely!) -- Two similar questions in 12 hours, so I figured a post was in order. My answer to both --

The internals.

Get the internals out there more, but do it with more intelligence. Two quick tips and thoughts, in order of preference and effectiveness:

1. If you own their own transfer agent ... - One of our clients has used the internal desk to call an advisor when a redemption order came through. You have T+3 before settlement and I'd bet you will be surprised at how many advisors you can talk off the ledge.
2. Or else ... use the Web reports - If you know which products are on your watch list make sure traffic reports or downloads of information about those products are promptly and delicately followed up on with by your internal desk on a daily basis. I'd like to reiterate the word *delicately.* You don't want your internals to come off as big brotheresque; rather, have these advisors be put into a regular call pattern with regular leading questions.

This is a situation best handled by people who can readily get to wherever they are needed. Who better than the internal wholesaler?

We just have to give them better tools.