So let’s assume you’re an asset manager, and you’re a tad bit nervous about all the ‘in-sourcing’ that your potential clients are talking about and indeed taking part in. After all, if public pensions and sovereign funds start managing their own assets, they’ll no longer need to (over) pay the asset managers to do it for them! So, for example, you may be wondering if this could mean a certain NYC pension fund will soon stop paying $450+ million each year to Wall Street in fees and, instead, start paying its staff more than the $4 million it does now? Zoinks!
Well, deeeeeep breath, asset manager, you don’t need to panic (yet). The governance is so miserable at certain funds, a core group will continue to be incapable of taking control of their own asset management; they’ll be outgunned and completely at the mercy of the private sector. (Phew!)
Notwithstanding, there is an interesting question to consider here that could offer some insights into where the asset managers may need to position themselves if they are going to continue to win business from the (growing) camp of in-sourcers. In other words, how do the most sophisticated pension and sovereign funds – some with as much as 95% of their assets in house – work with private sector managers? What roles can external managers play within the world of in-sourced institutional investment?
To consider this topic, I thought we could quickly look at three of the more sophisticated and internally oriented funds: GIC, NBIM and CPPIB.
1) Singapore’s Government Investment Corporation: Here are some excerpts taken directly from GIC’s most recent annual report:
“As GIC has upgraded our internal management capabilities, the role of external managers has become more nuanced. In general, we apply the principle of best sourcing, where we appoint external managers in equities and fixed income only if they augment the overall performance of the Government’s portfolio. External managers have to justify their management fees by delivering superior performance net of fees. Additionally, some of our external managers operate in niche markets or employ an investment style or strategy beyond GIC’s current capabilities...Our external managers bring other benefits. They share their market and investment insights with GIC. These insights benefit our macroeconomic forecasts and asset allocation research and sometimes challenge our own investment beliefs...Sometimes our external managers refer co-investment deals to our investment teams. They also keep us informed about best practices and norms in areas such as risk management, trade operations and settlements, compliance and monitoring.”
2) Norway’s Norges Bank Investment Management: NBIM has upwards of 95% of its assets managed by in-house teams, which begs the question: Why use external managers at all? Here’s an explanation:
“NBIM has over time increased the proportion of specialised country and sector mandates, particularly in markets where having a local presence is an advantage. Of the eight mandates awarded in 2011, four were specialized on small- and mid-sized companies in a developed country, three were in the emerging markets of China and Malaysia and one was specialized on environmental investments.”
And here’s more:
“Local managers have greater opportunities to visit the company and meet its management. At the same time, the fund has an upper limit on ownership of a company of 10 percent and will always be a minority shareholder. This role is a particular challenge in emerging markets, which have a shorter history of well-functioning capital markets. NBIM has therefore identified local managers in these markets who we consider to be skilled investors with high ethical standards. Locally based managers are well placed to look after our interests and will help reduce the risk in our investments.”
3) Canada Pension Plan Investment Board: Here’s how the CPPIB describes its external relationships on its website (while carefully avoiding the word “manager” and replacing it with “partner” to indicate a different sort of relationship than would be typical between asset owners and managers):
“External partners continue to be critical to how we invest, create value and operate the organization. Partnering enables us to enter markets faster, at lower cost and with more diversification than we could currently achieve on our own...Primarily in Private Investments, we look to our partners for guidance in developing our own capabilities and look forward to investing with them as principals when attractive opportunities arise. The CPP Investment Board has adopted a structured approach to establishing and maintaining relationships with our partners. This policy stipulates that the CPP Investment Board will:
- Ensure there is proper alignment between the CPP Investment Board and how the partner will deliver value
- Focus on the broader, long-term relationship
- Select partners with whom we are willing to experiment in developing new opportunities.”
In sum, the GIC, NBIM and CPPIB really only look to external managers in niche areas where their own internal expertise is deficient or where they believe local knowledge is paramount. They also want external managers to provide intelligence in the form of market insights, deal flow, and even operational and strategic know-how. In a way, these in-sourcers want external managers to integrate further into their organizations, playing a broader role than might be typical in the asset management community today.
As such, I think it is fair to suggest (as the CPPIB does) that these external relationships are akin to “partnerships”. This is a more balanced equation, where the asset owners can add value to an investment, and the manager can add considerable value to the asset owner’s organization. Is this where asset management is headed? I kind of hope so.
