Institutions Affirm Faith in Active Management Exploring the Opportunity for Active Managers in the US Institutional Market April 2017
Table of Contents Introduction... 1 Key Findings...2 7 Institutional Investors Remain Stalwart Institutional Assets Remain Active Future Demand for Active Mandates A Market of Opportunity for Active Managers Strategic Implications...6 Methodology...8 Copyright 2017 by Market Strategies International. All rights reserved. Reproduction of any part of this report is illegal under Federal Copyright law (17 USC 10 et seq.) and is prohibited. Photocopying or transmission of the information in any electronic or mechanical fashion outside of the purchasing organization is strictly forbidden, unless the user has purchased an annual usage license from Market Strategies International that allows the user the capability to quote directly from the content with attribution to the firm. This report is intended exclusively for distribution within the purchasing firm. Distribution to or use by any other firm, subsidiary, affiliate, external agent or client is prohibited. Contact Market Strategies International to learn more about redistribution/attribution permissions. Analysis relies on data from primary research and third-party sources deemed to be reliable. Although believed to be accurate, this information is not guaranteed. Publication date: April 2017
Introduction Throughout 2016 and into 2017, there has been no shortage of news coverage on the shift of assets from actively managed to passively managed investments in the wealth management industry. With the heightened focus on investment-related fees and increased skepticism over active portfolio managers ability to outperform the market index over the long term, many industry pundits are projecting a massive consolidation of active asset managers in the future, with only the strong and the few able to survive. Yet at least one segment of the market continues to offer opportunity for active managers: the institutional market. In fact, research conducted by Cogent Reports in Q4 2016 found that institutional investors were reaffirming their commitment to actively managed strategies and maintaining or even increasing their active asset allocation levels despite the uncertain political climate during the latter half of 2016. This research paper examines the reasons that institutional investors are shunning the prevailing industry shift to passive management and identifies ways in which active asset managers can position themselves successfully to capture future growth opportunities. We begin this exploration by revisiting the political and economic environment in play during the timing of our survey fielding period. Next, we look at the current allocations of US institutional investors by asset class, noting any significant changes year-over-year. Digging deeper, we explore pension and non-profit allocations by asset size and category to both passive and active products along with the changes in asset allocation that these institutional investors anticipate. We conclude this paper by looking at the factors that are driving projected changes in asset allocation. Armed with the knowledge of the current environment along with a view of future demand, active asset managers will be able to better inform their sales and marketing strategies in order to maximize their new-business acquisition potential. Source: US Institutional Investor Brandscape. February 2017. 1
Key Findings Institutional Investors Remain Stalwart The 2017 US Institutional Investor Brandscape online survey was fielded from October 21, 2016 to January 3, 2017, truly a unique period in our history. The US political future was uncertain, with former Secretary of State Hillary Clinton and then-rnc nominee Donald Trump, perceived as a wild card, head-to-head in the election. The waves of populism, propelled by Brexit, hit land in the US on November 8, 2016 with the election of Trump. While in-field, we observed a Twitter effect of then President-elect Trump, in which his social media activity seemed to correspond with positive market reactions. Since then, the Dow Jones Industrial Average has surpassed 21,000, a milestone embraced by many asset managers and investors alike. The timing of our survey this year caught institutional investors at the intersection of this market utopia and political dystopia. Yet in a world conflicted, these institutions are the epitome of stalwartness. They are resolute when there is anxiety all around them and within, yet also optimistic and welcoming to new ideas that will further their mission. It is this stability, predictability and openness that makes institutional investors invaluable to asset managers as a target market. EXHIBIT 1 EXHIBIT 1 RESEARCH TIMING AND CONTEXT DJIA 20,000 18,590 US presidential election 11/08/16 19,964 Market high 01/03/17 19,000 Institutional Investor Brandscape 15 17,556 average 17,401 Brexit 06/23/16 18,000 15,974 Market low 02/08/16 17,000 16,000 Institutional Investor Brandscape 14 17,602 average Institutional Investor Brandscape 16 19,124 average 15,000 2 Institutions Affirm Faith in Active Management
Institutional Assets Remain Active Despite the broader industry trend toward passive management, actively managed equities continue to comprise the majority of institutional allocations. Overall, active equities account for one-third of institutional investment allocations, with 24% in US active equities and 10% in international active equities. More than half (50%) of pension assets are invested in equities. Domestic equity investments make up the bulk (76%) of the equity allocation and account for 38% of the total pension allocation. Similarly, equities account for the majority (53%) of the non-profit asset allocation. Within the equities category, actively managed domestic equities represent a substantial portion of non-profit asset pools (45% of equity allocation, 24% overall). Importantly, no segment reports a significant decrease in its allocations to active domestic equity or active international equity strategies over the past two years. EXHIBIT 2 Despite the broader industry trend toward passive management, actively-managed equities continue to comprise the majority of institutional allocations. EXHIBIT 2 ASSET ALLOCATION BY CATEGORY Total Corporate DB PENSION NON-PROFIT Public DB & Taft- Hartley Endowment Foundation TEO US equities active 24% '14 24% 26% 27% '14 22% 25% US equities passive 14% 12% 10% 9% 16% 15% International equities active 10% '14 11% '14 11% 14% 9% 9% '14 International equities passive 4% '14 3% 3% 3% 7% 5% '14 US fixed income active 20% 27% 23% 13% 11% 20% US fixed income passive 6% '14 9% 4% 5% 6% 7% '14 International fixed income active 2% 3% 2% 2% 2% 2% International fixed income passive 1% <1% 1% 1% 1% 1% Alternatives 6% '14 2% 5% 11% 8% 6% '14 Private equity 5% '14 1% '14 6% 6% 4% 2% '14 Real estate/reits 3% 2% 5% 2% 6% 2% Real assets/commodities 2% 1% 2% 2% 3% 2% '14 Other asset categories 1% 1% <1% <1% <1% 2% Cash/cash equivalents 4% '14 3% '14 3% 3% 6% 4% '14 Low High Base: All Institutional Investors Key 5% 6% to 10% 11% to 16% 17% to 21% 22% / = Significant change from stated year / = Significant change observed in 2015 sustained in 2016 Source: US Institutional Investor Brandscape. February 2017. 3
In an environment with open debate on the ability to deliver alpha and a growing media emphasis on increasing use of passive investments, we find rays of light for active managers. In fact, our survey results reveal that corporate pensions have significantly increased their allocation to actively managed traditional strategies compared with two years ago. Moreover, a larger percentage of corporate pensions report that 100% of their investments are actively managed compared with 2014. The increasing prevalence of a 100% active approach is evident across non-profit segments as well. Continuing the trend we observed last year, more non-profits managing less than $250 million in assets and tax-exempt organizations report a 100% active approach to their investments than in 2014. EXHIBIT 3 EXHIBIT 3 Asset allocation: proportion of active vs. passive By Asset Size and Category $20M <$100M $100M <$250M $250M <$1B $1B+ Corp. DB Public DB & Taft-Hartley PENSION 18% 11% 16% 22% 11% '14 20% 15% 34% 26% 15% 25% '14 17% 67% 55% 58% 63% 65% 63% '14 Other Passive Active Proportion 100% actively managed 70% 16% 13% 17% 38% '14 39% NON-PROFIT $20M <$100M $100M <$250M $250M <$1B 21% 20% 27% 30% 21% 17% $1B+ 37% 12% 26% 27% 18% Endowment Foundation 30% TEO '14 17% 27% 49% 59% 56% 51% 56% 43% 55% Proportion 100% actively managed 30% '14 39% '14 31% 46% 42% 16% 39% '14 Base: All Institutional Investors / = Significant change from stated year / = Significant change observed in 2015 sustained in 2016 4 Institutions Affirm Faith in Active Management
Future Demand for Active Mandates In order to forecast the demand for future institutional mandates, we review the percentage of institutional investors (respondents) who are likely to increase or decrease their use of a particular asset class. Readers should note that the numbers reported do not represent the proportion of assets that institutional investors are likely to move, but rather the difference between the percentage of investors who would increase their use of the asset class and the percentage of investors who would decrease their use of the asset class. Therefore, the percent changes will not sum to 100%. The strongest demonstration for net increases in particular asset classes is seen among non-profits, where substantially more investors say they intend to increase their use of private equity, real estate/reits, active international equities and alternatives. Further, substantially more non-profits report the intention to put their cash to work by reallocating to other asset classes than increase cash allocation. Asset classes that receive the highest net-positive mentions among pension investors include passive US equities and private equity. Meanwhile, more pensions report they plan to decrease allocation to active US equities and active international equities. EXHIBIT 4 EXHIBIT 4 Anticipated asset allocation modifications: next THREE years Net Change Total Pension Non-profit Private equity 15% 11% 18% Real estate/reits 13% 6% 18% Alternatives 12% 7% 15% Real assets/commodities 11% 8% 14% US equities passive 11% 17% 6% International fixed income active 10% 6% 13% International equities passive 7% 5% 9% International equities active 6% -7% 17% Other asset categories 6% 8% 4% International fixed income passive 2% 3% 1% US fixed income passive 2% 5% -1% US equities active 1% -7% 7% US fixed income active 0% 5% -4% Cash/cash equivalents -9% 0% -16% Base: All Institutional Investors Source: US Institutional Investor Brandscape. February 2017. 5
A Market of Opportunity for Active Managers With an understanding of the asset classes in most demand for future institutional mandates, we turn our view toward the factors that are driving anticipated shifts in institutional asset allocation. Among pensions, the search for higher returns displaces de-risking as the lead driver for asset allocation shifts this year. This risk-on mentality is also evident in the asset classes poised for increased allocations public and private equities, real estate/reits and commodities, as previously noted. Importantly, this desire for higher return is more prominent in certain segments, such as pensions managing $20 million to just under $100 million in assets and public/taft-hartley plans. Meanwhile, de-risking continues to be the leading driver among corporate pensions and those managing at least $1 billion in assets. Similarly, pensions managing assets of $20 million to just under $100 million and public/taft-hartley plans are seeking higher yield from their investments, whereas search for yield is a weak driver for allocation changes among plans managing assets of at least $1 billion. Approximately 10% of anticipated changes to allocation, across various pension segments, are driven by the need to reduce costs/fees. Strategic Implications Institutional investors have some pleasant surprises in store for investment managers. Despite the broader industry trend toward passive management, many institutions are likely to increase their use of actively managed strategies. Across asset segments and types, institutions are putting their available cash to work and report the intention to increase their allocation to active international equities and alternatives. Additional asset classes poised to benefit from allocation shifts include non-traditional asset classes such as private equity and real estate/reits. Industry media headlines focused on muted future return expectations are causing institutional investors to prioritize performance over de-risking, which opens the door for active managers to demonstrate their unique alpha-generating capabilities. Yet the undercurrents of de-risking and reducing costs remain prominent in institutional investors minds, underscoring the need for active managers to emphasize the risk-adjusted returns and value provided by their actively managed solutions. Similar to previous years, the search for higher returns drives anticipated allocation changes for non-profits of all types and sizes. In addition, non-profits also indicate the need for increased diversification as a driver of change. The smallest non-profits along with taxexempt organizations de-emphasize de-risking as a driver for allocation changes this year. Meanwhile, non-profits managing $250 million to just under $1 billion in assets place less weight on capturing tactical opportunities and de-risking as drivers of change. Importantly, endowments are the only segment of non-profits to indicate that reducing costs/fees is more important than in the past. Collectively, these findings underscore the importance of targeting sales and marketing outreach to the needs of each segment of the institutional market. EXHIBITS 5 & 6 Insights shared in this white paper are derived from our US Institutional Investor Brandscape report. The full report examines the behaviors and attitudes of senior investment professionals across defined-benefit pension plans, and private and public foundations and endowments. Conducted since 2010, this study covers overall trends in asset allocation and investment strategies, the variables that lead to selection, and the current state of brand equity, differentiation and loyalty in this critical market. 6 Institutions Affirm Faith in Active Management
EXHIBIT 5 DRIVERS OF ANTICIPATED ASSET ALLOCATION MODIFICATIONS Constant Sum Exercise: Distribution of 100 Points, Pension Total $20M <$100M $100M <$250M AUM $250M <$1B $1B+ Corporate DB CATEGORY Public DB &Taft- Hartley Seek higher returns 22.1 30.2 19.0 17.1 13.7 16.4 25.2 De-risking 20.3 '15'14 15.7 19.7 20.3 33.3 35.0 '14 11.8 Seek higher yield 14.8 '15 23.7 7.5 14.6 3.5 12.6 '15 15.1 Increase diversification 11.2 7.0 17.4 9.9 14.2 10.2 14.0 Reduce costs/fees 9.8 10.1 9.6 10.5 8.4 11.2 8.6 Inflation protection 6.7 2.1 13.5 5.8 9.2 2.9 6.1 Capture tactical opportunities 6.4 4.6 6.0 9.2 7.8 5.7 6.9 Manage liquidity 4.9 2.8 5.5 6.1 7.7 4.7 5.5 Reduce home bias 2.1 0.3 1.9 5.6 1.4 1.3 1.7 Low High Base: All Pensions Key 7.24 7.25 to 14.17 14.18 to 21.10 21.11 to 28.03 28.04 / = Significant change from stated year / = Significant change observed in 2015 sustained in 2016 EXHIBIT 6 DRIVERS OF ANTICIPATED ASSET ALLOCATION MODIFICATIONS Constant Sum Exercise: Distribution of 100 Points, Non-Profit AUM CATEGORY Total $20M <$100M $100M <$250M $250M <$1B $1B+ Endowment Foundation TEO Seek higher returns 24.5 23.8 25.8 24.2 32.4 26.6 19.6 26.6 Increase diversification 14.8 15.5 12.0 '15 14.8 14.4 13.3 19.4 12.6 Reduce costs/fees 11.8 11.9 11.7 12.8 7.3 13.0 '14 8.5 13.2 Seek higher yield 11.7 12.0 14.1 6.7 8.9 9.7 15.9 10.0 Manage liquidity 10.3 10.6 8.2 11.2 12.1 8.9 8.4 11.9 Capture tactical opportunities 9.1 8.9 9.2 10.2 '14 10.5 7.7 11.6 8.3 De-risking 6.7 '15 5.7 '15 10.0 7.4 '15 5.8 7.3 6.7 6.4 '15 Inflation protection 5.4 5.3 5.3 7.4 3.0 7.9 5.9 4.2 Reduce home bias 2.5 2.8 1.3 1.5 4.5 4.1 3.6 1.2 Base: All Non-Profits Low High / = Significant change from stated year Key 7.46 7.47 to 13.70 13.71 to 19.94 19.95 to 26.18 26.19 / = Significant change observed in 2015 sustained in 2016 Source: US Institutional Investor Brandscape. February 2017. 7
Methodology Cogent Reports conducted an online survey of a representative cross section of 374 investors managing $20 million or more in institutional investable assets from October 21, 2016 to January 3, 2017. Survey participants were required to play a direct role in the evaluation and selection of investments or asset managers within their organizations. Linda York Senior Vice President, Syndicated Research & Consulting For more information, contact us at cogent-reports@marketstrategies.com or 617.441.9944 About Market Strategies International Market Strategies International is a market research consultancy with deep expertise in financial services with practice areas serving wealth, banking, payments and insurance. We blend primary research with data from our syndicated, benchmarking and selffunded studies as well as Big Data to help our clients grow their businesses and brands. Market Strategies research specialties include brand, communications, CX, product development and segmentation. Our syndicated products, known as Cogent Reports, are the wealth sector s leading source for insight on the attitudes, opinions and behaviors of key investor populations, including advisors, plan sponsors and affluent and institutional investors. Founded in 1989, Market Strategies is one of the largest market research firms in the world, with offices in the US, Canada and China and additional industry expertise in consumer & retail, energy, healthcare, technology and telecommunications. Read Market Strategies blog at FreshMR, and follow us on Facebook, Twitter and LinkedIn. Visit us: cogent-reports.com Read our blog: freshmr.com