Investment Management After the
Global Financial Crisis
Presentation of the 2010 CFA Monograph authored by Frank Fabozzi (Yale
University), Sergio Focardi (EDHEC Business School, Nice), Caroline Jonas
(The Intertek Group, Paris)
Zurich, 25 January 2011
Geneva, 26 January 2011
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Investment Management After the Global Financial Crisis
My Objective Here Today
Present results of the study published by
CFA Institute under the title Investment
Management after the Global Financial Crisis
Discuss some of the things asset managers
might want to do differently going forward
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Investment Management After the Global Financial Crisis
Context Leading to the Monograph
 From mid 2007 through Q1 2009, financial markets were
shaken by a series of shocks
 The summer of 2007 saw liquidity dry up and the beginning
of the subprime mortgage crisis
 Following the collapse of Lehman Brothers (Sept 2008), the
financial markets began a slide which was to see major
indexes such as the S&P 500 and the Morgan Stanley
Composite Index (MSCI) lose more than half of their value
compared to their highs of 2007
 By the end of Q1 2009, most investors had suffered serious
losses; asset management firms were in survival mode
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Investment Management After the Global Financial Crisis
2009, 2010…
 Conventional assets under management in the global fund
management industry were estimated to be 71trillion USD
end 2009, a 14% increase over 2008 due essentially to the
recovery in equity markets
 The S&P 500 reached a low of about 680 in Q1 2009, down
55% from its peak of about 1500 in 2007 but rebounded to
1150 by end 2010
 And is now at 1280, the level it had reached five years ago
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Investment Management After the Global Financial Crisis
Trends and Considerations Still Valid
 Though the equity markets have rebounded
 The trends and considerations made remain valid
 Essentially because the causes of the crisis have not been
removed
 And many of the trends are long-term trends that could have
been identified even prior to the crisis
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Investment Management After the Global Financial Crisis
The Objective
The Research Foundation of CFA Institute asked the authors to
reveal how the financial crisis would impact investment
management decisions and processes and the investment
management industry itself
“For everyone in asset management – managers, consultants and institutional
investors – it is vital to do a ‘lessons learned’ exercise.The industry failed
to do so when the Internet bubble burst in 2000: everyone said that it was
the investment banks and brushed it off, moved on.This time we need to do
a lessons learned exercise at every level, we need to understand the 10
things that we need to do differently.”
CIO at a large Northern European institutional investor
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Investment Management After the Global Financial Crisis
The Research Methodology
 A review of the literature
 Conversations with 68 industry players, industry observers, executive
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recruiters, and academics:
17 institutional investors with a total of €570 billion in investable assets
15 investment consultants and private wealth advisors with €5 trillion in
assets under advisory
15 asset and wealth managers with €4.5 trillion assets under
management
6 industry observers
6 executive recruiters
9 academics
The geographical breakdown: Europe (roughly 2/3) and North America
NB: Most interviews were realized in H2 2009. Academics contributed
their evaluations in early 2010
Investment Management After the Global Financial Crisis
Finding #1: Asset Allocation Is Back
 The central role of asset allocation in generating returns and
protecting the downside has been clearly re-established
 The events of 2007-2009 highlighted the need for a topdown approach in which macroeconomics will play a bigger
role
“One thing that strikes me is the growing client awareness
that asset allocation drives everything.”
Investment Consultant
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Investment Management After the Global Financial Crisis
Allocating Assets More Dynamically
 Given the high levels of volatility, asset allocation is also
becoming more dynamic; timing asset-allocation decisions
will play a big role in explaining returns
But:
 Academics were skeptical as to investment managers’ ability
to successfully time asset allocation decisions
 Nevertheless, academics pointed to evidence that suggests
that it is easier to time parts of the market (for example large
cap versus small cap or individual securities) than to time
broad asset classes
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Investment Management After the Global Financial Crisis
Asset Allocation and Diversification
 Investors are turning to greater diversification in asset classes to
protect assets from market movements and generate higher
returns
 The investable universe once centered around two asset classes –
equities and bonds – has been expanded to include new strategies
and asset classes including real estate, hedge funds, private equity,
currencies, commodities, natural resources such as forests and
agricultural land, infrastructure, and intangibles such as
intellectual property rights
 The percentage of alternatives in the aggregate asset allocation of
the pension funds in the seven countries with the largest pensions
markets was estimated to be >16% by year-end 2008 (17% year
end 2009)
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Investment Management After the Global Financial Crisis
Asset Allocation and Diversification, ctd
But:
 Academics we talked to noted that there is not much history
on the (risk-adjusted) performance of many of these
alternative asset classes
 In particular, academics were skeptical that private equity
should generate more stable/better (risk-adjusted) returns
than public equity: is it simply a question of lack of pricing
information?
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Investment Management After the Global Financial Crisis
Consequence of the
Return of Asset Allocation
With asset allocation re-established as the most important
factor explaining returns:
 Asset-allocation products are expected to have strong growth
 In particular, investment products with an element of active
asset allocation are being engineered for defined-contribution
plan members and retail investors
 Example: lifestyle funds
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Investment Management After the Global Financial Crisis
Finding #2: Focus on
Risk Management
 During the 2007-2009 market turmoil, investor’s attention
shifted from returns to risk
 Sources identified risk management as the area that has
changed/will change the most following recent market
turmoil
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Investment Management After the Global Financial Crisis
What Is Changing
in Risk Management?
 In general, return expectations will have to be better aligned
with the overall ability of markets and the economy to
generate returns
 In addition to market risk, we can no longer ignore other
risks such as liquidity risk, counterparty risk, systemic risk,
and the effects of leverage
 Innovative products, such as the complex structured products
introduced by investment banks, have added a new element
of risk, calling not only for special methodologies for
measuring their risk, but also a greater understanding of the
products one is investing in and how they work in different
economic contexts
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Investment Management After the Global Financial Crisis
New Tools for Analyzing Risk
 To gain a better appreciation of risk, methodologies such as
Monte Carlo simulations, stress testing are being more
widely adopted
 Conditional VaR is being used to measure risk in the presence
of fat tails (i.e., large events such as large market
movements)
 In the area of systemic risk, aggregation phenomena are being
studied (for the moment by academia and central banks)
using methodologies such as the theories of percolation and
random networks
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Investment Management After the Global Financial Crisis
Not All Risks Can Be
Easily Estimated and Hedged
 Academics we talked to underlined the difficulty in hedging
liquidity risk given the lack of data and the likely non-linear
impact of liquidity shocks
 As for new risks due to complex structured products – a risk
underlined by industry players – academics cautioned on
their use given the asymmetry of experience and lack of
competition in the market
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Investment Management After the Global Financial Crisis
Finding #3: Growing Pressure on Costs
Investors who saw their assets shrink as major indexes lost
around half of their value in the crash of 2008-2009 are
taking a hard look at management fees and other costs
“If returns are low, the cost of producing them
becomes more and more important”
Institutional Investor
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Investment Management After the Global Financial Crisis
Institutional Investors’ Strategies
to Reduce Management Costs
 Renegotiating fees especially, but not only, in the alternatives
arena
 Investing more assets in index funds
 Bringing management (increasingly) in-house
 Including, for the larger funds, setting up in-house teams to
manage alternative investments, and pooling assets to wring
out layers of intermediaries
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Investment Management After the Global Financial Crisis
Individuals’ Strategies
to Reduce Management Costs
 High-net-worth individuals are: moving towards simpler, more
transparent products such as ETFs, and towards banks that offer
more competitive fees, more competitive products
 Retail investors are: reducing management fees by putting their
investable assets into low-cost funds, a trend already underway for
a number of years in some markets (93% of all new net purchases
of S&P500 Index mutual funds concentrated in least costly funds
2000-2009)
 Trend towards equity index funds continued despite recovery of
the market (13.7% of all US equity mutual fund assets year end
2009 up from 13% year end 2008)
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Investment Management After the Global Financial Crisis
Finding # 4: Towards a
Redistribution of Roles
 Redistribution of roles among investors, consultants, and
asset and wealth managers has accelerated
 Large institutional investors are increasingly bringing asset
allocation and asset management in-house and the largest are
building platforms to service smaller funds
 Consultants are moving into “implemented” or fiduciary
management in an attempt to boost revenues that slumped as
the value of assets under management fell and firms sought
to control costs
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Investment Management After the Global Financial Crisis
Finding # 4: Towards a
Redistribution of Roles, ctd…
 Asset managers are offering asset allocation advice, both in
response to investor demand and to provide value over and
above that added within the manager’s asset-class mandate
 Asset managers are also making inroads in asset allocation in
the defined-contribution (DC) pension arena, offering “allweather” portfolios for DC plan members as plan sponsors
seek to give some sort of downside protection to plan
members
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Investment Management After the Global Financial Crisis
Other Players : Investment Banks, Insurers
 Investment banks will continue to play an important role in
assisting corporate pension plans, providing hedging of
liabilities with interest rate derivatives and perhaps also,
more generally, as a provider of swap-based exchange-traded
funds (ETFs)
 Insurers will play a bigger role as small pension funds
outsource the management of their assets, governments try
to push down the cost of management, and retiring baby
boomers demand principal-protection and risk-mitigation
products
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Investment Management After the Global Financial Crisis
Finding # 5: A Greater Attention
to Ethical Behavior
 Consultants and investors are stepping up due diligence,
especially in alternative investments
 Larger consultancies are building up their research teams,
esp. in the area of operational risk
 Institutional investors – burned by hot money in hedge funds
– are taking a closer look not only at who is managing the
money and how, but also who the co-investors are
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Investment Management After the Global Financial Crisis
Finding # 5: A Greater Attention
to Ethical Behavior, ctd…
 In addition, continental European funds are taking a closer
look at what activities are behind the profits of the firms in
their portfolios
 While investors in English-speaking countries are focusing
more closely on governance and other ethical issues that bear
on the value of the firm
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Investment Management After the Global Financial Crisis
Finding # 6: Biggest Challenge for All in the
Industry: Regain Investor Trust
Will require:
 More transparency
 More communication with investors, especially on risk
 Better management of expectations
 Some help from financial markets
“Bubbles come and bubbles go and leave a lot of people angry. Asset
managers need a trust proposition”
CIO, European asset management firm
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Investment Management After the Global Financial Crisis
The Challenge for Pension Funds
 The challenge: pay the pension promise in what many
investors expect to be a highly uncertain, low-interest-rate,
low-return environment
Among the strategies:
 Get costs down
 Move more assets into in-house management wherever
possible
 Try to increase returns with greater diversification and more
opportunistic, active asset allocation,
 While paying more attention to the macro environment
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Investment Management After the Global Financial Crisis
The Challenge for Consultants
 The challenge: add value as investment strategies pursued by
institutional investors become more complex
Will require:
 A bolstering of competencies in risk budgeting, asset
allocation, and new asset classes
 Might include enlarging the service offerings to include, for
example, fiduciary management
 Or merging (ex Towers Perrin/Watson Wyatt) or considering
alliances with asset managers or institutional investors
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Investment Management After the Global Financial Crisis
The Challenge
for Investment Managers
 The challenge: redefine the offering, aligning the promise with the
ability to deliver
Strategies:
 Play a bigger role in asset allocation – advising institutional investors and
engineering products for retail investors – and in risk and liquidity
management
 Restructure: As investors move their assets increasingly into index funds
on the one side and alternatives on the other, the industry is expected to
restructure, with a few large firms with a comprehensive product
offering including alternatives and advice, and a large number of
specialized boutiques
 Separation of production and distribution: As the industry consolidates
and the pensions market undergoes “retailization,” the industry is moving
towards a separation of production and distribution in which revenuesharing will be a major issue
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Investment Management After the Global Financial Crisis
Employment Trends
 Mid 2009: 20-55% drop in overall recruitment mandates due
to downsizing at large asset management firms as they tried
to control costs in the face of falling assets under
management and investors’ preference for lower-margin
products
 By end 2010 recruitment firms reported that dramatic cost
cutting was over and recruiting was up again though still not
up to 2007 levels
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Investment Management After the Global Financial Crisis
Compensation Trends
 Compensation in the industry was down 20-40% in 2009
compared to 2008, due essentially to a reduction of bonuses
 Compensation bounced back 10-15% in 2010 but it is still
below 2007 levels
 Compensation structures are also being reviewed, with a
larger percentage of compensation being deferred,
performance evaluated over several years, and incentives
aligned with the long-term performance of the firm
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Investment Management After the Global Financial Crisis
Recruited Most / Least in 2009
Demand up for:
 Asset-allocation specialists and persons with multi-asset experience and
quantitative skills
 Risk managers, including counterparty and operational risk managers
 Global and emerging markets specialists
 Credit specialists
Demand down for:
 Stock pickers, as investors moved assets into index funds
 Equity portfolio managers for developed countries
 Retail wholesaling staff, with the decline of the open-architecture model
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Investment Management After the Global Financial Crisis
What We Might Do Differently
“For everyone in asset management – managers, consultants and
institutional investors – it is vital to do a ‘lessons learned’ exercise.
The industry failed to do so when the Internet bubble burst in 2000:
everyone said that it was the investment banks and brushed it off,
moved on.
This time we need to do a lessons learned exercise at every level, we need
to understand the 10 things that we need to do differently.”
CIO at a large Northern European institutional investor
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Investment Management After the Global Financial Crisis
#1 : More Effective Diversification
 Consider correlations at the relevant time horizons
 Instantaneous correlation between the returns of different assets
and asset classes does not fully reflect the behavior of the returns
of assets or asset classes in times of crisis
 Diversification based on correlations at short time horizon does
not protect against crises
 One needs to understand trends at intermediate times and
diversify trends
 Or equivalently diversify at the relevant time horizons and
 Understand cointegration that is the clustering of price processes
around a small number of key trends
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Investment Management After the Global Financial Crisis
# 2 : Review Asset Allocation
More Frequently
 Today’s markets experience more large swings in valuations
and change behavior in fundamental ways that affect the
forecasts of entire asset classes and require dynamic asset
allocation
 But: while dynamic asset allocation holds the promise of
higher returns, it is a source of risk given that it shifts assets
dynamically from entire asset classes, leaving little margin for
mistakes in the difficult task of timing
 Therefore the need to understand what asset subclasses can
be forecasted most accurately
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Investment Management After the Global Financial Crisis
#3 : Consider Extreme Events
 Extreme events do occur more frequently than today’s risk
models forecast
 Empirically, we know that returns distributions are fat-tailed
 In addition, there are hidden sources of extreme risk that
have to be accounted for, e.g., 6 May2010 flash crash
 The presence of fat tails implies that linear correlations do
not reflect co-movement between asset returns
 But we still have to separate fat tails of short-term returns
from prolonged market slides
 And understand when extreme events are triggers of crises
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Investment Management After the Global Financial Crisis
#4 : Consider Liquidity Risk
 Consider carefully the magnitude of losses should one need
to unwind positions rapidly
 Recent events have demonstrated that a sudden withdrawal
of liquidity from markets might occur, leading to potentially
very large losses on leveraged strategies
 But liquidity is difficult to understand
 Because it is a non linear phenomenon only partially
explained by standard asset pricing theories
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Investment Management After the Global Financial Crisis
#5 : Consider the Complexity of the Web of
Relationships Between
Agents, Investment Products
 The structure of market links has come to the forefront as a
source of risk as complex derivative products might
propagate losses throughout the economy well beyond what
was believed realistic before the 2007-2009 crisis
 The Bank of England’s Executive Director of Financial
Stability Andy Haldane has proposed measures of market
connectedness
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Investment Management After the Global Financial Crisis
#6 : Consider
Macroeconomic Quantities
 The real economy does matter
 Though macroeconomic variables move slowly, they are
important insofar as they can signal the building up of
situations that might lead to large losses
 For example, the progressive building up of excessive
mortgage exposure is a fact that could have been revealed by
economic analysis
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Investment Management After the Global Financial Crisis
#6 : Look at
Macroeconomic Quantities, ctd…
 Financial returns must have an economic basis
 One has to understand the sources of returns…
 And their sustainability
 The economy, markets are finite,
 While classical finance theory essentially assumes infinite
markets
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Investment Management After the Global Financial Crisis
#6 : Look at
Macroeconomic Quantities, ctd…
 We know a lot about crises, in particular about the links
between crises and the excess of money and credit
 Studies have underlined common characteristics of the
economy in periods preceding a crisis (e.g., Minsky, Reinhart
& Rogoff)
 But these forewarnings are often interpreted as signs of a
favorable situation for generating returns
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Investment Management After the Global Financial Crisis
#6 : Look at
Macroeconomic Quantities, ctd…
 The injection of money in the economy will have to be
closely monitored
 It might be profitable to split inflation into an inflation vector
with many components including asset inflation
 In order to understand if the realignment of different sources
of returns is likely to happen smoothly or through more
frequent boom-bust cycles
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Investment Management After the Global Financial Crisis
#7: Consider the Risk that
Hedging Strategies Can Fail
 The failure of Lehman Brothers demonstrated that apparently
solid counterparties can and do fail
 With the crisis that started in 2007, hedging has acquired a
new dimension as the possibility of failure of counterparties
such as major banks and insurance firms has increased beyond
what was considered likely before the crisis
 Need to care not only about the reliability of counterparties
but also of their environment, interconnectivity
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Investment Management After the Global Financial Crisis
#8 : Build up Multi-asset and
Multinational Capability
 Exposure to alternative asset classes among the seven largest
pension markets has gone from 6% to 17% in the last ten
years
 Markets are global and investors increasingly expect those
who manage their money to have a global view on the
investment environment
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Investment Management After the Global Financial Crisis
#9 : Build up the Quantitative
Capability
 The size and complexity of today’s (equity) market is
enormous
 By yearend 2010, worldwide regulated exchanges listed over
45,000 firms with a total market capitalization of 55 trillion
USD
 Optimal execution increasingly calls for automation and
quantitative capabilities
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Investment Management After the Global Financial Crisis
# 10 : Align the Promise with What the Investment
Management Industry Can Deliver
 Investors have been stunned by large swings in market
valuations three times in the past 10 years (1997-1998, 20002002, 2007-2009) years
 The industry needs to regain investors’ confidence
 More transparency will be needed
 Investor confidence cannot withstand another crisis, markets
cannot function correctly in the absence of a minimum level
of trust
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Investment Management After the Global Financial Crisis
A Final Word from Academics:
“Don’t forget that there really is a risk-return
trade-off. If something looks too good to be
true, it probably is.”
Professor John Finnerty, Professor & Director of the MS in
Quantitative Finance Program,
Fordham Graduate School of Business
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Investment Management After the Global Financial Crisis