Investment Management after the Global Financial Crisis

Abstract

Only rarely do we in the investment management profession have the pleasure-or pain-of seeing a major secular change in our own line of work unfold before our eyes.In the working lifetimes of most readers of this book, many social, technological, and business changes have taken place-in particular, the emergence of the computer as the primary work tool and the internet as the principal means of communication.But these are changes in the infrastructure of our work, not in the essence of it.The 40 years prior to the crash of 2007-2009 have seen only two truly major changes in what economists call the "industrial organization" of the investment profession: (1) in the 1970s and 1980s, the creation of a critical mass of independent investment management firms and the migration of assets from banks and insurance companies to these new institutions and (2) in the 1990s and 2000s, the emergence of alternative investments as a serious challenge to traditional investment managers and their risk-controlled, benchmark-sensitive portfolios.We may be on the verge of a third such change in response to the global financial crisis and market crash of 2007-2009.1 What is the nature of the changes that have yet to unfold?We can speculate:• New regulations will limit leverage in an attempt to avoid the "necessity" of further bailouts; the role of moral hazard and principal-agent conflicts in investing and in corporate management will come to the forefront.• The desire to avoid paying alpha fees for beta performance will lead investors increasingly to allocate funds to low-fee index strategies and to high-fee, but potentially high-returning, hedge funds.Traditional active management may be in trouble.• The shift in retirement finance from defined-benefit (DB) pensions to definedcontribution (DC) savings plans, now in its third decade, will likely result in almost everyone being covered by DC plans.Even public plans, the last bastion of DB plans, are facing a funding crisis on a scale not contemplated before the economic crisis, which affected tax revenues very negatively.(Tax revenues are hypersensitive to economic activity.)This situation is not good.It has been said, and it is only a modest exaggeration, that the worst DB plan is a better guarantor of the retirement security of the mass of participants than the best DC plan.DC plans, however, will improve greatly through the use of efficient portfolios, cost-saving annuities, and other "innovations" (conceptually more than half a century old but still in need of being implemented).1 By focusing on industrial organization, we can overlook (for the sake of the present argument) such wonders as the emergence of derivatives and of index funds.These are changes in technology, which may or may not lead to changes in industrial organization. Investment Management after the Global Financial Crisis viii ©2010 The Research Foundation of CFA Institute• In a related trend, the investment management profession will pay more attention to the individual investor, as it did in our grandfathers' day.• A new type of financial institution-the sovereign wealth fund-will continue to emerge and thrive.• Retail acceptance of alternative investments will broaden, and new technologies will be developed to broaden the reach of these investments.Change is always interesting to observe, but it is not always good.Although transaction costs have fallen dramatically, investment management fees are probably the highest they have ever been.As a result, because of the zero-sum arithmetic of active management, after-fee performance relative to benchmarks must be the lowest it has ever been!Some investment managers may be worth these fees and then some, but we cannot all be worth such high average fees.But are we on the verge of a change in investment institutions that brings fees down to an economically justifiable level?I do not see it happening quickly, and the survey evidence presented in this timely monograph by veteran Research Foundation of CFA Institute writers Frank Fabozzi, CFA, Sergio Focardi, and Caroline Jonas suggests that fees are not likely to fall as quickly as customers might like.There are, however, "green shoots" that suggest the direction of change is the right one.For example, a 2 and 20 hedge fund mandate is now a rarity.Among the many changes documented by these authors, who with this volume are presenting their third survey-based study of investment management trends, perhaps the most welcome is that asset allocation is back on top.Good-because that is where it belongs.A sign of the times is that the prestigious Institute for Quantitative Research in Finance (the Q-Group) is producing a seminar called "No Alpha Now?So Let's Work on Beta."Yes, let's do that and build the building instead of just the ornamentations.The first two Research Foundation monographs written by these authors (with some personnel changes among the authors) studied trends in quantitative finance.This book substantially expands the authors' territory to cover the whole investment management industry, not just that part of it that specializes in quantitative methods and approaches.They ask where the most profound changes are likely to be as the industry regroups from the disasters of recent years and moves forward into the future.We are exceptionally pleased to present it.

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