Expanding the Efficient Frontier
Managers and clients must use new strategies and an evolving
investment landscape to their advantage.
By Chris Carlson
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Chris Carlson
Managing director of strategic development for Northern Trust's global investment group
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It is striking to look across the asset management business and witness so much change. Around the world, investors are experiencing unprecedented challenges that asset management firms are just beginning to address. Pension plan funding pressures, changing demographics, normalized investment returns and increasing regulation are just a few megatrends changing our business.
Institutions are responding by shifting the burden for financial planning to the individual, and requiring more cost-efficient capabilities from asset managers. Clients are looking at existing investment frameworks and realizing capabilities that seemed to make sense just a few years ago are now inadequate to fund their future needs and aspirations.
Initially, asset management firms were slow to respond, overwhelmed by so much turmoil resulting from the bursting tech bubble and the growing importance of alternatives. But recent asset management innovations are giving us a glimpse into the future of our business.
Whereas we once took an approach defined by long-only, style box confined capabilities, allocated through traditional methodologies, today’s tool box takes a much more sophisticated approach to portfolio construction. Driven by an increasing reliance on risk budgeting, managers and clients are partnering to build portfolios that have absolute return goals, incorporate active extension capabilities and, where benchmarks are used, often focus on nontraditional standards such as liability-driven requirements.
As a result, the skill set incorporated by clients and investment professionals who seek success in this new world will be substantially different. Traditional portfolio construction, monitoring and execution are no longer enough. Successfully helping clients meet their needs will require advanced risk-management skills, financial engineering capabilities and structuring competencies to package investments into focused financial solutions. No longer can managers simply focus on providing alpha and/or beta return. Beta return now comes at a rational price, alpha return must be consistently sourced and the two must be paired in a portfolio that can meet the client’s future needs.
This approach is pushing investors to increase their use of derivatives and incorporate asset classes that were previously considered alternative. It also is driving traditional and alternative investment management skill sets to converge. Successful firms of the future must be able to tailor more sophisticated investment solutions than in the past.
As we arrive in this new asset management world, clients will benefit greatly. New capabilities such as portable alpha and structured products, combined with a renewed focus on liability-driven benchmarks and risk management, will allow managers and clients to partner in constructing investment portfolios that are more tailored to each client’s individual needs.
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