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New Business Models for New Asset Allocations?

The start of the new millennium has heralded significant change in investment management. Equity market falls and consequent solvency issues have focused investors' attention on their liabilities (as have the new risk-based capital reporting requirements for insurers).

There has been a considerable reorganisation of assets which has included significant reallocations to asset classes that generate lower fee revenues.

Ironically, at the same time as the fee revenue pool has decreased, business pressures continue to mount:

  • the burden of compliance and disclosure has expanded incessantly.
  • competition for investment management talent has increased considerably due to the realignment of asset allocations towards expanding or "new" asset classes.
  • expansion of the alternative investment universe - and hedge funds in particular - has challenged the structure of traditional long-only investment manager reward and incentivisation packages. Traditional long-only investment management firms that have developed hedge fund units have faced additional pressures.
  • the business planning and administrative burden has expanded with renewed interest in performance-related fees and new forms of investment mandates, where short-run volatility in the revenue stream can give rise to considerable business issues.
At the same time, the industry has evolved and there is a greater awareness of the distribution and impact of risk. It is very likely that the drive towards the separation of alpha (the excess return over the market return) and beta (the market return) will continue. Increasingly, investors are less willing to pay high fees for broad market exposure (which they can achieve through low cost vehicles) and more willing to focus fees on those investments which offer the opportunity of alpha for the same level of risk. Within this environment, significant future institutional flows are likely to be directed towards alternative investments with continuing capital reallocation from traditional long-only asset classes.

Investment managers need to adapt to this changing market environment. But by how much and in which direction will vary - standing still is not an option in today's competitive market place. However, efficient and effective change can only be delivered through both acknowledgement of the limitations of the existing investment service offerings and understanding of the structure of the broader institutional market and how it is likely to develop.

The threat from managers of alternative investments will continue to increase as their business models and infrastructure evolve to appeal more to mainstream investors. As such, the opportunities for the future lie in understanding fully the structure of the institutional market and likely future trends in:
  • the expansion and contraction of asset classes
  • the development of institutional market segments and opportunities (beyond the traditional core)
  • the development of new service offerings
The successful investment managers of the future will be those which actively embrace change and realign their business models in anticipation of the evolving market.