平成２４年７月１２日
各 位
一般社団法人

日本投資顧問業協会

CREATE－Research 社の報告書

このたび CREATE-Research 社の”Market Volatility: Friend or Foe”と題する調査報告書を、ホームページに掲載しました。同社は、英国の独立系のグロ
ーバルなコンサルティング会社であり、金融、航空宇宙、IT、石油、製薬、テレコム等の幅広い産業をカバーしています。
同報告書には、資産運用業の将来に対する多くの示唆が含まれており、また、
同報告書の作成に際しては、当協会の一部の会員へのアンケートやインタビュ
ーの内容が反映されております。資産運用業に携わる方々にとって役立つものとなれば幸甚です。

以上MARKET VOLATILITY:FRIEND OR FOE?

Author: Prof. Amin Rajan
First published in 2012 by:
CREATE-Research
Vauxhall Lane
Tunbridge Wells TN4 0XD
United Kingdom
Telephone: +44 1892 526 757
Email: amin.rajan@create-research.co.uk© CREATE Limited, 2012
All rights reserved. This report may not be lent, hired out or otherwise disposed of by way of trade in any
form, binding or cover other than in which it is published, without prior consent of the author.

FOREWORD
We at Principal Global Investors are pleased to be

The effectiveness of diversification has been a topic of debate

partnering with CREATE-Research in our fourth annual

over the last few years. One of the most compelling insights

report. Professor Amin Rajan of CREATE-Research is one offrom the study is that investors’ views about risk and returnthe most respected commentators on the subject of asset

are evolving rapidly, calling for a more dynamic approach to

management and we look forward to sharing this research

managing volatility. We at Principal Global Investors believe

on volatility, a topic that is top of mind with all investors.

that it’s never been more important than now to have a trusted
partner, a long-term investment strategy, and disciplined

This year’s report provides a view of the challenges andexecution, to benefit from volatile times.

opportunities presented by market volatility. The subjectof volatility is particularly important considering the last
four years have been among the most volatile in thehistory of global markets.
The current sovereign debt crisis in Europe and the 2008
credit crunch have led to fragile investor sentiment that

Jim McCaughanCEO
Principal Global Investors

has amplified market movements. Nevertheless, history
shows that opportunity is inherent in periods of high risk
and times of high risk can reward active management.

iACKNOWLEDGEMENTS
This 2012 global survey is part of an annual

The second group comprises Principal Global Investors, who

research programme by Principal Global investors

sponsored the publication of this report, without influencing

and CREATE-Research.

its findings in any way. Their impartial support over the past
four years has enabled us to share valuable insights with all the

It is designed to highlight the forward trends in global asset

players in the investment value chain in multiple jurisdictions.

management. The programme has delivered a number ofacclaimed reports, white papers and articles to be found at

The final group comprises my immediate colleagues. I would like towww.create-research.co.uk. Brief details are given on therecord my special thanks to Lisa Rajan and Dr. Elizabeth Goodhew.

last page of this report.
After all the help I have received, if there are any errors andOn this occasion, I am deeply grateful to three groups ofomissions in this report, I am solely responsible.

organisations and people who have made this report possible.
The first group comprises 289 asset managers, pension plans,
pension consultants and fund distributors who participated in our
global survey. One hundred of them were also involved in ourProf. Amin Rajan

post survey structured interviews, thereby adding the necessary

Project Leader

depth, rigour, colour and nuances to our survey findings.

CREATE-Research

Their unstinting support over the years has helped to develop an
impartial research platform on issues that are critical to a vibrantinvestment industry after the turmoil of the past four years.

ii

CONTENTS
Forewordi

Acknowledgementsii

Executive Summary

2

Volatility Dynamics:

14

How do clients see it?

Making a Virtue Out of Necessity:

24

How will re-risking and de-risking pan out?

Rebooting the Business Models:

34

What do asset managers need to do?

Appendix

40|

1 EXECUTIVE SUMMARY“

The golden era of high-growth,
low-inflation is over. We’retransitioning to more cyclicalmarkets, where pricedislocations are significant,as are buying opportunities.
- AN INTERVIEW QUOTE”INTRODUCTION
The last four years have been the most volatile in the historyof equity markets.
Price fluctuations of 4% or more in intra-day sessions have occurred
six times more than they did on average in the previous forty years.
Extreme spikes in market volatility and asset class correlations havebeen common. 2011 was a nerve-shredding year.
Fear, greed and stress have amplified market cycles. The priceearnings ratios have no sensible anchor points for now.
The debt crisis in the West is the prime cause. Tackling it will bea long haul, fraught with policy errors and political expediency.
Politics, more than economics, will likely drive the markets
during this decade.
But history tells us that times of high risk are also times of big
opportunities. Naturally, investors in all client segments areasking whether asset managers can convert market volatility
into an investment opportunity for their end-clients. After all,that is the raison d’être of active management.

2

Accordingly, this study addresses four questions:

Survey participants by geography and size of AUM• Are capital markets in an era of frequent volatility
and price dislocations?

Australia

India

Singapore

Austria

Ireland

South Africa

Belgium

ItalySouth Korea

Canada

Japan

Spain

China

KuwaitSwedenDenmark

Luxembourg

Switzerland

Finland

Malaysia

TaiwanAs with previous reports in this Principal Global Investors/

FranceNetherlands

UK

CREATE annual series, our research approach relies on two

Germany

NorwayUSAphases: a global survey followed by structured interviews.

Hong Kong

Saudi Arabia• If so, what will be the end-clients’ predominant approaches to risk?
• Which asset classes are likely to feature strongly in theirinvestment choices?
• Which capabilities do asset managers need to develop
if their clients are to benefit from volatility?

289 asset managers, pension consultants and fund distributors
from 29 countries participated in the survey, with a total AUM
of $25.2 trillion. The survey was followed by 100 interviews,
which included pension plans.

AUM (US$ trillion)

25.2

Following are four key findings and the seven core themes thatemerged from them.

Source: Principal Global Investors/CREATE Survey 2012

3

EXECUTIVE SUMMARY

continued

KEY FINDINGS

volatility cloud. Hence, there is as much concern about missing

Four headlines sum up the findings from the survey

the next rally as about being caught by its untimely demise.

and interviews.

Flight or fight will not be the only choice. Many clients will

1. Political horizons, market horizons and investor
horizons will remain out of sync

blend both within a bigger permutation. If caution is the new

The unusual market volatility and asset correlation sparked byexisting risk budgets and some will drive down costs.

the 2008 credit crunch will not abate as long as the sovereign

Discretionary re-risking will exist alongside automatic re-risking

debt crisis overshadows growth in the West. Far from an early

activated by glide path mechanisms in many retirement products.

watchword, opportunism is the new interest. Some investors
will ramp up risk, some will squeeze extra returns from theirresolution, there are signs of back sliding on key reforms.
De-risking will rely on a new form of diversification that is far
There are also concerns about the unintended side effects

removed from the traditional asset-based approach that has longof new financial regulation in the West. It will force perverse

relied on historical assumptions of risk premia and correlations.

investment behaviours from banks and insurance companies.

Liability Driven Investing will remain in the ascendancy.

It will also impact market liquidity and price discovery.

Hedging tools, e.g. stop-loss mechanisms, option contracts andAided by other forces, e.g. globalisation, high frequency trading

structured products, will command limited appeal because ofand leveraged exchange traded funds (ETFs), regulation will

their cost and counter-party risks. Style box investing, too, will

accelerate the directional velocity of markets.
78% of respondents anticipate prolonged turbulence. Over 60%
expect two or more systemic crises before this decade is out.
Fear, more than fundamentals, will drive the markets. Priceanomalies will be rife.

take a back seat while the markets remain wild.

3. Equities and credit will come under the spotlight
In the Defined Benefit (DB) space, clients are likely to tilt
towards equities in their medium-term asset allocation. They
are seen at their most attractive relative to bonds in 50 years.

Having weathered many rollercoaster rides since the bear

Volatility has driven out swathes of panic sellers since 2008,

market of 2000, investors have grown weary of new risks. But

creating conditions for a generational bull market.

they haven’t given up on chasing a bargain when they see one.
Emerging market equities are also likely to benefit from the

2. Investors will blend caution with opportunism in
the face of too many wild variables

projected tilt. Many clients also see them as an opportunistic

Worldwide, corporate fundamentals look good. Fears of a hard

However, the bulk of their opportunism will occur in the credit

landing in China have receded. The debt mountain in thespace, dominated by distressed debt, high yield bonds andU.S. has started to shrink. End-clients see a silver lining to thethe ‘secondaries’ in real estate, private equity, commercial“

mortgages, collateralised loan obligations and senior debt.

Our clients want to see a good trackrecord and merit-based incentives
from their managers before buying
into the volatility story.
- AN INTERVIEW QUOTE

4play via low-cost ETFs.

”

New opportunity sets will gain traction, as banks in the West
withdraw from these areas to beef up their capital base by$3.5 trillion under Basel III.
In the Defined Contribution (DC) space, plans that aremanaged by trustees will aim to de-risk their portfolios while
investing in structures that permit re-risking when required.

Those that are managed by individual members will rely

Driven by the greed/fear cycle, they often make choices

on glide path mechanisms to do automatic re-risking andcontrary to their own best interests.

de-risking in the face of random market swings.
To overcome the obstacles, actions are being taken by asset
In the retail space, clients are expected to err on the side of caution,on the whole, with brief bouts of opportunism. There will be a clear
divide between the West and the East. Those in the West will remain

managers in four key clusters.

ACTIONS BY ASSET MANAGERS

over-cautious in the wake of past losses and impending retirement.

The first cluster seeks to promote enhanced investment

Those in the East will continue to be momentum-driven.

capabilities around price dislocations, improve the track recordon volatility and avoid unrealistic claims about returns. Success

4. Asset managers will need to reboot theirbusiness models, if they are to convert
volatility into an opportunity

is about having multi-asset class capabilities.
The second cluster seeks a better alignment of interests. Successis about replacing skewed incentives with ones that ensure that

Investing during turbulent times is scary. Whereas 71% of ourinvestment professionals share pain and gain in volatile times.

respondents see volatility as an opportunity, only 13% areconvinced that they can convert it into an opportunity. Two

The third cluster seeks to promote corporate nimbleness via

hurdles stand in the way.

free thinking and high conviction investing within the talentpool. Success is about having a small company mindset in a

INVESTMENT HURDLES

large company environment—a mind-set that is quick to

The first is the rapid ‘industrialisation’ of asset management

spot opportunities and mobilise all corporate resources inover the past two decades. With the dilution of its craft

their pursuit.

heritage, the skills that translate market ructions into investment
opportunity have become scarce. The big picture understandingof investing has become rare when specialist mandates replacedbalanced ones. There is an industry-wide shortage of managers
with the requisite insights into holistic drivers of risk premia, asset
correlation and tactical tilts in periods of dislocation. Our 2009
report highlighted the actions being taken by a minority of asset
managers. The rest have yet to follow suit.

The final cluster seeks to promote greater client engagement
to minimise the ‘wrong time’ risk and the ‘regret’ risk. Clientswant product alpha that is time dependent and solutions
alpha that is need-dependent. Both need greater engagement.
Success is about getting the timing right as much as choosing
the right strategies.
In sum, if volatility persists, the asset industry will need a big

Besides, the level of trust required to motivate clients is not

makeover to avoid the prospect of another ‘lost decade’.

there in many parts of the industry: after all, clients were rarely
advised to cash out in good times.
The second hurdle is clients’ own herd instinct that often
ignores the cardinal investment rule: buy low/sell high.

“Peer risk, agency risk and market risk have dumbed down what we do. We all- AN INTERVIEW QUOTE
use the same mean-variance optimisers.

”

5

THEME 1:

Markets are now in an era of heightened volatility
Like fear, volatility feeds upon itself. 78% of our respondents believe

High frequency trading (HFT) will be a further reason. If the May

that markets are now in an era of prolonged turbulence; and 19%

2010 ‘flash crash’ had been a little later in the day, prices would

think this is possible (Figure 1.1a).

not have had the chance to recover before the U.S. markets closed,
potentially causing carnage when Asian and European markets

Hence, over 60% expect two or more systemic crises before
the decade is out (Figure 1.1b). As ever, the definition of crisis

opened the next day. By ‘front running’, HFT will continue toaccelerate the directional velocity.

is subjective. But few believe that the worst of the last four
years is over.

In summary, fear will continue to obscure the fundamentals. Historicparameters and investment assumptions will remain suspended

The reason is obvious: the mother of all debt bubbles in the Westwhile the turbulence lasts. It all adds up to a changed landscape.

is being deflated against the most disorderly political background.
Policy attempts have reshuffled the debt, not reduced it. But there
are other reasons, too.
New financial regulation is fraught with unintended consequences.
The Dodd Frank Act in the U.S. and Solvency II in Europe will

INTERVIEW QUOTES:“Europe’s broken banks are in a deadly embracewith their broke governments.”

perversely turn banks and insurance companies into forced sellers“The biggest risk is political. You can’t model itin a spreadsheet.”both worlds: reduced market liquidity and distorted price discovery.
of securities in times of distress. The Volcker rule risks the worst of

Aided by technology and the 24-hour news cycle, growing
globalisation will amplify investor mood swings and compress
their decision spans from calendar time to real time.

“The average stock holding period on the NYSE
has fallen to 4 months.”

FIGURE 1.1a

FIGURE 1.1b

Are capital markets now in an era of
frequent volatility and price dislocations?

How many more systemic crises—like the current one—
do you expect over the rest of this decade?
40

78%

3%
19%

Yes
PossiblyNo% of respondents

35
30
25
20
15
10
5
0

Source: Principal Global Investors/CREATE Survey 2012

6

0

1

2

3

4

5+

THEME 2:

The volatility cloud still has a silver lining
While markets have been yo-yoing, corporate balance sheets

The reported gap is indicative of certain hurdles that need to beworldwide have been unusually strong. Many of them haveovercome (Theme 7). But it also signals a lack of consensus on thehoarded cash, paid down debt, done buy-backs and locked into

global economic outlook, as revealed in our post-survey interviews.

low interest rates.
There are divisions in asset managers’ views about the future:
U.S. joblessness is on a downward trajectory. Its industrial
bellwethers report record profits. America has outpaced its
European peers in deleveraging since the start of this ‘balance
sheet’ recession sparked by the trans-Atlantic sovereign debt

• 35% of asset managers are ‘inflationists’ who think positively
about quantitative easing despite its inflationary side effect.
• 40% are ‘undecided’. They fear that markets may revertcrisis. The fears of a ‘hard landing’ in China are also receding, as itto their pre-1985 state when politics mattered more thantransitions towards a consumption-led economy with a rising yuan.

economics.

No wonder the Dow flirted with its pre-recession levels at thestart of 2012. As in early 2009, a big wall of money is parked on• 25% are ‘deflationists’ who envisage no clear directional
shifts in the markets until the debt mountain shrinks visibly.

the sidelines waiting for the green light. Unlike 2008, this is aconfidence crisis, not a liquidity crisis.

INTERVIEW QUOTES:

Hence, 71% of our respondents believe that continuing volatility“Equities have dropped from 60% to 18% in our clients’portfolios. Is this panic selling or a lasting shift?”will offer a great opportunity to active managers to deliver good
returns to their end-clients; a further 22% see this as a possibility(Figure 1.2, left-hand chart).
Yet only 13% of total respondents believe that they can“Asset managers and clients are learning to live withvolatility—as a matter of necessity rather than choice”

capitalise on it; a further 54% see this as a possibility“Where else are opportunities, if not in volatility?”(Figure 1.2, right-hand chart).

FIGURE 1.2
Will greater volatility offer a great opportunity to active managers and will they succeed in delivering good returns net
of fees over the next 3 years?

OPPORTUNITY

SUCCESS

13%

22 %

Yes

Yes

20%

7%
71%

PossiblyNo

13%

Possibly54%

UnsureNo

Source: Principal Global Investors/CREATE Survey 20127

THEME 3:

The reality of risk-on/risk-off investing is far morenuanced than its over-blown rhetoric suggests
The regular headlines on risk-on/risk-off trades imply that investors

Notably, in the face of acute funding gaps, DB clients will resort toonly make binary choices as markets fluctuate. This caricature is

one or more of three options.

too simplistic.
First, a small minority will dial up the risk by venturing further out on
End-investors have been responding differently to the crisis

the risk frontier via higher yielding assets.

(Figure 1.3a).
Second, the majority will chase the investors’ equivalent of the Holy
• 5% are ‘adventurists’ who believe in contrarian investing

Grail: getting additional alpha without taking on further beta risks.

and market timing amid turmoil.

Via periodic portfolio re-balancing, some will aim to use fundamental
indices to create ‘smart betas’ that deliver cheap alpha at no extra risk.

• 35% are ‘pragmatists’ who believe in portfolio re-balancing
when momentum is working.

Third, some will squeeze costs to get existing returns at a reduced fee.

• 40% are ‘purists’ who believe in buy-and-hold investingIn sum, even though investors worldwide have grown weary of new

and see volatility as a risky game.

risks, the greed-fear cycle will still be lurking in the background.

• 20% are ‘pessimists’ who lost a bundle in the last decade

INTERVIEW QUOTES:

and can’t wait to exit at an opportune moment.
Such behavioural differences show that flight or fight will not be
the only choice. It can also be both or neither. Caution will prevail“Once the green light comes, markets will bounce
by 20% before Joe Public knows it.”alongside opportunism. All client segments are likely to blend the“Distant history is a better guide to today’s turmoil
than the past 20 years.”

two (Figure 1.3b).
Worldwide, DB clients are more likely to de-risk; while DC clientsand retail clients are more likely to de-risk as well as re-risk. Value
investing will retain its hypnotic appeal but it will be tempered byvalue traps from periodic dislocations.

“Investors who took the pain can’t wait to get out
when the time is right.”

FIGURE 1.3a

FIGURE 1.3b

How have end-clients reacted to volatility since 2008?

Over the next three years, what will be your clients’
predominant approach to risk?
50

40

35%

Pragmatists

5%
20%

40%

Purists% of respondents

Adventurists
30

20

Pessimists
10

0
De-risk

Source: Principal Global Investors/CREATE Survey 20128

DB Clients

Re-riskDC Clients

Both

Neither

Retail Clients

THEME 4:

Equities will re-emerge from the wilderness
When asked to identify the asset classes that are most likely toFirst, equities will bounce back at the first sign of progress on

be chosen in the face of prolonged volatility, our respondents

the debt crisis. This is the key difference in the findings between

drew a distinction between those that will be targeted for short-

this survey and its predecessor in 2009. Second, re-risking willterm opportunism and those for medium-term asset allocation

be more pronounced in the credit space than elsewhere. Third,(Figure 1.4). The ‘adventurists’ and ‘pragmatists’ are moreanything up to 50% of investments in emerging markets andlikely to target the first group and ‘purists’ the second group.

gold will be via ETFs. The ability of ETFs to slice and dice theinvestment universe will remain a plus. But, in the process, far

In Figure 1.4, starting with institutional clients, between 27%

from tracking the markets, they risk leading them, causing aand 43% of respondents expect them to chase high total returns
by going opportunistic via one or more of the asset classes listed
in the ’High total returns’ quadrant. High on their list will bemajor concern. Finally, for institutional clients, the choice of one
asset class over others will become academic, as they resort to arisk-based diversification (Theme 5).

distressed debt and ETFs.
Alongside, 43% to 58% of respondents expect their institutional
clients to go for modest returns with high liquidity via asset

INTERVIEW QUOTES:“30% of our clients no longer slavishly follow thebenchmarks. They see opportunity in periodic downdrafts.”

allocation (’Returns & liquidity’ quadrant). Top on their list will
be global equities and emerging market equities and bonds.

“ETFs account for nearly 40% of the trading volume
in the U.S. stock exchanges.”

Similarly, 14% to 23% of our respondents expect their retailclients to chase absolute returns via opportunism (’Absolute
returns’ quadrant); and 28% to 46% expect them to chase capital“Retail clients in the East are far more opportunistic
than their peers in the West.”

protection via asset allocation (‘Capital protection’ quadrant).
Variations by regions and behavioural groups are set out in
Section 3 of this report. Four points are worth noting here.

FIGURE 1.4 Which asset classes will feature in tactical opportunism and in asset allocation?
Institutional clients% of respondents

HighHi
igh total retur
returns
rns

Tacticalopportunism

Distressed debt
Exchange traded funds
Emerging market equities
High yield bonds
Currency funds
Hedge funds

ReturnsRe
eturns & liquid
liquidity
dity
43%
37%
30%
29%
29%
27%

Global equities
Global equities with EM revenues
High income equities
Emerging market bonds
Emerging market equities
Infrastructure

AAbsolutebsolute returns
Indexed funds
Actively managed equities and/or bonds
Theme funds (e.g. Shari’ah, SRI, environment)
Mutual funds using hedging tools (e.g. Newcits)
Capital protection funds% of respondents

58%
54%
46%
44%
43%
43%

Asset
allocation

CapitalCa
apital protecti
protection
ion
Capital protection funds
Tax efficient retirement funds (e.g. IRAs in USA)
Actively managed equities and/or bonds
Mutual funds using hedging tools (e.g. Newcits)
Indexed funds

23%
22%
22%
19%
14%

46%
34%
32%
30%
28%

Retail clients
Source: Principal Global Investors/CREATE Survey 20129

THEME 5:

Diversification will have a new incarnation in the DB space
Three conventional investment assumptions have not worked:

inflation protection (box four). Markets can turn on a dime. So,• Risk generates returns

the new approach also covers a time element via short-term assets
like cash and Treasuries, medium-term assets like equities with high

• Hedged portfolios give better returns than the unhedged portfolios

dividends, and long-term assets with a deep value bent.

• Diversification is a free lunch
The evolving asset allocation approach also replaces benchmarkThe new wisdom is that nothing is an opportunity, until we know

related measures, e.g. tracking error and information ratio, with

its risks, their likelihood and their impact. Also, volatility and asset

those focused on absolute risk. This is the key difference in thecorrelations may not follow their historic norms.

findings between this survey and its predecessor in 2010.

The newly evolving approach to asset allocation aims to manage

The percentages in Figure 1.5 are indicative, not definitive.

risks more than returns, conserve capital rather than grow it,

They illustrate how DB clients are developing new ways to deal

connect the dots between asset classes rather than treat them aswith volatility that are far removed from simple binary risk-on/

isolated islands, and blend top-down and bottom-up styles rather

risk-off trades.

than see them as rivals. It reflects a risk-minimising mindset more

INTERVIEW QUOTES:

than a return-enhancing mindset. One is holistic, the other siloed.

“Multi-asset class portfolios will dominate the corein the core-satellite model.”the 1990s and the 2000s (Figure 1.5, boxes one and two). Now it’sThis is a far cry from the asset allocation approach that prevailed inabout clarity of means and clarity of ends.
The means separate out alpha and beta; opportunism and buy-andhold investing; re-risking and rebalancing (box three).
The ends rely on distinct buckets to target five distinct goals:
growth assets, high income, regular cash flow, high liquidity and“Not all betas are created equal, or cost the same.
We need to know their granularity.”“We want to pick the bandwagon premium whenmomentum is working.”

FIGURE 1.5 How are the large DB plans changing their asset allocation approaches?
ASSET FOCUS

LIABILITY FOCUS

2010-20152010-2012
2000s
1990s
40%
Bonds
60%
Equities

8%
Exotic beta
22%
Alternatives
70%
Long only

25%
Alpha assets
75%
Beta assets
35%
Opportunistic investing65%
Buy-and-hold investing
15%
More risk for more return
85%
Same risk for more return

STRATEGIC ASSET ALLOCATION
Source: Principal Global Investors/CREATE Survey 201210

5%
Inflation protection: TIPs, commodities
10%
High liquidy: Cash, Treasuries
15%
Cash flow assets: Property, infrastructure
20%
High income: Bonds, credit
50%
Growth assets: Public equities

DYNAMIC ASSET ALLOCATON

THEME 6:

The DC space will polarise under the new risk dynamic
Three segments populate today’s global DC spectrum

All varieties are likely to grow, since their embedded advice(Figure 1.6). At one end are the employer-led schemes wherefeatures expressly counter clients’ behavioural biases in periods

the employer guarantees the contributions and target returns.

of high volatility. Their automatic rebalancing—buying low,
selling high—is deemed a big plus. Hence, two changes are

In the middle are the trustee-led schemes where investment

likely in the DC landscape.

choices rest with trustees or default options, but members bear
all the risks.

First, there will be more diversity in the trustee-led schemes
via diversified funds and lifecycle investing; thus veering themAt the far right are employee-led schemes where members

towards the employee-led schemes. Second, lifecycle investing

make the choices and bear all the risks.

will spread from the U.S. and the UK to other DC markets;

By their very nature, the employer-led schemes are largely

thus ensuring that their discretionary risk tools embracede-risked and will remain so. The trustee-led schemes, on the

non-discretionary elements.

other hand, were historically overweight in equities. The poor
returns of the past five years have been driving them towards
either diversified funds (Theme 5) or lifecycle investing.
The latter relies on advice-embedded products such as target

INTERVIEW QUOTES:“Like their peers in the DB space, trustees of the DC
schemes want to offload the risks one way or the other.”date, target risk and target income funds. Some follow a fixed
glide path on asset allocation that allows automatic rebalancingof portfolios in the event of turbulence. Some have a dynamic
path that allows discretionary rebalancing. Some embrace
LDI-lite vehicles that benchmark members’ liabilities. Somemove growth assets into cash and use the collateral to buy“The trustee-led schemes will switch from single
to multi-strategy portfolios that can withstand large
market shifts.”“Lifecycle investing will grow in Australia, Hong Kongand Europe.”

interest rate swaps—instead of wasting growth assets to buy
bonds when approaching retirement.

FIGURE 1.6 What will happen in the global DC space?
EMPLOYER-LED
SCHEMESTRUSTEE-LED
SCHEMESEMPLOYEE-LED
SCHEMES

Employer guarantees capitals Popular in countries
with a strongsavings cultures Popular in countries
with a clean slate startto pension plannings Popular in countries
with a strong
investment culture

Asset choices made by employers

s Focus on insuranceoriented products

s Focus on poolingthe investments

s Focus on
individual choices

Employer bears all risks

Employer guarantees contribution
Asset choices made by employees
Variable choices

Very cautious choices
Bonds predominate

Employee bears all risks

Exemplified by:
Belgium, Chile,
Germany, Switzerland

Exemplified by:Australia, Austria,
Denmark, South Africa

Exemplified by:Hong Kong, Japan,
the UK, the U.S.

Equities predominate

Source: Principal Global Investors/CREATE Survey 201211

THEME 7:

The asset industry has to dump some mental baggage
so as to improve its track record on volatility
The 2000s was a ‘lost decade’. To prevent its repeat, clients are

Few products have survived the panic buying and selling of thereconsidering their approaches, but they fear that, in pursuit ofpast four years, no matter what their intrinsic merits. Many havescale and scope, asset management has diluted its craft heritage

fallen prey to ‘wrong time’ risk. Also, the level of engagement

and the nimbleness essential to cope with volatility. Long-term

necessary to help clients to identify bargains has not been there

relationships have given way to brief affairs. Peer risk, agency riskin large swathes of the industry. There is a clear need for new

and skewed incentives have prevented a strategic understanding

ways of engagement to manage expectations on what can andof client needs. Funds are sold, not bought. Worse still, clients’

can’t be delivered in today’s volatile markets.

own herd instinct has not helped. They often make choices that

For their part, asset managers recognise that they can no longer

are contrary to their best interests.

rely on the fine print of their product prospectus to educate their

Remedial actions have been identified in four clusters thatclients. Winds of change are evident.

expressly recognise that investing in today’s markets is amassive leap of faith.

INTERVIEW QUOTES:The first cluster covers skills. It enjoins managers to enhance their“Will today’s new approaches prove to be justanother costly phase in our industry’s history?”

capabilities around price dislocation, improve their track recordon volatility and avoid unrealistic claims about returns.
The second cluster covers culture. It enjoins mangers to adopt“Our clients are not too worried about returning to
the table because we’re their co-investors who eat
while promoting common time horizons and investment beliefs.
our own cooking.”
meritocratic incentives that share pain and gain with their clients,

The third cluster covers structure. It enjoins managers toencourage nimbleness, free thinking and high conviction
investing within its talent pool.

“Client behaviours often seem like buying/sellinga bet on a horse half way through the race.”

The final cluster covers client engagement. It enjoins managers
to go beyond regular reporting and engage in issues thatdeliver mutual benefits (Figure 1.7).

FIGURE 1.7 What does greater client engagement mean in today’s market environment?

GREATER CLIENT ENGAGEMENT

Benefits for Managers
Understand their clients’ dreams and nightmares•

Solicit new ideas by tapping into clients’ investment expertise•

Manage expectations in what can and can’t be delivered•

Minimise ‘wrong time’ risk and ‘regret’ risk in buying and selling•

Communicate bespoke research that addresses unique issues
to clients•

Highlight proactive buying opportunities in periods of big
price dislocations

Source: Principal Global Investors/CREATE Survey 201212

MUTUAL BENEFITS•

Benefits for Clients•

Seek better alignment of interest via common beliefs and time horizons•

Obtain a second opinion on their asset allocation and correlation risks•

Gain deeper insights into what works at different stages of market cycle•

Develop mental agility to capitalise on periodic market dislocations•

Minimise behavioural biases and herd instincts provoked byperiodic volatility•

Understand the‘health warnings’ that are usually lost in the fine printof legal agreements

“History tells us that times of highrisks are also times of the big
opportunities. Our biggest challenge
is to convince our clients that intrinsic
value always triumphs in the end, butthey should not ignore opportunities”

thrown up in the meantime.
- AN INTERVIEW QUOTE

13

|

2 VOLATILITY DYNAMICS“

Of the 20 biggest daily upswings
in the S&P 500 since 1980,
10 have occurred in the last five
years. Similarly, of the 20 biggest
downswings, 13 have taken placein the last five years. Rarely havethe stock markets been so wild;
nor is there a precedence of somany asset classes fluctuating
so much and so uniformly.
- AN INTERVIEW QUOTE”HOW DO CLIENTS SEE IT?
OVERVIEW
Since the Lehman crash in 2008, markets have displayed unusual
volatility and unusual correlation. Asset classes have moved inlock-step. Price-earnings ratios have lacked sensible anchor points.
Fear, greed and stress have amplified market cycles.
Against this background, this section explores the views ofasset managers, pension plans, pension consultants and fund
distributors on four questions:• What factors will drive volatility in capital markets overthe next 3 years?
• As a result, what will be their clients’ predominant
approaches to risk?
• What tools are likely to be used by clients who choose
to de-risk their portfolios?
• What tools are likely to be used by clients who choose
to re-risk their portfolios?

14

KEY FINDINGS
Volatility Drivers
The strong rally in the first quarter of 2012 is already overshadowedby the latest banking crisis in Spain. So big is the current debt
overhang in the West that the deleveraging will be a long haul,
fraught with policy errors, political expediency and social turmoil• ‘Pragmatists’, who believe in momentum investing that
may or may not deliver more returns with no extra risks• ‘Purists’, who believe in long-term investing backed byshort-term fee compression• ‘Deflationsists’, who can’t wait to get out at an
opportune moment

over the rest of this decade.
In sum, like their asset managers, clients also see opportunity
Recent attempts have reshuffled the debt, not reduced it,

in volatility. But they need convincing that their managers cancausing it to remain the key driver of volatility in the 2010s.

deliver it.

It will be reinforced by others, too. These include: the unintended
effects of the new financial regulation, the globalisation of

De-Risking Portfolios

markets, and the fear of a ‘hard landing’ in China, high frequency

In the meantime, those who de-risk are likely to rely on a variety

trading and complex ETFs.

of avenues.

However, there is no clear consensus on their future impact in• DB clients will use LDI, diversification, and fiduciary management.

the light of the market rally in early 2012.

• DC clients will use advice-embedded products, diversification• 35% of our survey respondents still detect positive straws in thewind while recognising their inflationary consequences.
• 40% remain undecided. They do not rule out the possibility

and capital protection strategies.
• Retail clients, too, will rely on diversification, advice-embedded
products and capital preservation tools.

that markets may revert to their historical long-term state where
politics matter more than economics—as happened before thelong bull market that started in 1985. Yet, they do not rule out
a continuing recovery in the U.S. that could act as a locomotive
for Europe.
• 25% hold a pessimistic view. They envisage no clear directional

Notably, hedging tools—that deliver stop-loss mechanisms,
option contracts and structured products that limit upsides anddownsides—are likely to be used on a limited scale because of
their costs and counter-party risks.

Re-Risking Portfolios

shifts in the markets, as further quantitative easing merely piles

Similarly, those who re-risk their portfolios expect to use aup the current ‘cash mountains’ on both sides of the Atlantic.

variety of avenues.

Yet, one thing is clear: while investors worldwide have grown wearyof new risks, they are unwilling to forego a bargain when they see it.

• DB clients will use absolute return strategies, unconstrained
mandates, and high conviction approaches—while intensifyingpressure on fees. Reputation risk and career risk will limit the

It is reinforced by the widespread belief that successive bouts ofscale and scope of their re-risking endeavours, however.

volatility since the 2008 credit crunch have severely distorted
market valuations. The resulting price anomalies argue forblending caution with opportunism.

• DC clients will use glide path strategies, absolute return
approaches, and high conviction investing.
• Retail clients will use active trading strategies, absolute return

Dominant Risk Approaches

approaches and unconstrained mandates.

Some investors will de-risk their portfolios, some will re-risk
them, some will do both and some do neither. Notably, all

Style box investing will take a back seat, while the market cycles

client segments are likely to re-risk, at varying degrees.

remain wild.

On the whole, though, DB clients are more likely to de-risk;

In summary, some clients will aim to ramp up risks, some will

while DC clients and retail clients are more likely to re-risk as

aim to squeeze extra returns from their existing risk budgets

well as de-risk. This diversity reflects the emergence of fourand some will seek to drive down costs.

investor groups since 2008, as identified by individual asset
houses in our post-survey interviews:• ‘Adventurists’, who believe in contrarian investing andmarket timing during turmoil“”

20% of our clients do contrarian- AN INTERVIEW QUOTE
investing.

15

Political horizons, market horizons and investor horizons
are out of sync due to forces with no historical parallels
As we saw in the Executive Summary, the worst is far from over.

55% see high frequency trading as a significant source ofAt least nine in every ten respondents expect further upheavals

instability, arguing that if the May 2010 ‘flash crash’ had beenover the rest of this decade due to the current debt overhang.

a little later in the day, prices would not have had a chance
to recover before the U.S. markets closed, potentially causing

The first attempt by the U.S. Federal Reserve in 2009 merely

carnage when Asian and European markets opened the next day.

socialised the bank losses. The latest one by the European
Central Bank (ECB) has merely pre-empted sovereign defaults.

43% anticipate a hard landing in China in response to the asset

Debt shows no sign of going away, despite a good start in the

bubble at home and the economic turmoil in Europe, its largest

U.S. No wonder financial markets have been displaying a split

foreign market. But this does not rule out the scenario in which

personality via random bursts of risk-on/risk off trades unrelated

China transitions to a resilient consumption-led economy withto business fundamentals.

a rising yuan.

Our respondents expect volatility to persist over the next three

33% envisage ETFs to remain a notable source of instability

years under the joint impact of six political, economic and—especially when they rely on synthetic structures, excessive

structural factors (Figure 2.1):

leverage or inverse bets.

72% of respondents expect the sovereign debt crisis in Europe

As for the future, post-survey interviews with asset managers

and the U.S. to continue dogging the markets, since many key

identified three schools of thought:

governments either lack the necessary majority for swift actions (theU.S. and the UK) or the requisite governance mechanisms (Europe).

INTERVIEW QUOTES:

68% expect the Dodd Frank Act in the U.S. and the Solvency“Dodd Frank deals with too-big-to-fail but has ended
up too-big-to-read.”

II Directive in the European Union (EU) to create unintended
consequences that will hit market liquidity or force perverse
investment behaviours on the part of banks, insurance“The risk-based rules of Basel III and Solvency II will
herd investors into using the same tools to seek the
64% expect greater contagion susceptibility from globalisation,same outcomes.”
companies and pension plans.

as technology and 24-hour news cycles continue to amplify

investor mood swings and compress their decision spans from
calendar time to real time.

“High frequency trading is far removed from the realfunctions of the capital markets.”

FIGURE 2.1 What factors would drive volatility in capital markets over the next 3 years?

Sovereign debt crisis in Europe and the USA
Unintended fall-out from the new financial regulation
Greater contagion susceptibility from globalisation
High frequency trading
Economic problems in China
Use of ETFs
0

Source: Principal Global Investors/CREATE Survey 2012

16

10

20

30

40

50

% of respondents

60

70

80

72% expect sovereign debt
crisis to drive volatility

68% expect new regulation
to drive volatility

64% expect globalisation
to drive volatility

The ‘inflationists’ (35% of asset managers) detect positive

Unless quantitative easing rebalances the economies in the Weststraws in the wind via recovery in the U.S., debt resolution inaway from finance, there will be a repeat of the 2008 meltdown. For

Greece, and currency revaluation in China. They expect thenow, historic parameters and assumptions are not valid—this group

U.S. growth engine to lift Europe out of its current mire before

believes that there are more ways of losing money than making it.

long. But they expect inflation to accelerate as the current cash
mountain unwinds in the West.

Thus, there is no consensus about how markets will evolve fromhere on. The nascent rally in the first quarter of 2012 may fizzle

The ‘undecided’ (40% of asset managers) believe that the period

out like similar ones in the past two years. Or it may not, if the

1985-2007 may have been an historical aberration, thriving on

U.S. story gains traction. Only time will tell.

a rich stew of financial irresponsibility, political ineptitude, laxregulation and perverse incentives. These ramped up leverage,
causing a raging bull market. From here on, notions of fair value
may be driven more by politics than economics. But neither thegreed-fear cycle nor mean reversion is dead. This school believes
that blending caution with opportunism may not be such a bad
idea until the fog clears (”A view from the top”).
The ‘deflationists’ (25% of asset managers) describe the current
Western political dynamic as inertia at best and procrastination
at worst. They see deleveraging as a bumpy ride, causing
frequent policy errors and investor over-reactions, leaving few
directional shifts in the markets; with no certainty that the U.S.
will return to its long- term growth trajectory any time soon.
How can it be that the excessive leverage that got it into sucha sorry mess is also being relied upon to rescue it?

One thing is certain, though: having weathered many rollercoasterrides since the bear market of 2000, investors worldwide havegrown weary of new risks, but they haven’t given up chasing
a bargain when they see one. Most are sitting on the sidelines
watching events unfold and looking out for opportunities.

INTERVIEW QUOTES:“China remains a wild card: with a lot in its favour
and a lot against it.”
“QE2 stinks. It’ll stoke up inflation and debase ourcurrencies. But the alternatives are even worse.”“The U.S. will recover to the point at which it will
drag Europe out of its economic mire.”

A VIEW FROM THE TOP...
Financial markets have seen extreme volatility, with daily moves

liquidity and price discovery. Solvency II will disproportionately

of 3% to 5%. The ‘flash crash’ of May 2010 was the most

hit risky assets and perversely turn insurance companies anddramatic example, when the Dow tumbled by 990 points inpension plans into forced sellers in times of distress. The problems

about 5 minutes, only to snap back part of the way.

are compounded by high frequency trading and ETFs, which areThat apart, reactions to the debt crisis in America and Europe

amplifying directional velocity and market volatility.

have brought extreme spikes in market volatility and asset classHowever, we also see some positives on the horizon. The

correlations. These things have also happened in the past but

U.S. recovery is gathering momentum. The European Central

there is a big difference now: our governments have run out

Bank’s (ECB’s) Long Term Refinancing Operation has offeredof policy bullets. The lowest interest rates and highest budget

a breathing space to tackle Europe’s deep-seated debt anddeficits in living memory have not worked, forcing successivecompetitiveness malaise. China may well avoid a hard landing

rounds of quantitative easing. But, as in Japan, our households

since it is also doing a lot of things right.

and corporates are simply hoarding cash: they fear deflation.

But history tells us that times of high risks are also times of the

To compound the problem, there are other structural forces at

big opportunities. Our biggest challenge is to convince our clients

work; regulatory creep being one of them. The sheer complexitythat intrinsic value always triumphs in the end, but they shouldof the Dodd Frank Act makes you wonder what its eventual rule

not ignore opportunities thrown up in the meantime.

book will look like. The Volcker Rule, in particular, will hit market– A GLOBAL ASSET MANAGER

17

Investors are being pragmatic in the face of too many
wild variables that cannot be modelled on a spreadsheet
As discussed in the Executive Summary, a very large majority

and 19% expect them to re-risk. A notable 35% expect bothof our respondents believe that the current volatility offers

approaches to prevail while 21% expect neither to prevail.

an opportunity to achieve good returns for their clients.

De-risking is more likely on the Continent where DC plans are

However, they also recognise that things are viewed

managed by trustees, who tend to prefer safer insurance-based

differently by the client.

investment options and higher contributions. Re-risking is more likely

After a turbulent decade, end-investors have learnt that thein the U.S. and the UK where target date funds with fixed glide paths

timing of entry points and exit points have a big impact on

automatically increase allocations to equities when they are down.

returns. Some have learnt that it pays to be bold when others are
fearful. Some accept that every crisis is a concealed opportunity.
Yet, others display the once bitten, twice shy mentality. Investor
expectations are adaptive and eclectic across the risk spectrum.

The pragmatic re-risking and de-risking is more likely in Australia
where the 70:30 equity-bond mix is being gradually replaced bya more dynamic version of the old style balanced funds.

This much is clear when our respondents were asked to identify

Finally, 33% expect their retail clients to de-risk, against a hefty

the predominant approaches that are likely to be adopted by their

38% who expect an eclectic approach. Regionally, de-risking

three core client segments over the next three years (Figure 2.2).

will be more prevalent in Europe, re-risking in Asia, and theTaking each segment in turn, 46% of our respondents expect theireclectic mix in Europe and the U.S.

DB clients to de-risk their portfolios in this era of frequent volatility

We encountered examples of clients capitalising on bothand only 9% expect them to re-risk. Notably, a further 39% expect

temporal volatility via market timing and cross-sectional

both de-risking and re-risking. And a tiny 6% expect neither.

volatility via portfolio rebalancing since 2008.

There are differences between the countries as well as withinthem. The emphasis on de-risking is evident in Europe and Asia
where the recovery periods allowed under pension regulations
are shorter in the event of deficits. In Asia (excluding Japan),DB plans remain home-biased, peer-biased and bond-biased.

INTERVIEW QUOTES:“Everyone’s fearful about markets. Yet few are willingto miss the next rally.”

The emphasis on re-risking is evident in the U.S., especially inthe public sector plans with big deficits and mounting politicalpressure to tackle them. A pragmatic re-risking and de-risking“Black Swans await those who ignore the sources of
the current global malaise.”

will be the norm in all regions
Moving on to DC clients, the picture is different. 25% of the
respondents expect their clients to de-risk their portfolios

FIGURE 2.2“Risk as we know it now was not factored into
returns historically. Its metrics ignored the dynamicside of risk.”

50

Over the next 3 years, what will
be your clients’ predominant
approaches to risk?

DB Clients40% of respondents

DC Clients
Retail Clients

30

20

10

0
Source: Principal Global Investors/CREATE Survey 201218

De-risk

Re-risk

Both

Neither

46% expect DB clientsto de-risk

35% expect DC clients tode-risk and re-risk

38% expect retail clientsto de-risk and re-risk

Research done within individual asset houses, reported in

DB plans planning buy-out options; and retail clients in their

the Executive Summary revealed the prevalence of fourlate accumulation phase, as exemplified by mutual funds in the

behavioural groups:

U.S., which recorded net outflows for a fifth straight year in 2011.

• Adventurists (5%): they believe that the risk pendulum

The numbers associated with each camp are indicative, nothas swung too far in the wrong direction, distorting asset

definitive. However, they show that clients have a moreprices and rewarding market timing via contrarian investing.

discerning approach to volatility, being gripped by uncertainty

Examples of such investors came from retail clients in Asia

like their asset managers. Their time honoured behaviouraland high net worth individuals in Europe.

traits—opportunism, herding and prudence—have yet to be• Pragmatists (30%): they believe in value investing but fear valuedented by successive bouts of volatility. But they need to be

traps caused by price dislocations. So, they are keen to capture theconvinced that their managers understand their needs andbandwagon effect while momentum is working. Examples of suchknow how to meet them in a volatile environment. We returninvestors came from all client segments and regions.

to this point in Section 4.

• Purists (45%): they remain buy-and-hold investors and see
volatility as a mug’s game. They have done rebalancing topursue value investing and liability matching, without incurring
extra risks. Examples came from the DB space in Canada,
Japan, Europe and the U.S., and the DC space in the U.S.

INTERVIEW QUOTES:“The cash mountain is getting bigger everywhere.
The key concern is whether all this money can be
put to good use.”• Pessimists (20%): for them, risk failed to generate returns
in the last decade. The traditional return drivers—like risk
premia, diversification and bar belling—have lost their hypnotic
appeal. They see a large lumpy risk legacy where any initial“Times of high risks are also times of big opportunities.
Clients know that. But it’s a matter of once bitten,
twice shy.”market bounce will not last long. They can’t wait to get out
when the time is right. Examples came from private sector“Unconstrained mandates are on the rise.”

A VIEW FROM THE TOP...
The debt crisis in the EU has forced our coverage ratio into

The second choice is to squeeze more juice out of our existing

uncharted territory. There are definitely new forces at work that

assets. This is the investor’s equivalent of the Holy Grail: getting

make investing more erratic in this decade. At the same time,

additional alpha without taking on further beta risks. We’re

our room to manoeuvre is restricted by the tough Dutchdoing this by using fundamental indices, pursuing long-term

regulatory regime. It not only requires us to have a minimum

themes and a diverse asset base to create ‘smart betas’ thatcoverage ratio of 105% and a risk-free discount rate fordeliver cheap alpha. This approach is also used to make tactical

calculating our future liabilities. It also enjoins us to have capital

rebalancing when we spot bargains in the markets.

buffers as we venture into risky or illiquid assets—as now being
proposed in the Solvency II regime for all the pension planson the Continent.

The final option is to squeeze our costs: get existing returns at
a reduced fee. We’re in-sourcing many of our active strategies
and switching them into the smart beta bucket, which is now

So, we’re left with three options. The first one is to dial up theby far the largest one. We’re also recruiting smart managers who

risk. This means venturing further out on the risk frontier via

can help us develop new absolute returns strategies, with low

higher yielding assets, as done by the iconic Yale Foundation

volatility. Our biggest problem is to find out what constitutes ain the last two decades. But our trustees would have none of it

bargain when there have been no sensible anchor points forbecause our earlier forays into alternatives were hit by the mass

P/E ratios in the last 10 years.

redemptions in 2008 when liquidity dried up.

– A DUTCH PENSION PLAN

19

De-risking will rely on the refinements of old tools
Before looking at the specific tools, there are two general points

Starting with DB clients, more than two in five survey

to make about the de-risking tools that are likely to be used

respondents cite LDI, fiduciary management and robust

over the next three years.

stress tests as the most likely tools. Taking them in turn,
LDI will be morphing into a holistic balance sheet tool, while

First, in all client segments, the key tool will be diversification(Figure 2.3). Its newer version is deemed superior to the old one
crushed by the Lehman crash. It will focus more on managing
risks than targeting returns; conserving capital than growing it;
connecting the dots between asset classes than seeing them as
exclusive entities; blending top-down and bottom-up styles thanproviding a dynamic hedging strategy in light of changing
funding ratios. So far, these changes are confined to Europe.
But they will spread to Japan, South Korea and the U.S., asever more plans migrate to mark-to-market rules. LDI will
gain traction in Asia.

treating them as rivals (“A view from the top” on the facing page).
The new version will have a macro overlay on stock picking.

INTERVIEW QUOTES:The second general point relates to overt hedging tools such

“In this inter-connected world, it’s hard to connect thedots on all conceivable risks.”

as stop-loss mechanisms with clear thresholds, option contracts,
and structured products that limit upsides and downsides.
Contrary to their inherent appeal, their cost and counter-party
risks vary directly with volatility. As such, their use is likely to be
somewhat limited.
As for the rest of the tools, their use will see refinements of theold tools within different client segments (Figure 2.3).

FIGURE 2.3“Options contracts or stop-loss tools are expensive:with no sucker at the other end.”“Our LDI pipeline has grown from $6bn to $26bn
in two years.”

DB CLIENTS
Liability driven investing

What tools and approaches
are likely to be adopted byclients who choose to de-risk
their portfolios?

Significant diversification
Fiduciary management
Stress tests that use extreme scenarios
Longevity insurance/swaps
Full or partial insurance buy-out
Capital preservation strategies
DC CLIENTSAdvice embedded products
Significant diversification
Capital preservation strategies
High liquidity strategies
Fiduciary management
Stress tests that use extreme scenarios

Structured products limiting downsides and upsides
RETAIL CLIENTS
Significant diversification
Advice embedded products
Capital preservation strategies
Structured products limiting downsides and upsides
High liquidity strategies
Stop loss mechanisms with clear thresholds
Option contracts with asymmetric bets
Source: Principal Global Investors/CREATE Survey 2012

0

10

20

30

% of respondents

20

40

50

60

57% expect DB clients to
use LDI55% expect DC clients to use
advice-embedded products

48% expect retail clients todiversify significantly

Second, fiduciary management will be gaining traction outside

Moving on to the retail clients, more than three in every

the Netherlands, as newer mandates link the manager’s

ten respondents cite advice embedded products, capital

incentives with the solvency ratio of the client. Finally, stresspreservation strategies, and structured products as the mosttests will focus on geo-politics as well as macroeconomics.

likely tools for de-risking—for reasons that are similar to theones cited for DC clients.

Moving to DC clients, more than one in three respondents
cites the established advice-embedded products and capital

Notably, outside the U.S., the advice infrastructure is likely topreservation strategies as the most likely tools for de-risking.

improve in Hong Kong, the Netherlands and the UK due to new

These reflect the growing popularity of target date funds

regulations. In the past, clients were rarely advised to sell andwhose asset allocation varies with the age of clients, thereby

cash out. When they were, advisors’ choices were marred byminimising herd instinct and investor foibles so common in

conflicts of interest. Thus new tools will evolve alongside the old.

the 1990s. Some of these products will be LDI-lite by targeting
retirement income and capital conservation at various phases of

INTERVIEW QUOTES:

the glide path. Their use will spread from the U.S. to Australia,
Hong Kong, the Netherlands, South Korea, Taiwan and the UK.
On the Continent, the DC market will grow rapidly over the
next three years, especially in Belgium, France, Germany, Italy
and Scandinavia. Currently, capital preservation remains a
key end-goal and insurance contracts the preferred means.
However, growth is expected to promote diversity: employeeled DC products, where individuals bear all the risks—as inAustralia, the UK and the U.S.—are likely to become more

“In the last decade, risk failed to generate returns. So
the burden of proof has increased for asset managers.”“We’ll fail if we equate risk with opportunity. Today,risk also means unknown outcomes.”“Most of today’s de-risking tools have not had a mid-lifecrisis yet. We don’t know what they will eventually deliver.”visible in the Continental DC landscape.

A VIEW FROM THE TOP...
The biggest debt mountain we’ve known is being unwound at

funds in the DC space. A new broad-based diversification isa snail’s pace. Today, policy makers do not have the means toemerging, akin to the old style balanced mandate, but withreboot the global economy. We need growth to improve the public

four differences: a wider range of assets, frequent tactical tilts,

balance sheets. We need inflation to vaporise the debt. We needabsolute-return benchmarks and absolute-risk focus.

defaults to reduce the uncertainty. We need structural reforms
to ensure that weaker nations do not live beyond their means.
Instead, there is back-sliding on reforms.

A growing number of clients are also resorting to liability-driven
investing, in which the risk-budget approach is embedded in the
returns-enhancing portfolio. The popularity of LDI was initially

Our clients have learnt painfully that the term ‘market risk’ now

driven by the European DB plans when interest rates were high,involves all the things that can go wrong. That means looking wellwith a strong likelihood of decline. But even at today’s low levels,

beyond the normal macro risk factors. Nothing is an opportunity

our clients are continuously seeking to lock their assets into theirunless you understand the sources of risks, their likelihood, their

liabilities and escape the tyranny of relative returns and peer

potential impact and their mitigating tools. Our DB clients, onbenchmarks, at a time when up to 80% of changes in their

the whole, are de-risking, since there are too many contingent

funding ratios come from interest rate movements.

events, which may or may not happen. If they do, they can kill theportfolios. It is wiser to de-risk and extend the liability horizon.

Clients are also showing interest in fiduciary management.
These are small and mid-size plans which have neither the skills

So, clients are changing the asset allocation approach: asset

nor the governance nor the nimbleness to make ends meet inclasses are now being replaced by risk budgets. Everything is stress

today’s volatile environment. They see fiduciary management

tested to death to distinguish factors that can generate alphaas a sound way to access the right expertise and enjoy scalefrom those that can kill it. The emphasis is on risk minimisation

economies in the process.

rather than return maximisation. The new approach favours
multi-asset class funds in the DB space and diversified growth– A GLOBAL PENSION CONSULTANCY21

No client segment wants to miss the next rally eventhough caution is the new watchword
All client segments have learnt one lesson: it is unwise to ignore

investing (32%). They will be favoured by pension plans which

the power of mean reversion, since intrinsic value always shows up

have been the biggest victims of a double squeeze: falling value

in the end; but it is equally unwise to bank on it, in the light of theon the asset side and falling discount rate on the liability side.

random bursts of risk-on/risk-off trades of the past three years.

In the DC segment, nearly one in two respondents expect

Opportunism will prevail. So far, its degree is not big enough to

re-risking via the adoption of more glide path strategies inmake a large difference to client portfolios either way. The neartarget date funds.

30% drop in equity volatility as measured by the Chicago Board
of Exchange’s VIX, taking it below the psychological threshold

INTERVIEW QUOTES:

of 20 in January 2012, is a welcome development. Some asset
managers view that as a game changer, others, as the lull

“The risk pendulum has swung too far in the wrong
direction causing over-reactions.”

before the storm.
In the absence of another August 2011 type meltdown, our
respondents expect their clients in all three segments to re-risk
their portfolios over the next three years (Figure 2.4).
In the DB segment, more than one in three respondents
expect their clients to pursue one or more of four strategies:
absolute returns (45%), unconstrained mandates (37%), active“The ultra-safe sovereign debt pool has fallen by
70% in the space of six months.”“The timing of the entry point and exit point
determine returns; nothing else.”

trading strategies like hedge funds (34%), and high conviction

FIGURE 2.4

DB CLIENTSWhat tools and approaches
are likely to be adopted byclients who choose to re-risk
their portfolios?

Absolute returns strategies (e.g. Libor +)Unconstrained mandates (benchmark agnostic)
Active trading strategies (e.g. hedge funds)
High conviction strategies
Volatility regimes around business cycles
Volatility indices (e.g. Vix tracking, S&P 500)
Strategies using derivatives, leverage and shorting
DC CLIENTS
Dynamic glide path strategies
Absolute returns strategies (e.g. Libor +)High conviction strategies
Unconstrained mandates (benchmark agnostic)
Active trading strategies (e.g. hedge funds)

Thematic plays pursuing specific sectors, thesis or regions
Volatility regimes around business cycles
RETAIL CLIENTS
Active trading strategies (e.g. hedge funds)
Absolute returns strategies (e.g. Libor +)Thematic plays pursuing specific sectors, thesis or regions
Unconstrained mandates (benchmark agnostic)
High conviction strategies
Dynamic glide path strategies
Volatility indices (e.g. Vix tracking, S&P 500)
0

10

20

30

% of respondents
Source: Principal Global Investors/CREATE Survey 2012

22

40

50

45% expect DB clients to use
absolute returns strategies

48% expect DC clients to use
dynamic glide path strategies

34% expect retail clients to
use active trading strategies

These are likely to embrace LDI-lite vehicles that aim to

relevance in today’s climate where the past is a poor guidebenchmark implicit liabilities of the member, by targeting a pre-to the future. Outside the U.S., style box investing has lost its

set level of retirement income. They will also have the discretion

bloom, at least for now.

to change the pre-set asset allocation formula to prevent losses
from potential major market events. These changes are in
the pipeline in the UK and the U.S. However, high conviction
investing is likely to be more popular in the trustee-based plansin Australia, the Netherlands and Scandinavia. In Australia,
the weaknesses of the old 70:30 equity-bond formula chasing
relative returns have been exposed dramatically in the past
four years. Superannuation funds are now considering more

Second, many DB plans in Canada, Japan, South Korea, the UK
and the U.S. find it hard to become more adventurous becauseof the career-risk and reputation-risk of their boards. In somecases, neither their committee structures nor their sponsor
covenants permit anything more than periodic rebalancing, andthen only after a big review. The required degree of nimblenessfor re-risking is just not there.

dynamic approaches that target CPI plus 3% (p. 29).

INTERVIEW QUOTES:
Finally, in the retail segment, the incidence of re-risking
is likely to be lower. Around one in every three respondents
expect their clients to pursue active trading strategies (34%),“There’s a pile of cash waiting for the green light: nobody
wants to miss the big bounce when it comes.”

absolute returns strategies (28%), or thematic plays on sectors
or regions. Such re-risking is more likely in Europe and the
U.S.—although clients will require a lot of convincing, as we shall“Sooner or later, pension plans will have to dial up riskor seek extra cash from their sponsors.”

see in Section 4.
In our post-survey interviews, two pertinent points emerged.
First, the well-groomed style box investing approach has less“In hindsight, periods of market distress have been goodentry points.”

A VIEW FROM THE TOP...
A DC plan is very different from a DB plan in who bears the

Accordingly, two innovations are likely over the next three years,

investment risk. That does not mean that it can’t borrowboth of which will improve the risk approaches implicit in the glide

innovations from its older cousin.

path strategies.

The target date DC funds, based on a pre-set glide path, haveFirst, the current target date funds will also have a clear

proved superior to the traditional approach, where individuals

retirement income benchmark, akin to liabilities in DB plans. Assetmake their own asset allocation decisions. Its ‘set-it/forget-it’

allocation will be outcome driven. It will aim to deliver a minimum

mechanism adapts investors’ risk profile to their age—starting out

acceptable level of income in retirement relative to the income

with aggressive equities and switching to cautious bonds nearer

earned in employment. This implied replacement ratio will become

the retirement date. This has prevented poor asset allocation

the de facto liability benchmark against which asset allocation will

choices, driven by herd instinct that was rife in the 1990s.

be adjusted on a discretionary basis.

From the volatility standpoint, these funds have also had

Second, the resulting dynamic glide path will bring LDI-lite

another spin-off. Their pre-set allocation formula buys equities

structures into the DC space. They will move growth assets into

when markets are down and sells them when they are up. Such

cash and use the collateral to buy interest rate swaps. The current

automatic re-risking has proved beneficial in the aftermath of themethod of using growth assets to buy bonds prevents the pot size

2008 market collapse.

from getting bigger on approach to retirement.

They are now likely to witness further improvements. The glide

The automatic re-risking mechanism in the current glide path

path is perceived as overly oriented towards the target retirement

strategies will embody a discretionary element to boost the returns

date rather than the target retirement pot. The latter is implicit.

and target a pre-set income ratio.

Furthermore, the path has no automatic mechanism to ring-fence
the accumulated gains at the time of big market upheavals.

– A UK ASSET MANAGER

23

MAKINGA
VIRTUE
OUT
3 OF NECESSITY|“ ”

Being contrarian pays: after goingoverweight in equities in 2009, ourfund has surged 23%.
- AN INTERVIEW QUOTE

HOW WILL RE-RISKING AND
DE-RISKING PAN OUT?
OVERVIEW
Clients see a silver lining in the volatility cloud. But they arealso plagued by uncertainty.
Lack of consensus on economic outlook suggests that markets cango either way in the foreseeable future. Regular bouts of risk-on/
risk-off trades since 2009 have thrown up bargains for thosebrave enough to act. Most of all, such bouts may well become an
important feature of the investment landscape.
Against this background, this section aims to identify the strategies
that are likely to be used by clients to pursue:• Short-term opportunism. This may involve market timing or
portfolio rebalancing or both. These may involve dialling up risk
and/or squeezing extra returns out of existing risks.

24• Medium-term asset allocation. This may involve individual
or multi-asset class strategies.
The report focuses on four investor segments:

Those that are managed by individual members will proceedalong two separate tracks:• Those using target date funds will do automatic re-risking
and de-risking through the glide path mechanism• DB clients• DC clients• Those doing their own asset allocation will also do
discretionary rebalancing.

• Retail clients• High net worth clients

Over time, however, the discretionary element is likely to diminish,
as target date funds increasingly become the default option.

KEY FINDINGS

Retail Clients

DB Clients

Retail clients are expected to err on the side of caution, on the

Banks are likely to offload their asset-backed mortgage(ABM) securities and loan books to meet the new solvency

whole, with periodic bouts of opportunism. But there will be aclear divide between the West and the East.

margins under Basel III. In response, DB clients are likely

Those in the West have become over cautious in the wake ofto move up the risk curve and go opportunistic in thepast losses and impending retirement. A large cohort will soon

credit space dominated by distressed debt, high yield

be migrating from the accumulation to the decumulation phase.

bonds and the ‘secondaries’ in real estate, private equity,

But they may well pursue risk-on trades when opportune.

commercial mortgages, collateralized loan obligations(CLOs) and senior debt.

In contrast, in the East, notions like de-risking and re-risking are
far removed from the reality on the ground. Driven by client

Alongside such opportunism, those DB clients taking an

foibles, all investing is opportunistic. It is unlikely to change in

optimistic view are also likely to tilt heavily in the direction

the absence of more financial education.

of equities in their medium-term asset allocation. Equities
may well re-emerge from their recent ice age.
Those DB clients who take a pessimistic view of the
future will favour minimum variance equities, macro
hedge funds, global tactical asset allocation (GTAA) anddistressed debt.
Emerging market equities are likely to be accessed via ETFs
as a cost effective means to capitalise on new bursts ofmomentum. However, there are concerns about ETFs as asource of volatility. Their leveraged versions are seen as
market setters, rather than market followers.

DC Clients
DC clients are expected to adopt a variety of approaches toreflect their diversity.
Those that guarantee nominal returns via insurance contracts
are already de-risked and expect no change.
Those that are run by trustees will aim to de-risk theirportfolios while investing in structures that permit re-risking

High Net Worth Clients
They, too, will remain ultra-cautious in the face of volatility,
but this will be punctuated by periodic opportunism. Thosein the developed markets remain to be convinced that theirwealth managers can convert volatility into an opportunity.
In contrast, those in the emerging markets attribute their poor
returns in the recent past to structural forces that work againstclient interests. Better returns will require a rapid transition froma savings culture to a buy-and-hold culture.

“”

Stocks are at their most attractive- AN INTERVIEW QUOTE
in 50 years.

as, and when, required.

25

Equities will bounce back but credit will also
remain attractive
When asked to identify asset classes that are likely to be chosen
by their DB clients, our respondents drew a distinction between
those that would be targeted for short-term opportunism andthose for medium-term asset allocation (Figure 3.1).

Behind these numbers lie five salient points.
First, it is widely held that equities are due for a generationalbull market. Volatility has driven out swathes of panic sellers
since 2008. In the U.S. alone, equity mutual funds have seen net

The ‘adventurists’ and ‘pragmatists’ (p.19) are more likely tooutflows since 2008, despite the near doubling in the stock market

target the first group and the ‘purists’ the second.

since the March 2009 low. Fear has obscured the fundamentals.
But on a three to five year view, equities look cheap, according

Six asset classes that are likely to be targeted forto the ‘pragmatists.’ They are already rebalancing in favour ofopportunism include:

minimum-variance equities that have outperformed their high• Distressed debt (43%)

volatility peers since 1926. The ‘purists‘ will favour minimum• ETFs (37%)

variance equities, macro hedge funds, GTAA and distressed debt.

• Emerging market equities (30%)

INTERVIEW QUOTES:• High yield bonds (29%)“An equities bounce is long overdue. Bond prices
defy logic.”• Currency funds (29%)• Hedge funds (27%)“Since 2000, cash has outperformed equities inour portfolio.”

In contrast, four that are likely to be targeted for
asset allocation are:
• Global equities (58%)“You can’t have good returns without taking risk.
But we need to know what that risk is and what
its pay-off is.”• Equities with emerging market revenue (54%)• High income equities (46%)• Emerging market equities (43%)

FIGURE 3.1 Which asset classes and generic products are most likely to be chosen by your DB clients for short-term
opportunism and which ones are likely to be chosen for medium-term asset allocation?
Global equities
Global equities with emerging market revenues
High income equities
Emerging market bonds
Emerging market equities
Infrastructure
Real estate (inc. CMBS nearing redemption)
Global tactical asset allocation products
Investment grade bonds
Government bonds
Indexed / enhanced indexed equities
Private equity
Hedge funds
High yield bonds
Opportunism

Commodity funds
Exchange traded funds

Asset Allocation

Currency funds
Distressed debt
Source: Principal Global Investors/CREATE Survey 2012

-50

-40

-30

-20

-10

0

10

% of respondents

26

20

30

40

50

60

58% expect their DB clientsto use global equities in theirasset allocation

43% expect their DB clientsto use distressed debt inopportunistic investing

37% expect their DB clientsto use ETFs in theiropportunistic investing

Second, DB clients have also been moving up the risk curve inrather than outperform them, and offer low cost exposure tosearch of yield in the credit space. The ‘secondaries’ in private

different markets is widely recognised. On the flip side, there

equity, commercial mortgages, CLOs, and senior debt areare concerns about ETFs as a source of volatility. While the leverage

expected to notch up good returns as banks offload their ABM

and inverse funds make up just 3% of ETF assets, they account for

securities and loan books; and replace them with ‘covered’around 15% of ETF trading. Investors hold them for an average ofbonds to meet the new solvency margins under Basel III. Some

3 days, compared with 16 days for plain vanilla versions.

$1.5 trillion of credit is likely to materialise in Europe alone overFinally, for DB clients, preference for one asset class overthe next 5 years. Investors are already eyeing the $125 billion

another is increasingly spurious, as they resort to a broad

junk bond market. Besides, borrowers are now favouring bonds

diversification (“A view from the top” below). The old styleover loans due to favourable coupons, quicker deal process andbalanced mandates will stage a reincarnation with a variety of

ample liquidity in bond markets. These will see far more re-asset classes, tactical tilts and a focus on absolute risks.

risking than the equity markets.

INTERVIEW QUOTES:

Third, anything up to 50% investment in the emerging markets
will be via ETFs. They will aim to capitalise on frequent burstsof momentum via cheaper options and better liquidity. Besides,
as the S&P 500 has far outperformed BRIC equities since 2008,
they no longer offer a free lunch. Their correlation with thedeveloped markets has risen steadily towards 0.9.
Fourth, ETFs will be increasingly seen as a mixed blessing. Their“Fundamental credit is strong. But it’s dogged byirrational fears about Europe and America.”“We select funds rather than managers. This allows
a lot of opportunism within a diversified portfolio atmuch lower costs.”

ability to slice and dice the investment landscape, track indices“The index universe is excessively fuelled by ETFs. Far
from tracking the markets, they’re leading them.”

A VIEW FROM THE TOP...
Our funding levels had a double whammy. The S&P 500 index

experience an unusual second recovery over the next three years,

returned 2.7% p.a. over the past decade, including re-invested

after a weak one in the last three years. We also see potential in

dividends, compared with our target rate of 12%. We had

the credit space as banks retreat to beef up their balance sheets

assumed a discount rate of 8% for calculating our liabilities,

under Basel III.

which also turned out to be too optimistic. This was before the
big losses in 2011. Our funding ratio is now so low that we would
need a 30-year recovery period in the absence of big changes.
So we’ve changed our asset allocation approach. To start with,
we no longer believe that volatility and correlations among asset
classes will follow their historical norms. We’ve gone from asset
diversification to risk diversification by adopting five risk buckets.
The first one covers assets that provide ready liquidity in times
of extreme volatility. They include cash and Treasuries. The
second bucket covers inflation-proof assets like commodities andinfrastructure. The third bucket covers fixed income assets thatprovide a steady cash flow. The fourth one covers real assets like
property and forestry that deliver high illiquidity premia. The final
bucket includes growth assets like equities. A large chunk of ourassets are now in this growth bucket because we believe that the
U.S. economy may well be on the verge of a come-back. It may

This form of diversification also incorporates a time element, since
the markets can turn on a dime. So, within the buckets, we havea mix of short-term assets like cash and Treasuries; medium-term
assets such as stocks with safe and rising dividend payouts; andlong-term assets with a deep value bent.
Finally, our diversification is significant within as well as
between the buckets. It involves both single and multi-asset
class strategies. It involves risk parity portfolios that include goldand leverage on low-risk assets. It also permits opportunistic
rebalancing within and between the buckets. In the immediate
aftermath of the Lehman debacle, we became ultra-cautious. As
events have unfolded, we’ve learnt that volatility is here to stay
and we have to make a virtue out of necessity. We’re replacing
benchmark-related measures, e.g. tracking error and information
ratio, with measures that focus on absolute risk.
– A U.S. PUBLIC SECTOR PENSION PLAN

27

In the DC landscape, automatic re-risking will
be more prevalent than discretionary re-risking
Three broad segments define the global DC spectrum today.

very broad diversification across risk buckets with regular

At one end are employer-led schemes where employers

tactical tilts. Other countries in this group will follow suit, as

guarantee the nominal returns on investments. Such schemes

they reduce overall risk in their portfolios but with the flexibility

are popular in Belgium, Chile, Denmark, Germany, Slovenia

to re-risk when opportune.

and Switzerland.

Finally, the employee-led schemes will see limited opportunism

In between sit the pooled trustee-led schemes where(Figure 3.2). It will occur via automatic as well as discretionary

investment decisions rely on trustees or default options, withmeans. The automatic ones will rely on a fixed glide path inmembers bearing all the risks. Such schemes exist in Austria,

target date, target risk and target income funds. They will

Australia and South Africa.

rebalance their portfolios: buying equities when they fall andselling when they rise. These funds are likely to become moreAt the other extreme are employee-led schemes, where
members make the investment choices and bear the associatedrisks via individual accounts. Such schemes are popular in Hongpopular in the English-speaking world, where they are viewed
as advice-embedded products. On the other hand, their closest
competitors, diversified growth funds, relying on a very broad

Kong, Ireland, Japan, Sweden, the UK and the U.S.

diversification, are likely to grow in popularity on the Continent.
This diversity, in turn, will influence their approach to risk overthe next three years.

INTERVIEW QUOTES:Taking them in turn, the employer-led schemes are alreadyde-risked to start with, given their nature. By law, most of them
are invested in long-term insurance contracts, with a strong“Trustees want to offload the risk on the individual. The
middle ground in the DC space will shrink over time.”

focus on fixed income.
In contrast, the trustee-led schemes will increase diversification.
Those in Australia expect to move away from the 70:30
equity-bond mix that has proved too risky in the aftermathof 2008 (“A view from the top” on the facing page). They
will migrate to structures similar to diversified growth funds in
the UK or multi-asset class vehicles in the U.S. These allow“Individuals who manage their own plans end up withlow plan balances due to poor asset allocation andtiming choices.”“Without intelligent rebalancing, opportunism can bevery costly in DC schemes.”

FIGURE 3.2 Which asset classes and generic products are most likely to be chosen by your DC clients for short-term
opportunism and which ones are likely to be chosen for medium-term asset allocation?

Target date retirement funds
Equities
Diversified growth funds
Bonds
Target risk retirement funds
Customised investment/self managed plans
Target income retirement funds
Opportunism

Guaranteed insurance contracts
Deferred annuities

Asset Allocation

Cash-like products-20
Source: Principal Global Investors/CREATE Survey 2012

28

-10

0

10

20

% of respondents

30

40

50

60

52% expect their DC clientsto use target date funds intheir asset allocation

49% expect their DC clientsto use equity funds in theirasset allocation

20% expect their DC clientsto use equity funds inopportunistic investing

Finally, the discretionary rebalancing will occur in schemes

The DC landscape will polarise over time between employer-led

where members manage their own funds—as in Hong Kong,and employee-led schemes.

the UK and the U.S. Like retail clients (p. 30), they remain

INTERVIEW QUOTES:

prone to herd behaviours: buying high, selling low, thus
inadvertently burning their portfolios regularly. To counter
that, the 2006 Pension Protection Act in the U.S. overtly
endorses target date funds, as does the new National
Employment Savings Trust in the UK.
As a result, the target date funds will come to dominate default
options over time. Even trustee-led schemes are likely to move

“The employer-led schemes sound great. But they arelike savings accounts with little investment content
and meagre returns.”“Trustee-led schemes are either too cautious (Europe)or too risky (Australia). Both are changing.”

in that direction over time, since their current plan balances are
deemed too low to buy a decent annuity on retirement.

“Over time, target date funds will become the default
option in most DC countries.”

A VIEW FROM THE TOP...
Investment strategies pursued by many Australian superannuationreference to his/her age, financial circumstances or retirement

funds (“supers”) appear to say one thing, but do another.

needs. Such uniformity worked so long as the markets were

Nearly every fund has a return target expressed as inflation
plus 3% but their investments are generally managed andassessed against peers on an annual basis. Members have theoption to switch funds, but very few ever do. So there has been
little pressure to reduce peer bias, at least until recently. The

booming. But it has caused a lot of soul searching since theGreat Financial Crash of 2008. One state government fundhas already broken ranks by taking the bold step of looking atlifecycle investing—popular in the USA—and ditching the peer
league tables. Others may follow soon.

resulting short-termism has forced many supers to be more

Accordingly, the DC segment will become more diverse,

worried about the financial risk of their businesses and thealbeit gradually. Self-managed plans will exist alongside trustee-

career risk of their executives than with generating the returns

managed plans; lifestyle products will exist alongside pooledthat members are led to expect.

assets; advice-embedded products will exist alongside mechanicalSupers’ default options typically have a mechanical allocationof a 70:30 equity-bond mix. Over 80% of members use thisdefault funds. Consolidation among the supers will accelerate,since the current industry structure only works in a bull market.

option, such that it holds 70% of assets across all supers. Such

The key challenge for the supers now is two-fold: they need to de-risk

peer-herding has long ignored a big undiversified equity risk. It

their portfolios that have long been weighed down by equity risk;

didn’t matter in a period like 1990-2007, when a raging bullthey also need to find smarter ways of investing that deliver absolutemarket delivered double-digit returns almost year-on-year. Since

returns at times when simple cash products fetch around 5%.

then, however, outcomes have been sub-par. Most of the default
funds have neither met their real return objective nor performed
well against low-cost cash funds over five, seven or 10-year periods.

Supers are responding by re-examining their asset allocation
approaches. Old-style balanced mandates are being re-adapted
under the guise of diversified growth funds. The aim is to achieve

Unsurprisingly, many people are opting to manage theirbroad diversification via separate risk buckets, encompassing

own funds in a Self-Managed Super Fund, akin to a private

a wide array of assets that lend themselves to periodic tacticalretirement plan in Sweden, the UK or the U.S. From a late start,

switches. Risk parity portfolios are using leverage on safer assets.

this option already holds more than a third of Aus$1.4 trillion

As in Europe and the U.S., a new form of diversification is comingof total super assets in Australia.

to Australia that offers re-risking and de-risking within a broad

Another contributory factor is the one-size-fits-all approach.
The fund of each member is managed similarly, with noproduct structure.
– AN AUSTRALIAN ASSET MANAGER

29

Risk will divide the retail markets between East and West
The investment choices of retail clients will err on the side

On the other hand, it is likely to be punctuated by periods ofof caution. 46% of our respondents expect their retail clientsrisk-on trades, if the recent recovery shows signs of turning into

to choose capital protection products for medium terma full-blown bull market.

asset allocation. 34% expect them to opt for tax efficient

On past form, such temporary bursts of risk taking will involve active

products (Figure 3.3).

and passive equity funds; doing market timing as well as portfolio

However, opportunism is unlikely to go away. Four strategies

rebalancing. In the process, style box investing, long popular in theare likely to be deployed:

retail space, will be sidelined. Retail money will become ever lesssticky. It will expect quick wins when taking big risks.

• 23% vote for index funds

The second salient point concerns retail investors in Asia.

• 22% for actively managed equities and bonds

Countries as diverse as China, India, Japan, Malaysia, Singapore• 22% for theme funds

and Taiwan display two common traits.

• 19% for mutual funds that use hedge fund-type tools

First, up to 55% of household financial assets are held in savings(e.g. leverage, shortage and derivatives)

accounts. A decent return plus capital protection is one factor.

Our post-survey interviews identified two salient points with

Even in Japan, the near-zero interest rate translates into a reala clear East-West divide.

positive return due to falling prices.

The first one concerns the retail investors in the West. On thewhole, their behaviours have followed a jagged path.

INTERVIEW QUOTES:“The bulk of U.S. retail money is going fromthe accumulation to the decumulation phase.
the losses sustained in the two bear markets of the last decade.
Their confidence was especially shattered in 2008, when several
Risk aversion is very real.”
On one hand, they have become ultra-cautious in the wake of

U.S. money market funds ‘broke the buck’, with net asset values
falling below one dollar.
The ageing population, holding the bulk of retail assets now,
has an especially low tolerance for risk in a prolonged era of“Having lost out in the past, some retail clients willexit in despair but many want a final fling in thenext rally.”

volatility. When the markets recover, many are likely to de-risk
their portfolios; some will even exit altogether in search ofplain savings options. The pronounced hemorrhaging in the“Generation X and Generation Y are keeping a low
profile. As yet, their investments are small.”mutual funds sector in America and Europe since 2008 may
be indicative of a new secular downward trend.

FIGURE 3.3 Which asset classes and generic products are most likely to be chosen by your retail clients for
short-term opportunism and which ones are likely to be chosen for medium-term asset allocation?
Capital protection funds
Tax efficient retirement funds (e.g. IRAs in the USA)
Actively managed equities and / or bonds
Mutual funds using hedging tools (e.g. Newcits)
Indexed funds
Theme funds (e.g. Shari’ah, SRI, environment)
-30

-20

-10

0

20

10

30

% of respondents
Source: Principal Global Investors/CREATE Survey 201230

Opportunism

Asset Allocation

40

50

46% expect their retail clientsto use capital protection funds
in their asset allocation

23% expect their retailclients to use indexed funds
in opportunistic investing

22% expect their retailclients to use active funds
in opportunistic investing

The second common trait is the lack of buy-and-hold culture.

contemplating similar moves, as a part of a concerted effort

The average holding period of mutual funds varies between

to create a vibrant indigenous fund sector.

four and 12 months. The average shelf life of a mutual fund

Furthermore, their institutional investors are no longer mainlyis around 2.5 years. Most investors rely on stock picking andbond-biased, peer-biased and home-biased, after their recent

concentrated bets (“A view from the top” below). All investing

push into broader diversification. They are being emulated byappears opportunistic; risk taking is rife, as are behavioural biases.

large fund distributors who are introducing multi-asset class

These have badly burnt client portfolios since 2007. Outside

funds that divert investor attention from concentrated bets

the institutional space, notions of re-risking and de-risking haveand momentum investing.

limited validity.

INTERVIEW QUOTES:The volatile nature of local markets has blurred the distinction.
The BRIC markets have been four times as volatile as the
S&P 500 since 2008. The advice infrastructure is limited.
Banks dominate distribution and thrive on front-end
commissions. Product push remains a powerful factor.
However, there are positive straws in the wind. The abolitionof front, trail and exit commissions in India is likely to promotea new generation of fiduciary gatekeepers with their primaryoath of allegiance to end-clients. Other Asian countries are“Like Warren Buffett, investors in Asia go forconcentrated bets. Without skills, that’s like buying
lottery tickets.”“Herd mentality costs Asian retail investors dear.
They promote a casino mentality.”“Without more financial education, China will not bea fund super power.”

A VIEW FROM THE TOP...
Concepts like re-risking and de-risking are far removed from how

Unlike their peers in the West, Chinese investors are often

the current generation of retail investors operate in China.

mesmerised by volatility. They prefer high volatility stocks to low

For a long period of time, they have been nurtured on positive
returns and capital protection offered by savings accounts at banks.
Their incursion into the world of investing has been marred byvolatility stocks in the belief that they can make a quick killing bymarket timing. They also tend to hang on to losing stocks in the
belief that they will recover before long.

approaches that recognise neither value investing nor time investing.

There is a strong tendency especially to hang on to mutual funds

People make choices that seem contrary to their best interests.

when their NAV is below 1.0 and to sell them when it goes above

Despite the availability of mutual funds, for example, retailit, irrespective of the market conditions and intrinsic value.

investors prefer to make a few big bets based on everything

Worst of all, there is an unconscious bias towards low-price-stocks

from hot tips, lucky numbers and IPOs to detailed fundamental

syndrome: investors prefer to invest in companies with low nominal

analysis. Recent data show that the median number of holdings

value in the belief that they will eventually come to match theiramong all Hong Kong investors is four, with a median value ofhigh-value counterparts. The latter are often used as benchmarks.

HK$150,000.

Of course, it is okay to take advantage of price dislocations that

Most investors have out-sized exposure to company-specifichave characterised the Chinese stock markets over the past ten

risks in the belief that returns mainly come from stock selection.

years. But the principles guiding their approaches have a high

The concept of asset allocation has yet to take root, as has theprobability of delivering more pain than gain.

concept of macro risks that regularly buffet all emerging markets.

As in other BRIC economies, the mutual fund industry is ripe for

Worse still, investors also tend to over-rate their stock picking

take-off in China. But it won’t come until we have far higher

skills even when the markets are doing well. For example, thefinancial literacy and far better advice channels.

Shanghai Composite Index bounced back by 80% in 2009. Yet
82% of the investors did not earn more than 50%. Almost a– A CHINESE FUND ADVISOR

quarter ended the year in negative territory.

31After big losses in the last decade, high net worth
individuals are turning into ultra demanding investors
In 2008, in all regions, high net worth individuals (HNWI) lost

As a result, since 2008, simple capital protection productsout disproportionately, being overweight in equities as well as

offering high liquidity have been the preferred option. Therealternatives such as hedge funds, currency funds and private

have also been periodic forays into ETFs in the ‘risk-on’ periods,

equity. For the foreseeable future, like their retail peers, theyespecially in Europe.

will err on the side of caution (Figure 3.4).

However, as the markets have shown signs of revival lately,• 55% of our respondents expect their HNWI segment

opportunism is back on the table. But it is unlikely that they will

to invest in capital protection funds.

make big bets unless they are convinced that their wealth managers
now have the capacity to turn market volatility into an investment• 42% expect them to opt for absolute return funds targeting

opportunity. We return to this point in the following section.

a CPI plus 3% benchmark that relies on cash-plus products.
• 35% expect them to invest in real estate with a ‘distressed’ label.

In the emerging markets, on the other hand, past losses haveforced a significant introspection amongst HNW clients and their

At the other extreme, they are also likely to go opportunistic

managers. Both are wising up. Rather than focusing on re-risking

when bargains emerge. Commodity funds (especially gold),and de-risking, the talk is about cultivating an investment cultureindexed funds (especially ETFs), currency funds and hedge

that eschews the entrenched feast and famine mentality.

funds will top their list.

INTERVIEW QUOTES:At surface level, these results do not suggest clear regional“Our HNW clients want return of capital before returnon capital.”differences. However, in our interviews, we sensed amarked difference between the developed markets andthe emerging markets.
In the developed markets of the West, the psychologicalimpact of past losses was far greater and the resulting loss of“Market cycles in the West get amplified in the East.
There is no sign of decoupling.”

confidence in their wealth managers more pronounced.

“Volatility has whipsawed the wealth of the nouveau
rich investors in India.”

FIGURE 3.4 Which asset classes and generic products are most likely to be chosen by your high net worth clientsfor short-term opportunism and which are likely to be medium-term asset allocation?

Capital protection funds
Absolute / real return funds
Real estate
Hedge funds
Active equities and bonds
Indexed equities
Commodity funds (inc. gold)
Currency funds

Opportunism

Private equities

Asset Allocation

Indexed bonds
-40

-30

-20

-10

0

10

% of respondents
Source: Principal Global Investors/CREATE Survey 2012

32

20

30

40

50

60

55% expect their HNWclients to opt for capital
protection products

42% expect their HNWclients to opt for absolute
return funds

31% expect their HNW clientsto use commodity funds to doopportunistic investing

There is less finger pointing at wealth managers and moreagainst client interests. But there is ample recognition that theat structural factors that need attention, if these countries

whole infrastructure of investing needs to change.

are to accelerate their transition from a savings culture to an
investment culture that seeks to minimise investor foibles and

INTERVIEW QUOTES:

reward buy-and-hold investing (see below).
Countries as diverse as Brazil, Chile, China, India, Indonesia, South
Korea and Taiwan are keen to implement lasting reforms to ensurethat high domestic savings do not continue to earn low returns
in unproductive assets, while their populations are ageing rapidly.
Each has studied the drivers of investment culture in the West in
general and the U.S. and Australia in particular.
Although gradual, reforms are imminent. A lethal combination“Investors are always looking in the rear view mirror.”“Quite simply, we have to turn today’s short-term
savers into long-term investors.”“Clients often ask: if asset managers can’t deliver
excess returns in good times, how can they do it
in bad times?”of high market volatility and low financial literacy has conspired

A VIEW FROM THE TOP...
The Indian stock market has had a rollercoaster ride. From

While HNWI are drawn into term-deposits, their ultra-rich peers

a peak of around 22,000 in 2007, Sensex went into freefall,

are coming back into the market—albeit cautiously—via two

hitting 8,000 a year later. By late 2010, it had recovered lost

sets of products: asset allocation funds, blending equities andground, only to tumble again by 20% in 2011 due to thebonds; and high conviction strategies. However, in both cases,

European debt crisis.

they show zero tolerance toward mediocrity, such that the shelf

The markets have since rallied but the bulls are not in sight.
Quite simply, the recovery is a liquidity play. Most of the recent

life of a typical product is unlikely to exceed its long-term averageof 2.5 years.

net inflow came from foreign professional traders engaged in

Pundits regularly paint emerging markets as a source of untold‘carry’ trades based on the low interest rates in the U.S. and thebonanza for the wealth managers. But they ignore one stumbling

weak rupee at home.

block: the magnetism of the traditional savings culture. It has long

Our clients are staying on the sidelines. The memory of big losses
in the recent past is one factor. The other is the unintendeddelivered capital preservation and income upside that the riskreturn calculus of the investment culture has yet to match.

consequence of the abolition of commissions on mutual funds

This transition from savings to investment needs tail winds

and the introduction of advice-based fees. Upon discovering thatfrom six sources: a long bull market that inspires confidence,

anything up to 2.5% of their assets are taken up by fees, highcompulsory retirement planning that puts the onus on the

net worth investors have flocked to banks that offer up to

individual, tax breaks that provide the necessary incentives,

10% on term deposits (with an extra 0.5% for senior citizens).

higher levels of investment literacy that minimise herd behaviour,

For now, the old beat-the-market mentality that relied on hype,greed and fear is not so evident. Investors are wising up, as arean advice overlay that permits sensible asset choices, and good
corporate governance that offers accurate financial reporting.

their wealth managers. The latter have, on the whole, welcomed

In India, the first is unlikely for a while, the second is not being

the abolition of commissions as a necessary step towards

contemplated, but there are distinct baby steps towards the

kick-starting investor education and a buy-and-hold mentality.

remaining four. However, their impact will be diluted from time

Besides, the regulators are keen to ensure that distributors canto time by the very volatile nature of our stock market.

no longer run tacit auctions that place clients’ money with

The trajectory between the two cultures will be anything but

managers who offered the best commissions—irrespective ofa straight line. India may well be the next gold rush for wealthclients’ needs or managers’ track record.

managers—but later rather than sooner.
– AN INDIAN WEALTH MANAGER

33

REBOOTINGTHE
4 BUSINESS MODELS|“The asset industry has to dump
a lot of mental baggage before
it can deliver on volatility.
- AN INTERVIEW QUOTE”

WHAT DO ASSET MANAGERS NEED TO DO?
OVERVIEW
Section 2 identified the differing perspectives of clients. Many
believe in the U.S. story and may well re-risk their portfolios;
as would the ‘adventurists’, the ‘pragmatists’ and, to a muchlesser extent, the ‘purists’.
However, their perception of volatility as an investment
opportunity is far from unconditional.
The 2000s was a ‘lost decade’ for them. They don’t want tosuffer the same fate in this decade. If this is an era of prolonged
volatility, they would consider taking advantage of the periodic
dislocations, so long as they are convinced that their asset
managers can up the ante.

34

Accordingly, this section turns the spotlight on the changes

The first cluster aims to improve investment capabilities inthat asset managers think that they need to make to raise

specific areas, like price dislocations and high conviction investing.

their clients’ confidence level.
The second one aims to improve the alignment of interest via
It covers two specific issues:co-investing and more symmetrical incentives.

• What are the main external and internal hurdles that asset

The third cluster aims to promote nimbleness, free thinking

managers face when capitalising on volatility?
• What actions do asset managers need to take to overcome
these hurdles?

and high conviction investing.
The final cluster aims to enhance client engagement via better
understanding of their needs and avoidance of unrealistic claims
about returns.

KEY FINDINGS
External and Internal Hurdles
Over the past decade, as asset management has morphed intoa mass market industry with a global reach and a broad client
base, it has lost much of its craft heritage that was conducive
to riding the volatility wave.
The unintended outcome has been a vicious cycle, where
external and internal factors have reinforced one another tocreate a high degree of disintermediation and skewed incentives.
After the ‘lost decade’, there is a lumpy legacy of mistrust.
The key factors on the external side are: clients’ behaviouralbiases, their risk aversion, and with institutional clients, theirrestrictive policy guidelines. These have been reinforced by
the mediocre track record of active management.
The key factors that are internal to individual asset managers
include: lack of a credible track record on volatility trading,lack of tactical asset allocation capabilities, the entrenchedbuy-and-hold mentality and the adherence to style box investing.

Required Actions
To break this cycle, a number of mutually-reinforcing changes
are essential. They fall into four clusters.

Each Cluster Underscores a Distinct Imperative
First, alpha is in the eye of the beholder. Clients are increasingly
drawing a distinction between product alpha and solutions
alpha: one is about beating the markets, the other about meeting
their identified needs—like consistency of returns or customised
benchmarks. For both types of alpha, greater proximity to clients
is essential in setting and managing expectations.
Second, asset businesses need a lot of resilience. Improving
investment capabilities extends beyond skills. It covers a raft ofother areas that provide the essential shock absorbers in thisage of turbulence.
Third, investment professionals must put their money
where their mouths are. The asymmetric rewards inspire
neither trust nor motivation.

“

There’s a big gap between whatclients need and what we give them.
- AN INTERVIEW QUOTE”
35

Key hurdles remain to be crossed before volatility
can be turned into an opportunity
If there was one recurring theme in our post-survey interviews,

Internal Constraints

it was that the industrialisation of the investment business

As for the internal constraints, 51% of asset managers cite

has created a vicious cycle that makes it hard to profit fromthe lack of a good track record on volatility investing.

volatility. The cycle is reinforced by a mix of external and
49% cite scarcity of tactical asset allocation capabilities.

internal hurdles that asset managers face when dealing withvolatility (Figure 4.1).

47% cite entrenched buy-and-hold mentality that misses

External Constraints

opportunities in periods of price dislocation.

Starting with the principal external constraints, 59% of asset

43% cite adherence to style box despite high asset classmanagers cite clients’ behavioural biases that often ignore

correlations and uncertain risk premia.

conventional wisdom to buy low/sell high. Driven by thegreed-fear cycle, clients often make choices that are contrary

INTERVIEW QUOTES:

to their best interest.
53% cite risk aversion in the aftermath of the seismic shocks
unleashed by the Lehman collapse (2008) and the sovereign
debt crisis (2011).
47% cite the overall mediocre track record of active
management in beating the markets. Long fed on the dubious
virtues of peer and market benchmarks, most clients don’t
recognise their inherent limitations.
39% cite investors’ rules and guidelines that restrict their“What we need from our clients is patience. The
24-hour news cycle has distorted clients’ investment
time horizons.”“We can’t cope with volatility because there is nomindset of contrarian investing in our firm.”“The long-term relationship between us and our clientsgave way to brief affairs in this world of fast finance.”risk parameters.

FIGURE 4.1 What will be the main external and internal constraints that asset managers face whencapitalising on volatility?
EXTERNAL CONSTRAINTS:
Clients’ behavioural biases leading to herd mentality
Clients’ risk aversion due to economic uncertainty
Overall mediocre track record of active management
Institutional investors’ rules and guidelines
Low funding levels that promote risk aversion
Scary headlines on volatility in the mass media
INTERNAL CONSTRAINTS:
Lack of a good track record on volatility investing
Scarcity of tactical asset allocation capabilities
Prevalence of entrenched buy-and-hold mentality
Adherence to style box investingOver-reliance on backward looking risk models
Internal bureaucracy that slows things down in asset houses
0

10

20

30

% of respondents
Source: Principal Global Investors/CREATE Survey 2012

36

40

50

60

59% cite clients’ behaviouralbiases as a constraint

53% cite clients’ risk aversion
as a constraint

51% cite lack of track recordon volatility as a constraint

A number of factors are at play behind these numbers. The

The current arrangement needs step improvements to convince

key one is disintermediation by pension consultants andthe clients that volatility is an opportunity in practice as muchfund distributors. It has unduly inflated return expectations

as in principle. Such changes will not instantly convince themand created a legacy of mistrust, especially in the volatile

to re-risk. But they will raise the probability of it.

environment of the last decade. For their part, without sufficientknowledge about clients’ overall needs, asset managers have

INTERVIEW QUOTES:

resorted to a big product push, notably in Europe and Asia.
That has ignored an essential pre-condition for success in turbulent
times: client patience is just as important as the intrinsic merits of
their choices. In bad times, clients instinctively head for the exit,
because in good times they were rarely advised to cash out.

“Industrialisation has suppressed the skills that translatemarket ructions into investment opportunities.”“Like their clients, many asset managers follow theherd to manage the peer risk.”

Disintermediation has exacerbated the familiar principal-agency
problem as well as peer herding among advisers and managers
alike (“A view from the top”). It has also amplified the ‘regret’risk and ‘wrong time’ risk.

“Peer benchmarks are subtly powerful. It takes courage
to step away from them. Herding helps to manage thecareer risk.”

A VIEW FROM THE TOP...
As asset management became a mass market industry on a global

pension consultants and fund distributors. Thus, we have moved

scale, it has industrialised to the extent where it lost its cottage

away from our original mission to deliver absolute returns via highindustry heritage. Most of its current practices work againstconviction investing based on skills.

capitalising on volatility. Quite frankly, we’re no longer closeenough to our clients to inspire the necessary trust or motivation.

The disintermediation has forced us to provide products, notsolutions. We don’t know what clients’ overall goals are, so

Our industry has gone from art to science, from craft to scale,

we’re forced to exaggerate the virtues of our products. Thesefrom judgment calls to complex models far removed from reality.

intermediaries think they know better than clients or managers.

Some of the key innovations, e.g. shorting, leverage, portable

But they don’t. The result is an entrenched blame culture in whichalpha, high frequency trading, were conceived as clever mouse

career risk and reputation risk take precedence over investment

traps. But quite often, they failed to extract value, when there wasrisk. The principal-agency problem is as acute now as it’s evernone to start with. Systemic risks, product complexity and higher

been. Skewed incentives have encouraged herding.

charges have been the main outcomes.

Like clients, their advisers and managers stay within the ‘pack’

Introduced in 1986, the Dow Jones Industrial Average waswith no outliers. Everyone’s scared to stick their necks out. Moresimply a market proxy, not an investment idea. It was neveroften than not, they rely on client inertia and market recovery

designed to evaluate manager performance or promote a

to bail them out. After all, clients were rarely advised to cash out

beat-the-market mentality. However, over time, as it became

when markets were peaking. Why would they trust us when weapparent that markets were hard to beat, enterprising managers

ask them to invest when markets are so volatile?

saw an opportunity to deliver market representative returns atrock-bottom costs, never mind their intrinsic value. The big picture
understanding of investing was lost when specialist mandates
replaced the balanced ones. Few managers understand the real
drivers of correlation or TAA.

If volatility persists over this decade, this industry will need a
big makeover. We can’t roll back industrialisation but we caninject a big dose of realism in areas that can make a difference
to investment outcomes. The market turmoil of the last 10 years
has forced us to revisit our original mission within a new form ofClients want certainty in a world full of uncertainty. There’s a big

engagement that is free of dogmas, fads and clichés. We have togap between what they need and what we give them. So we’ve

learn to lean against the crowd and focus on the fundamentals.

created new concepts like risk premia, bar-belling and relative
benchmarks. We’ve also created new advice infrastructure via– A GERMAN ASSET MANAGER

37

The hurdles can be overcome via greater client proximity,
new investment capabilities and more co-investing
To overcome the hurdles, a range of investment-related

44% see the need for low charges plus high watermark fees.

and business-related changes were identified in our survey

42% favour low charge plus profit sharing.

(Figure 4.2). Further analysis suggests four neat clusters.

These percentages underscore three imperatives. First, without

The first cluster covers clients. 66% of respondents cite the needgreater client engagement, continuing volatility risks turning

to develop a better understanding of clients’ goals and challenges.

even more investors into ‘pessimists’ (p.19). Increasingly,

66% also single out the importance of greater client engagement.

clients are distinguishing between product alpha that is

59% caution against making unrealistic claims about returns.

time-dependent and solution alpha that is need dependent.

The second cluster relates to investment capabilities. 54% see
the need to improve the track-record of active management.
53% see the need to develop deeper expertise in anticipating
price dislocations.

INTERVIEW QUOTES:“Even our best products could not survive the panic
selling seen since 2008.”

The third cluster covers business nimbleness. 49% cite
the importance of a work environment conducive to highconviction investing.
The final cluster covers alignment of interests. 50% see theneed for co-investing that ensures that investment professionals
also have a personal stake in the funds they manage.

“Is volatility an opportunity or a disaster? We needskills to answer this question.”“If a volatility trade goes pear-shaped, it needs to hurt
the manager.”

FIGURE 4.2 Which capabilities do asset managers need to develop, if their clients are to benefit from volatility?
INVESTMENT RELATED:A deeper understanding of clients’ goals and challenges
Avoidance of unrealistic claims about returns
An improved track-record of active management
Enhanced capabilities to anticipate price dislocations
Deeper expertise to engage in co-investing
Deeper expertise in re-risking approaches
Deeper expertise in de-risking tools and approaches
More stress testing of new products before their launchGreater transparency around investment activities
BUSINESS RELATED:Greater client engagement through superior service
A work environment conducive to high conviction investing
Low charge plus high watermark fees
Low management charge plus profit sharing
A sharper focus on core capabilities
A deeper bench strength of talent
Enhanced expertise to offer fiduciary management
Ability to manage sub-advisory mandates
0
Source: Principal Global Investors/CREATE Survey 2012

38

10

20

30

% of respondents

40

50

60

70

66% cite deeper understandingof clients’ goals and challenges
as a solution

66% highlight greater client
engagement as a solution

54% highlight improved trackrecord of active management
as a solution

One is about beating the markets, the other about meeting

Finally, if clients are to re-risk on a notable scale, they want toclients’ identified needs. Each requires greater client

be sure that their managers put their money where their mouths

engagement. The current disintermediation in the industry needs

are. They want managers to eat their own cooking. The current

to be tempered by new avenues of engagement that go beyond

skewed fees structure is akin to a call option, which makes little

the regular reporting.

sense, after millions of clients have lost billions of dollars.

Second, if the era of prolonged volatility is here, it is essential

Whereas industrialisation is irreversible, it does not preclude

to develop better shock absorbers in the existing businessprogress in these clusters to restore the best features of its

models which have been severely tested since the 2008 crisis.

craft heritage.

To its credit, the industry has made progress. The adoption

INTERVIEW QUOTES:

of the multi-boutique model is an important step towards
nimbleness and a small company mindset in a large company
environment, as our 2010 CREATE Report showed. Adoptionof meritocratic staff incentives is also a step in the right“Clients want to see track record and co-investing before
taking on new risks.”

direction (our 2009 CREATE Report).
However, the asset industry is still perceived as a bastion of“Costs in this business are hydra-headed. They havea life of their own.”

entitlements, as evidenced by recent political hostility andregulatory creep. This perception needs to be countered bypractical examples of good practices.

“The volatility dynamic requires new corporateshock absorbers.”

A VIEW FROM THE TOP...
Investing during volatile times is scary. Our clients are ait helps to establish common beliefs and investment horizons,

heterogeneous group: some with a strong risk appetite, someto learn what works and what doesn’t at different stages of thewith none. In between, are the majority, who tend to blow withcycle, and to understand the ‘health warnings’ that are usually

the wind. After the wreckage of 2008, there were lots of bargains.

lost in the fine print of legal agreements.

But the level of engagement needed to persuade our clients to seethem as bargains was just not there. We did a number of client
perception studies and focus groups. One thing was clear: clientswant a solution to specific needs, which can require a multi-asset
class or a stand-alone product. They want good returns as a partof this solution. But they also judge us by how we develop a
strategic understanding of their needs and how we meet them.
This was a light bulb moment. We realised that no matter how
good our products are, they can fare badly, unless clients havesome understanding of their intrinsic worth and time horizons.
Our products can’t survive panic buying and panic selling of
the past four years. For our part, we also need a more rounded
picture of client needs before launching new products.
We have initiated regular pulse surveys and face-to-facecontacts with key clients in order to solicit new ideas, manage
expectations, minimise ‘wrong’ time risks, communicate bespoke
research, deliver products that are fit for purpose and highlightproactive buying opportunities. Clients like this approach, since

We believe that markets will remain jittery for a long time.
Absolute returns and unconstrained mandates will grow in
popularity. 35% of our clients use their liabilities as a benchmark.
Our task is two-fold: via greater engagement, to raise clients’
comfort levels during turbulent phases; and to deliver decent
returns by upgrading our own investment capabilities.
Our portfolio managers and research analysts are enjoined todevelop new skills that focus on asset correlations, risk premia,
geo-politics, systemic risks, balance sheet dynamics, behaviouralbiases and many others. Our investment processes incorporate
a variety of perspectives, including risk management andclient needs. New products are stress tested against extreme
macro-economic and geo-political environments.
All investment professionals are enjoined to invest their bonus
into the funds they manage. Some hold as much as 80% of
their net worth in the funds they manage.
– A SWISS ASSET MANAGER

39

APPENDIX
The Principal Global Investors/CREATE annual survey

retail clients and high net worth clients, in Tables A.1, A.2,

started in 2009. Items that are comparable over time in

A.3 and A.4, respectively.

our surveys are covered in this appendix to facilitate a timecomparison. They relate to clients’ choices of different asset
classes. Four client segments have been covered: Defined
Benefit (DB) plans, Defined Contribution (DC) plans,

TABLE A.1

Our classification of asset classes has evolved over time, suchthat a minority of items covered here do not have comparable
data. These have been identified as “not applicable” (n/a).

Which asset classes are most likely to be chosen by your DB clients for medium-term asset allocation
and which ones are likely to be chosen for short-term opportunism?
% of respondents

ASSET ALLOCATION:
Global equities
Global equities with emerging market revenues
High income equities
Emerging market bonds
Emerging market equities
Infrastructure
Real estate (inc. CMBS nearing redemption)
Global tactical asset allocation products
Investment grade bonds
Government bonds
Indexed / enhanced indexed equities
Private equity
Hedge funds
High yield bonds
Commodity funds
Exchange traded funds
Currency funds
Distressed debt

2012
58
54
46
44
43
43
40
38
37
35
34
29
29
23
18
16
10
6

2009
61
n/a
n/a
n/a
40
n/a
48
42
53
40
32
34
30
19
32
32
21
10

Source: Principal Global Investors/CREATE Survey 2012 and 2009

TABLE A.2

% of respondents

OPPORTUNISM:
Distressed debt
Exchange traded funds
Emerging market equities
High yield bonds
Currency funds
Hedge funds
Commodity funds
Global equities with emerging market revenues
Global tactical asset allocation products
Global equities
High income equities
Emerging market bonds
Indexed / enhanced indexed equities
Investment grade bonds
Private equity
Real estate (inc. CMBS nearing redemption)
Infrastructure
Government bonds

2009
59
18
34
51
25
21
31
n/a
21
23
n/a
n/a
17
27
18
20
n/a
13

n/a = not applicable

Which asset classes are most likely to be chosen by your DC clients for medium-term asset allocation
and which ones are likely to be chosen for short-term opportunism?
% of respondents

ASSET ALLOCATION:
Target date retirement funds
Equities
Diversified growth funds
Bonds
Target risk retirement funds
Customised investment / self managed plans
Target income retirement funds
Guaranteed insurance contracts
Deferred annuities
Cash-like products
Source: Principal Global Investors/CREATE Survey 2012 and 2009

40

2012
43
37
30
29
29
27
25
21
20
18
17
15
12
11
9
7
6
6

2012
52
49
43
37
36
34
34
23
23
18

2009
62
62
n/a
56
52
44
31
34
25
38

% of respondents

OPPORTUNISM:
Equities
Cash-like products
Diversified growth funds
Customised investment / self managed plans
Bonds
Target risk retirement funds
Guaranteed insurance contracts
Deferred annuities
Target date retirement funds
Target income retirement funds
n/a = not applicable

2012
20
18
7
7
6
5
5
4
3
3

2009
30
25
n/a
10
13
15
16
13
7
19

TABLE A.3

Which asset classes are most likely to be chosen by your retail clients for medium-term asset allocation
and which ones are likely to be chosen for short-term opportunism?

% of respondents
ASSET ALLOCATION:
2012 2009
Capital protection funds
46
55
Tax efficient retirement funds (e.g. IRAs in the USA) 34
53
Actively managed equities and / or bonds
32
49
Mutual funds using hedging tools (e.g. Newcits)
30
n/aIndexed funds
28
46
Theme funds (e.g. Shari’ah, SRI, environment)
28
n/a% of respondents
OPPORTUNISM:
2012 2009
Indexed funds
23
23
Actively managed equities and / or bonds
22
39
Theme funds (e.g. Shari’ah, SRI, environment)
22n/a
Mutual funds using hedging tools (e.g. Newcits)
19n/aCapital protection funds
14
29
Tax efficient retirement funds (e.g. IRAs in the USA)
6
13

Source: Principal Global Investors/CREATE Survey 2012 and 2009

n/a = not applicable

Table A.4 Which asset classes are most likely to be chosen by your high net worth clients for medium-term asset
allocation and which ones are likely to be chosen for short-term opportunism?
% of respondents

ASSET ALLOCATION:
Capital protection funds
Absolute / real return funds
Real estate
Hedge funds
Active equities and bonds
Indexed equities
Commodity funds (inc. gold)
Currency funds
Private equity
Indexed bonds
Source: Principal Global Investors/CREATE Survey 2012 and 2009

2012
55
42
37
30
29
27
20
11
9
6

2009
40
50
46
31
51
47
32
32
32
32

% of respondents

OPPORTUNISM:
Commodity funds (inc. gold)
Indexed equities
Currency funds
Absolute / real return funds
Hedge funds
Capital protection funds
Active equities and bonds
Real estate
Private equity
Indexed bonds

2012
31
28
28
26
24
13
12
9
5
3

2009
39
23
39
28
30
25
28
26
27
18

n/a = not applicable41

Other publications from CREATE-Research
The following reports and numerous articles and papers on the emerging trends in global investments are available at no costat www.create-research.co.uk.
• Investment Innovations: Raising the Bar (2011)• Hedge Funds: A Catalyst Reshaping Global Investment (2005)• Exploiting Uncertainty in Investment Markets (2010)• Raising the Performance Bar (2004)• Future of Investments: The Next Move? (2009)• Revolutionary Shifts, Evolutionary Responses (2003)• DB & DC plans: Strengthening Their Delivery (2008)• Harnessing Creativity to Improve the Bottom Line (2001)• Global Fund Distribution: Bridging New Frontiers (2008)• Tomorrow’s Organisation: New Mindsets, New Skills (2001)• Globalisation of Funds: Challenges and Opportunities (2007)• Fund Management: New Skills for a New Age (2000)• Convergence and Divergence Between Alternatives• Good Practices in Knowledge Creation and Exchange (1999)

and Long Only Funds (2007)• Competing Through Skills (1999)• Towards Enhanced Business Governance (2006)• Leading People (1996)• Tomorrow’s Products for Tomorrow’s Clients (2006)• Comply and Prosper: A Risk-based Approach toRegulation (2006)

Contact Details:

Prof. Amin Rajan
amin.rajan@create-research.co.uk
Telephone: +44 (0) 1892 52 67 57
Mobile/Cell: +44 (0) 7703 44 47 70

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Principal Global Investors is a diversified asset management organization and a member of the
Principal Financial Group®. We manage $258.2 billion in assets primarily for retirement plans andother institutional clients. Our investment capabilities encompass an extensive range of equity,
fixed income and real estate investments as well as specialized overlay and advisory services.
We focus on delivering excellent investment performance and client service on behalf of ourclients. Our capable team of over 1,200 employees, including over 475 investment professionals,
works within a collaborative environment from offices around the world. Our global reachprovides an information advantage in researching and managing investment portfolios. At thesame time, we serve clients on a local basis and tailor our capabilities to specific client objectives
and investment goals.

CREATE-Research is an independent think tank specializing in strategic change and the newly
emerging business models in global asset management. It undertakes major research assignmentsfrom prominent financial institutions and global companies.
It works closely with senior decision makers in reputable organizations across Europe and the U.S.
Its work is disseminated through high profile reports and events which attract wide attention in
the media. Further information can be found at www.create-research.co.uk.