Last year, Canada’s Top 40 money managers clocked substantial gains that pushed them back into positive territory in the wake of one of the worst financial crises in a century. This year, the growth story continues with a collective gain of 8% and total assets under management moving up to $526.4 billion. But while managers are winning new business and growing their assets, it’s hardly business as usual.
Post-2008, managers are regaining their footing, but their pension clients are grappling with big challenges—from market volatility to regulatory uncertainty—and demanding a different relationship with their managers. What do they want? These days, a two-way conversation and a little consultation go a long way. And managers say there’s plenty of that to go around, along with innovative approaches.
“Ten or 15 years ago, you could get away with your charm and wit,” says Peter Clarke, managing director, client service, with Beutel Goodman & Company Ltd. (No. 8 on the Top 40 list). “Today’s relationship is more fiduciary in nature.” He notes that two market crises have completely changed the pension business and what’s expected from managers. “The term consultative relationship started to appear post-crisis. It’s now a common theme among managers. Now the goal is not just to be seen as the manager of an asset class but as a resource for clients as well.” And this theme goes beyond just chasing benchmarks: managers are now being asked to provide feedback on how specific assets or strategies work.
The push for more consultation and feedback stems from extremely challenging times. “Every year, it gets tougher for plan sponsors,” says Robin Lacey, vice-chair with TD Asset Management (No. 1). “Economic crises, capital market gyrations and regulatory changes have placed increasing demands on them as fiduciaries. This has translated into the need for higher-quality service from managers as well as more education, support, innovation and customization.”
Managers who don’t deliver that level of service will find it more challenging to win or keep business, says Josephine Marks, managing director, pension assets, with Scotiabank Treasury Group. She believes that managers need to act as partners; those who don’t want to hear about clients’ issues will have a harder time meeting their needs.
Indeed, the pressures faced by today’s plan sponsors challenge the way pension funds invest. Zev Frishman, vice-president, global equity strategies, with the Ontario Teachers’ Pension Plan, says regulatory, market and demographic changes are making it harder for plans to stay focused on the long term. “There’s a growing tension for plan sponsors around their ability to be true long-term investors,” he says. “Traditionally, the risk in DB plans could be smoothed over the generations.” Now, however, plans have to be much more aware of short-term risks, which will affect the way they invest. “Plan sponsors are more risk-aware because of the need to mark to market assets and liabilities over relatively short periods of time,” Frishman explains. “In theory, we would like to think 40 years out, but due to demographic and regulatory pressures, we cannot avoid thinking shorter term. A great long-term asset mix will not fit in a three-year time horizon. Many DB plans are also more mature and cannot rely on positive cash flows and a large active workforce to mitigate risks.”
Such pressures are pushing pension funds to de-risk through liability driven investment (LDI), for example—which, Marks says, many DB plan sponsors have adopted or are working to adopt. But the challenge is making the choice between risk management and returns. “Plan sponsors either have to take risk for return or not take risk and get no return.” As plan sponsors seek the best way to implement LDI, these discussions are front and centre at committee meetings.
Listen up
Against this backdrop, managers are quick to point out the many innovative products and services they’ve developed in the last decade to meet these new demands. Without the new products that are available today, pension funds would not be able to pursue many of the portfolio management choices available to them. Says John Formusa, director of institutional investment solutions with Russell Investments Canada Ltd. (No. 32), “There are so many more investment options available today that did not exist when I started in this business.” These days, plan sponsors have access to asset classes and strategies—hedge funds, portable alpha, infrastructure and derivatives—that were once solely the domain of the largest pension funds.
According to managers, these products have improved the way pension funds manage risk. “Plan sponsors now need to invest across a much broader product lineup to improve risk-adjusted returns,” says Kevin Barber, senior vice-president with Pyramis Canada. “Plan sponsors are focused on downside protection and matching assets with plan liabilities.” He adds that this has led to new demands for strong diversification and asset classes with lower correlations.
At the same time, managers have embraced the need for customization, ensuring that products are tailored to meet plan sponsor needs. Peter Lindley, president and head of investments with State Street Global Advisors Canada (No. 6), admits that the menu of choices needs to expand beyond a single offering—particularly post-crisis, as plan sponsors focus closely on matching assets and liabilities. “Over the last two years, the average funded ratio has fallen. Whereas plan sponsors used to look for more standard-type structures, they now need more customization.”
The need for customization and risk management has changed the manager/plan sponsor conversation. Managers need to listen carefully, says Formusa. “It used to be that plan sponsors would sit back and managers would try to sell them products.” But with more complex demands and less time on their hands, “plan sponsors are demanding that managers spend more time and energy hearing what their needs are and coming back with solutions based on them,” he explains.
New products
“Given the changing nature of plan sponsor needs, money managers are becoming more like partners with plan sponsor clients,” says Benoît Durocher, executive vice-president and chief economic strategist with Addenda Capital (No. 11). He, too, sees managers playing a more consultative role.
In the fixed income area, Durocher says customization is more important than ever, especially in light of the push for LDI. “Plan sponsors are demanding fewer off-the-shelf products and more customized solutions,” so managers are now assuming a more consultative role, taking part in discussions around risk management. Post-crisis, plan sponsors are “rethinking their plans in a new light” as they get hit from both sides, with faltering financial markets and low interest rates. Plan sponsors have been lengthening the duration of their bond portfolios to better match their assets
and liabilities—and this has led to a significant jump and heightened interest in long-term bond mandates in recent years, Durocher adds.
As the relationship between managers and plan sponsors becomes more consultative, another big change has happened: plan sponsors aren’t as quick to fire and hire managers, especially in the wake of the 2008 financial crisis. “I have been through a lot of market cycles,” says Tristram Lett, chief investment officer with Integra Capital Management Ltd. “This is the first time I have seen plan sponsors stand back and not get trigger-happy.” Discussing the fallout from the crisis, Lett points out that plan sponsors, faced with no place to hide in tanking markets, stayed put instead of making fast and potentially rash moves on the asset allocation front. “You couldn’t even hide in cash,” he says of the dilemma faced by plan sponsors in 2008. “So they just sat back—it was a remarkable change. There was a recognition that acting for the sake of acting would only lead to higher transaction costs and chasing numbers.”
George Mavroudis, CEO of Guardian Capital LP (No. 29), has witnessed another change in the pension industry as some veterans retire and younger professionals take up the reins. “I’ve noted a huge generational change under way in the community, at all levels,” he says, adding that younger people are not only working for plan managers, they’re also on the money management and consulting sides of the business. “You are getting a heavy dosage of retirees and a new generation in gatekeeper roles.” This new wave of management is more comfortable with new asset classes (e.g., alternatives) and could drive growth in these areas.
DC challenges
The marketplace is also changing, as plan sponsors grapple with the best way to engage members in their DC plans. One innovation has been the introduction of lifecycle products, which don’t demand as much action from members. “There’s a real appreciation now that members need support and direction in how they invest,” Barber explains. Lifecycle products evolve with members’ needs over time.
Formusa thinks DC plan sponsors now have more options to offer members, including glide path-based products. But the challenge is helping them understand the plan and how to choose the most appropriate investments for their needs.
When it comes to The University of Western Ontario’s DC plan, however, Martin Bélanger, director of investments, is still looking for managers who can offer products for one of his big challenges: the de-accumulation phase, which, in his view, the industry hasn’t quite addressed yet. “Right now, we are still using the available pure investment products to match the de-accumulation phase. There are some products available, but selection is limited and costs are high.”
Another change is around products and services to help plan sponsors in a two-speed global environment, in which developed markets struggle for growth and new areas of the world thrive.
Keith Smith, president of GE Asset Management Canada (No. 31), believes the rise of emerging markets will change the face of global investing for pension funds and will have implications for the shape of the world economy. “We are seeing divergence between the anticipated GDP growth in emerging market countries and that of the developed world,” he says. With growth rates two to three times higher in emerging markets, there’s a sense that this is where the big opportunities lie on the global front.
Down the road
As the global investment landscape changes, so will the money management industry. Lacey thinks the “bifurcation” trend will continue, with mid-size managers being squeezed out and smaller boutique firms thriving alongside the big global players. “While clients will place a premium on alpha provided by investment boutiques, their definition of what constitutes added value is changing,” he says. Close partnerships with managers are key, of course, but Lacey also thinks that plan sponsors are going to benefit from the efficiencies, risk management and investment skills of larger providers. As liabilities dominate the discussion for the longer term, service quality and customization of solutions will be the new measures of a manager’s value, rather than just market index benchmarks.
In the decades ahead, this year’s Top 40 managers have a lot of work to do. As plan sponsors work out the best way to manage risk and generate the returns needed to meet liabilities, the industry will have to evolve to serve their needs. For that to happen, however, the plan sponsor/manager conversation will need to be more in-depth. And, as both sides seem to agree, that is key to sustaining a healthy pension investment industry.
Caroline Cakebread is editor of Canadian Investment Review.
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