In-sourcing of Asset Management. Are Institutional Investors ready – Part 1

Last week, I spoke about the structural shifts happening in the Asset Management industry.  This week I will focus on one of themost recent and prominent trends –‘In-sourcing of Assets Under Management’.

Well, one of the key questions occupying the minds of Financial Institutions (Pension Funds, Insurance Companies, or Central Banks, Endowments, etc.) today is which form of Asset Management is optimal for the beneficiaries (be it Institutional investors or trusts or plan beneficiaries, etc.) – Professional Asset Management or in-house Asset Management by the Institutions themselves or a combination thereof.

For those who believe in numbers – a recent survey by Sutherland Global Services of 40 Institutional Investors -Insurance companies, corporate defined benefit  plan sponsors, as well as endowments and foundations showed that only 21% of the firms that have external asset managers were satisfied with the asset manager’s investment performance.  

Another research study by Sutherland conducted between June and Sept 2012 showed that of the top pension funds in Australia, UK, US, and Canada approximately 21 of them brought back more than $65Bn AuM in-house in last twelve months.   


Some of the large Institutional Investors taking the plunge to in-source the Asset Management (partly or fully) in last six months included:

►   CalPERS – approx. $1bn

►   AMP, Australia’s largest retail and corporate superannuation provider, brought back ~$6bn management of the fixed-income assets in-house to ‘AMP Capital’

►   AustralianSuper brought close to $3bn of equity investments in-house

►   State of Wisconsin Investment Board is moving $3.9bn of externally managed international equity assets in-house

Why is this trend critical?  ‘In-sourcing’ of Asset Management is not new but the rate at which it is increasing has never been higher and the value of Asset brought in-house never been so massive.  Institutional Investors’ realization of ‘cost adjusted returns’ heightened when they saw their portfolios dwindle in the wake of financial markets collapse in 2008. Also, Institutional Investors today know that funds management is largely a fixed-cost business while their current fees to the external Asset Managers are not.

Case in point – The Teachers Retirement System (TRS) of Illinois – paid more than $1.3 billion for money managers and brokerage firms to handle its $30 billion-plus in financial assets during a 10-year period ending in fiscal 2010. Despite this high fee – TRS’ 10-year average rate of return during this span was ~ 3.7 percent excluding the cost of fees, far below its 8.5 percent annual target return (Source:  Well part of this dismal performance is attributed to market crash of 2008 and the portfolio recovered in 2010 and 2011.

Another example – Australian superannuation fund, AustralianSuper’s brought $3 Bn in-house (  Its head of investment operations stated in September 2012 that the fund spent about $200 million a year in external investment-management costs and predicts that if this was to continue they will end up paying about $500 million a year in a few years.  AustralianSuper plans to cut costs by about two-thirds by moving it internal.

Bottom-line – ‘Economics is in force’.  Differential between the cost of external asset management fee vs. the cost of managing it in-house is driving the latest structural shift.  Control over the investments as well as governance around the investment management process are also some of the other key factors.

In part – II and III of the series I will cover topics on ‘New Normal’ for the Asset Management industry including:

►   Factors that the Institutional Investors need to take in to account for the decision to in-source.

►   Which asset classes are most optimal for in-house Asset Management?

►   How to leverage the recent developments in global shared services models (not only for middle office / back office but for Investment Research, Investment decision support and monitoring) to succeed in your in-sourcing strategy.

Structural Shifts in the Asset Management Industry

There were many fall outs of the unprecedented US housing market collapse and Credit Crisis of 2008 – liquidity crunch, economic recession, closure of century old financial institutions, job losses of 8.8 million between 2007 to 2009 (source Bureau of Labor Statistics.  Job losses in 2008 of 2.6 million or the highest level in more than six decades (source::CNN Money, rapid erosion of investor’s wealth.   One of the biggest fall outs of the Credit Crisis was erosion of investor’s confidence on professional Asset Management function.  The lingering effects of that can be witnessed in the key drivers of the Asset Management business – Net Flows; Active Assets Under Management (AuM); Fee Rate; and Growth rates of Active vs. Passive Products.

The Global Asset Management industry continues to witness mounting headwinds. Yes, the post crisis rebound of late 2009 and early 2010 gave the required boost to the operating margins.  However, three out of every four of Global Asset Managers agree that the industry is undergoing fundamental structural changes.

Key Challenges and Structural Shifts facing the Asset Management Industry

  • Flat AUM - Professionally Managed Assets remain flat at 2007 level ($58 trillion)
  • Declining Net Flows – Net flows averaged at 0.2% p.a. between 2008 and 2011 compared to an average of 4.7% during 2004 to 2007
  • Increasing trend of ‘In-Sourcing’ - An analysis of 50 global institutional investors shows that investors have brought ~$65 billion worth of AuM in-house in last 18 months
  • Rising Regulatory Management Cost – Operating margins will continue erode due to implementation of current and evolving regulatory requirements (Dodd Frank, FATCA, MiFid, etc.)
  • Growing significance of Emerging Markets - Allocation to emerging markets has doubled in the last six years.  Substantial diversity exists in political and business environments in Emerging Markets requiring strong local operational expertise to generate Alpha
  • Shifting investor preferences from ‘Active’ to ‘Passives’ and Alternatives - Actively managed professional assets are declining.  Passive Asset Management products grown five times as fast as ‘Actives’ in the last seven years (2004-2011). Allocation to Alternatives has been steadily growing since 2008.

A number of the above changes are structural and will have long term impact on the operating model of Investment Management firms.  We believe that winners of tomorrow will do a thorough reassessment of business models, customer acquisition and retention practices, operating capabilities and governance frameworks.

In the next post, I will discuss, what are the ‘best practices’ that some of the best in class companies are deploying.  Also, look forward to the future post on what could be the ‘next practices’ for the Asset Management industry – an industry in rapid change and transition.