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.   

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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: http://news.heartland.org/newspaper-article/2012/04/20/big-fees-small-returns-illinois-teachers-retirement-system).  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 (http://investmentmagazine.com.au/2012/09/australiansuper-brings-it-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.