Hiring in internal expertise from the fund management industry has a long and established history, especially in markets such as the US and the Netherlands, and it’s a trend that is now gaining momentum in the likes of the UK, France and Germany. Perhaps this is only natural.
There isn’t a wall between external and internal fund management, says Roger Gray, CIO of the UK Universities Superannuation Scheme (USS). “Money and people migrate.”
However, some in the fund industry don’t see the recent hedge fund hires at Barclays as an obvious move. “That is more surprising to see,” says Gavin Ralston, global head of product and chairman of Emea at Schroders.
But recent statistics from Towers Watson suggest it’s a rapidly growing trend. The consultancy says 85% of the hedge fund searches it conducted in 2009 were for single-strategy funds rather than funds of hedge funds (FOHF) – a dramatic leap up from the previous year’s figure of 50% – suggesting a large-scale beefing-up of internal expertise.
For USS, which has a 75-person strong investment team and manages much of its £29bn (€32.4bn) portfolio internally, in-house capabilities allow customisation, such as creating a bespoke FOHF that exactly matches its requirements and fits in with the existing portfolio.
“If you look at our alternatives programme, we are building up a FOHF programme geared to complement the overall scheme’s strategic asset allocation,” says Gray. “So, for example, we have low equity beta and set other risk and governance characteristics to fit with the scheme’s strategy.”
As a large expert investor, USS can also hope to command good access.
“As a counterparty we hopefully conduct ourselves professionally,” says Gray. “We have a good working relationship with external managers and consultants. One of the advantages of being a sound and intelligent end investor is that we may be a preferred investor in certain funds.”
Smart and savvy
And, indeed, be it in the hedge fund sector or elsewhere in the industry, fund managers profess to prefer dealing with savvy clients.
“It’s a welcome trend for pension funds to raise their expertise,” says Ralston, of Schroders. “Any fund management firm wants to interact with clients who are as smart and sophisticated as possible.”
It might seem that investment consultants, who’ve already had to deal with larger asset management firms invading some of their territory through fiduciary management, would be less enthusiastic about knowledgeable and sophisticated pension funds. But Broccardo suggests they have nothing to fear.
“As far as consultants are concerned, we find their input helpful,” he says. “We are able to access some of the smartest people in those organisations – people who would look good in any organisation. As we’ve grown, they’ve been very supportive.”
Like fund management companies, consultants will benefit in some ways from dealing with institutional investors who know their onions. There may be dangers there too for consultants, but they shouldn’t trouble the very best in the industry.
“We’re trying to strike the right balance between in-house and out-of-house expertise,” says Broccardo. “The level of investment debate has stepped up and consultants know we can assess things they put forward quickly.”
Funds with internal expertise may also be more adventurous in their investment choices. “They make more intelligent choices,” says Ralston. “They have self-confidence, particularly when it comes to alternatives, which can be quite a big deal for a lot of pension funds to contemplate.”
It’s a balance, no doubt. If pension funds do as USS has done and manage a substantial part of their portfolio in-house there will be no interacting with them as they’ll be doing everything themselves. There are advantages to that for pension funds that have the requisite size.
“Internal managers are focused on one thing,” says Gray. “There are no marketing demands or commercial imperatives other than producing returns for the fund. Internal managers can adapt to what is required for the pension fund.”
This doesn’t just benefit the fund, it also has attractions for a certain breed of fund manager who wants to stick to his or her knitting. Working at a pension fund brings another benefit too: “For the manager, there is stability of capital and longer-term investment horizons,” says Gray.
Some pension funds will be more attractive than others to fund industry personnel, however. “One of the reasons for joining Barclays was that the governance structure was very clearly defined,” says Broccardo. “Trustees delegate certain responsibilities to the investment team. I operate alongside the CEO who deals with non-investment issues.”
As well as being able to manage money in-house if they choose, pension funds that are tooled up with industry hires may also be in a better position to call the shots when it comes to fees. “When it comes to terms and conditions we have the ability to make sure we’re getting the best,” says Broccardo.
But any danger to consultants and fund managers from the trend to hire internal expertise must be considered small. Funds such as USS that are big enough to manage a substantial part of their assets in-house are few and far between and, as Gray points out, getting the best price is often about “alignment of interests” rather than haggling managers down to rock-bottom fee levels.
Even a large fund such as USS can’t do it all itself. Passive is outsourced as is a global equity mandate, and Gray predicts that there will be more outsourcing “at the margin” in future. “I would expect to allocate somewhat more to external managers, particularly in specialisations where we don’t have competitive capability or where it might not be economic to build capability.”
And not all funds that hire in fund management expertise choose to manage money internally. Barclays, for example, has chosen not to as it didn’t consider this to be an economic way to use its resources.
“There have always been variations of shades in terms of how much is managed by different schemes internally and externally,” says Gray. “There are some large funds which don’t build up large teams. I don’t think one model is going to dominate.”
What is going to dominate, according to Broccardo, is the need for a whole-portfolio view in pension funds. “There is a huge demand for holistic oversight of portfolios,” he says. “Whether that’s done by an internal CIO or consultants or an asset manager offering fiduciary management doesn’t really matter, as long as it’s done.”
Typically, the model chosen will depend on size. This highlights a potential problem with the recruitment of internal expertise by larger pension funds.
“One of the issues it will raise is the difference between big and small funds,” says Schroders’ Ralston. “Only big funds can afford to go down this route. It leaves smaller funds very reliant on consultants.”
Some new companies are emerging that aim to help smaller pension funds with these issues. One such is Gatemore, which describes itself as is “a boutique investment consultancy serving mid-size pension schemes and ultra-high-net-worth private clients”. The company grew out of a US family office and now offers its services to UK pension funds. It aims to combine the best elements of fiduciary management and investment consultancy in a service that aims “to empower trustees to make investment decisions”.
“We work closely with trustees, taking the pressure off without shutting them out of the investment process,” says Mark Hodgson, managing director of Gatemore UK.
Gatemore’s target market is mid-size funds with less than £750m under management, an area of the industry which Hodgson says, “has been let down a little by large consultants”.
Another possible solution for smaller funds is to get bigger. “In some countries, there have been a lot of mergers between smaller funds,” says Ralston.
This is a solution not generally available to the UK funds targeted by Gatemore, however. “It’s much more difficult to do in the UK, especially if funds are in deficit.”
All these trends are basically being driven by one thing – the increasing complexity of investment. They may therefore be expected to intensify and the need for different types of internal expertise may be expected to increase. In the future, suggests Broccardo, there will be more people working on the asset side in internal roles, not just in pension funds, but also in sovereign wealth funds and US endowments.
©2010 funds europe