From an early age, kids are taught to cooperate, to share toys, to take turns, and to celebrate their differences by converging into a circle each morning.
However, “convergence” between different quarters of the asset management industry hasn’t always come as naturally. Now a report released this week by KPMG and UK-based consultancy CREATE says that although convergence is a new subject, it is already a key part of the curriculum.
Regular readers may remember the last report from this prolific partnership titled “Hedge funds: a catalyst reshaping global investment” (see related posting). Well, apparently the “catalyst” is catalyzing nicely. The newest edition, “Convergence and divergence: New forces shaping the investment universe” shows that hedge funds have stirred the asset management pot. The report basically makes the case that the asset management industry is re-inventing itself through a process of creative destruction. Here are a few of the report’s 12 key themes:
“Convergence is greatest between alternatives and long-only managers.”
From an orderly industry with its entrenched leaders and clearly delineated product offerings to a dog’s breakfast of cross-over funds, new innovations and non-traditional alliances in only a few years? According to the report:
“Thus far, convergence between long-only managers and hedge funds has been largely tactical in nature. Each has modestly ventured into the other’s area without major changes to their business model. A whole new class of products is emerging that sits somewhere between hedge funds and active long-only, and which has the potential for significant growth.”
“Long-only managers have attempted three things when entering the alternative investment world. First, using a regulatory device like UCITS III, they have offered hedge fund like products for retail investors. Second, using hybrid products like 130:30 and Global Tactical Asset Allocation (GTAA), they have widened the choice for their institutional clients. Third, via M&A, they have aimed to acquire alpha generation skills.”
“Convergence is far from uniform, characterised by purists, pragmatists and procrastinators.”
KPMG and CREATE say there are three kinds of players in asset management, “purists” who will always remain focused on their core business, “procrastinators” who know they should do something, but for whatever reason keep sitting on their duffs, and “pragmatists” who see the writing on the wall and are actively trying to eat the lunches of previously indirect competitors.
According to the survey results, long-only managers are least likely to be content to focus on their traditional business and most likely to either respond to new competitive pressures or to at least think about responding to them.
It’s no surprise that the long-only crowd is most interested in branching out. Remember that McKinsey report about how traditional managers are in a “vise-like” squeeze between cheap beta and high alpha?
“Managers expect their clients to demand higher returns from alternatives compared to long-only assets.”
Nearly 60% of managers who responded to the survey said that their clients will “be attracted” to single strategy hedge funds over the next 3 years. But curiously, the report also reveals that less than 20% of pensions actually plan to invest in hedge funds over the next three years.
While this divergence is technically possible (if, for example, all 60% of the managers were referring to the same 20% of pensions when using the term “clients”), the 20% figure seems awfully small to us.
“Convergence will promote further industry consolidation with long-only managers and investment banks in the driving seat.”
In what appears to the ultimate revenge for long-only managers, it is they who will take-out the hedge fund upstarts according to survey respondents. Only half as many respondents felt that it would be the hedge funds who take-out the long-only players (AOL/TimeWarner deja vu). And approximately half of all respondents felt it would be the current masters of the universe, investment banks, who will just thump everyone.
Although the report is generally positive about convergence and about the strengths brought to the table by both traditional and alternative players, there is one portion of the report that is decidedly negative on pretty much everything – the margin quotes from respondents. Given the apparent distain for innovation articulated by some survey respondents, it’s a wonder any of them even bothered to take part in the survey. There’s a bully in every class waiting to ruin everyone’s fun, eh? Check out these examples:
“There is an illusion that there is a huge pool of alpha opportunities. In fact, it is full of piranhas.”
“Due to a lack of investor education, innovation of new products will continue to the detriment of institutional investors.”
“Long-only managers have been knocked off their perch. They are history; yet pretend to be wannabes in the hedge fund world, with gimmicks like 130:30 funds.”
“This is a ridiculous market. People are not thinking sensibly any more.”
“The â€˜Yale’ effect has created an army of lemmings; most of whom will not live to experience it.”
“The absolute returns party will be over when the equity markets tank. They have kept all the boats afloat.”
Oh well. If you’re interesting in the impending structural mayhem to hit the asset management industry, this is required reading anyway. As the investment bankers used to sing in pre-school:
“There’s your funds and my funds – and my funds and your funds. The more we get together, the happier we’ll be.”