Active Management 2.0
An article by Dr. Frank Engels
Head of Portfolio Management at Union Investment
The world is always changing. For the capital markets – and the financial industry as a whole – this is truer than ever. It is true of the political and regulatory situation, of the actions of central banks and of economic trends. When have the stock markets, after a decade of growth, been faced with a rise in populism across the globe, growing protectionism, negative interest rates and an absence of inflationary pressure? The answer, of course, is never.
Active portfolio management faces challenges
Structural challenges have grown
These changes to the external factors that influence the capital markets have been accompanied by less obvious (but no less disruptive) changes affecting the investors themselves:
The growing awareness of the importance of sustainable, responsible Investment
The change in the market structure in respect of underlying liquidity, investor groups and investor behaviour as well as the speed at which the capital markets switch their attention to new themes
- The growing importance of systematic strategies and rules-based Investment
The coming into effect of MiFID II and the resulting regulatory changes to how research is provided by brokers; the strict regulatory separation of trading and the stricter transparency requirements imposed upon trading operations
The combination of all these factors presents a huge challenge to all those whose business is based on understanding and analysing the world and the economy and using their insights to make predictions. This includes, in particular, fundamentally oriented active asset managers, whose approach has come under huge pressure. The flow of funds in recent years, for example, shows a clear trend towards passive investment, which is often said to be on an unstoppable rise.
Active asset management becoming more important
The trend towards passive investment products shows no sign of slowing. This is a challenge as well as an opportunity for active asset managers. We are taking up both gladly.
There is a trend towards passive investment – and we see opportunities here for active asset managers
After all, the environment in which we now operate doesn’t just present challenges, it also presents new opportunities for fundamentally oriented portfolio management. In light of current developments and trends, we believe there are three major and compelling arguments for taking an active approach:
1. Capital markets are, in practice, not always 100 per cent efficient all of the time. There are various reasons for this, and it is even more true during periods of upheaval. The unorthodox monetary policy of the central banks, the growing influence of populist politicians and socio-political megatrends such as sustainability offer a whole host of new areas where active managers can look to beat the market – and in doing so deliver superior performance for our customers. Of course, not every product can live up to this billing during every phase of the market. However, we believe that the benefits of active asset management win out over the long term.
2. Rigorous and comprehensive risk management at all stages of the investment process also has a big part to play in active asset management. And the risks have increased: new climate risks, for example, are jeopardising traditional business models; liquidity is continuously falling in key segments of the capital markets while the frequency of unusually strong and rapid movements in the price of financial assets has risen markedly. Forward-looking approaches can minimise the threat to our investors’ assets. As well as structuring the portfolio accordingly, this also involves fulfilling our commitments as an active shareholder (engagement) and as a responsible investor focused on sustainability.
3. Functioning capital markets are predicated on actors behaving rationally, responsibly and with a view to the future. From this perspective, an active approach is undoubtedly in the broader interests of the market. The targeted selection of companies whose business models are not only commercially successful but also sustainable will result in a higher weighting of such companies in investment portfolios. Active management thus plays an important role for the economy and society in allocating and steering resources.
Essential enhancements initiated
But one thing is clear: the capital market environment is changing rapidly and so asset managers must be willing to adapt as well. To achieve enduring success going forward, it may be necessary to abandon tools that have served us well in the past. At Union Investment, we have taken up the challenge of raising the quality of active asset management to the next level. We want to create new USPs and competitive advantages, for example by ramping up our expertise in proprietary, theme-based capital market research, by focusing on the management of sustainable portfolios and by making targeted use of the latest technology – be it in data management (smart data), investment analysis and strategy (artificial intelligence) or securities trading.
We want to raise the quality of active asset management to the next level.
We have four specific goals: we are broadening, focusing and deepening our research base by expanding our activities in theme-based research that is relevant to all asset classes. By creating a new division, called Research & Investment Strategy (RIS), we have consolidated our expertise in this area. Investment and operational processes in portfolio management have been more strongly focused and thus further enhanced. And finally, we are making enhancements to portfolio management along the entire value chain. We are enhancing our operational efficiency by consolidating all process and interface responsibilities in the management and monitoring of segments.
At its core, the project is aimed at improving the ability of active asset managers to deliver. Investment in our intellectual capabilities is how we intend to achieve this.
Competitive advantages through more proprietary research and better integration
Inhouse analysis capability – and so becoming less dependent on external research providers – is becoming an increasingly important competitive advantage. This mainly relates to theme-based research, where trends in the economy and society, as well as geopolitical interdependencies, are analysed in terms of their effects across all asset classes. We are adding to our capacities in this area and consolidating the expertise that we already have. This enables us to bring an even greater diversity of ideas into our portfolios and, more importantly, is helping us to set ourselves apart from passive and index-linked products.
Rapid incorporation of theme-based research via portfolio trade ideas
In return, fewer inhouse resources – and bought-in, third-party resources – are being devoted to basic research. This shift in focus frees up the resources that are needed for more theme-based alpha Research.
Effectiveness and efficiency gains in core research provides scope to increase the amount of performance-focused alpha research
Conclusion: Active management is worth the money
The capital markets and competitive environment are changing rapidly. Asset management of the future will require first-class research, diligent risk management and a willingness to take responsibility where it counts. This will enable us to offer our customers an attractive yet profitable offering despite ever more challenging conditions. After all, good active management that delivers success is always worth the money.
Unless otherwise noted, all information and illustrations are as at 01 October 2019