Perspective - Summer 2009

The Investment Roadmap

The challenges of a fast-changing industry

By Watson Wyatt Worldwide Thinking Ahead Group (TAG)

THIS PAPER describes what we see as the current state of play in the investment industry. Our particular focus is on the challenges being faced by pension funds, investment managers and consultants in an increasingly complex environment.

Industry overview
The investment roadmap describes the connections that govern change in the investment industry. There are many different participants, all needing to respond to rapid change in order to meet the demands now apparent in pension fund management. The major players and their current challenges are shown in Figure 1 and described further below.

Institutional funds
Today's institutional fund operates in more pressurized circumstances than prior generations. There is a growing awareness of the crucial role that governance* plays in achieving the aims of funds. Growing numbers of funds are seeking to improve their governance and in so doing, improve their odds for success. Recent trends suggest an increased allocation to bonds and alternative assets/absolute return strategies. Alongside falls in equity content, the home bias in equities is also diminishing. Funds' investment efficiency has been enhanced by the use of a risk budget framework. The traditional two step approach � the strategic asset allocation process and then the manager selection process � is being challenged. Many funds now prefer to target alpha and beta separately. Only some funds are sufficiently adaptable to exploit the new opportunities. The dual mantras will be investment strategies fitted to governance budgets and greater attention as to how governance can be streamlined going forward.

*See article: Investment Governance Truly Drives Investment Results by Naomi Denning, Watson Wyatt Perspective, Winter 2008 (www.watsonwyatt.com/asia-pacific/pubs/perspective/docs/08Winter_MoneyTalk.pdf)

Investment managers
Investment managers face a formidable business challenge. There are the marketplace factors to consider: client appetite, client expectations and consultant support. Then there are the competency factors: meeting capacity and sustainability challenges, enhancing the talent pool where necessary, at the same time retaining operational flexibility. In addition, there are financial parameters: product margins and working with the brand. The big question is how to balance these factors successfully.

Both mainstream firms and alternatives firms face a challenge in meeting client goals as well as meeting business goals. Products now tend to be categorized as relative return mandates and absolute return mandates. The most notable difference between the two is the level of fees. An ad valorem fee (about 0.5 per cent) is common in relative return equity mandates. Absolute return mandates have much higher base fees (ranging from 1�2 percent) and an additional performance fee (around 20 percent). It is not easy to compare these as value propositions because the absolute return funds arguably do more for the investor and often are more concentrated in their risk taking. We believe, however, that funds will start to challenge excessive fees, leading to margin pressures for investment managers.

Central to the success of an investment management firm is its ability to attract and retain talented people. One of the key issues is leadership. While technical skills are required, key adaptive skills like motivation, creating vision and alignment are even more important. Exceptional talent can be massively influential to a firm's fortunes and the success of a number of newer forces in the industry can be attributed to the influence of one powerful leader.

Consultants
Consultants are being buffeted by the same cross-winds that managers and funds are battling with: performance pressure, often over unreasonably short time horizons; adoption of a set of more flexible but more complex strategies and fierce competition, particularly in attracting and retaining talent.

Institutional funds have a long history of using consulting services to increase their governance. Traditionally consultants have provided technical support for funds' decisions on strategy and line-up of managers. A segment of the market is looking considerably beyond just support, preferring an offering that is both proactive and direct. As a result, consulting now involves much greater depth and breadth of service. Some consulting firms have moved their offering to a 'manager of managers' or 'fund of funds' approach. Advice is still part of the approach, although the more this resembles fund management, the more the advice loses independence. This trade-off between taking greater responsibility versus independence is a dilemma.

The alternative model to consultants becoming fund of funds providers is to continue to emphasize the independent advisory position, but to do so with greater direction and proactivity than traditional approaches. With evidence of greater value added comes the ability to command a higher fee. With the blurring of the boundaries around consulting space, other players are entering this marketplace, leading to even greater competition. We discuss the role of investment consultants p29-30.

The war for talent
Competitive pressures in the industry have been seen most in a talent war for a mixture of investment, problem-solving and communication skills. Investment firms need 'rainmakers' � people who make a real difference in creating value for that organisation and its clients. They may have skills in investment content, marketing or delivery. Organisations need people who can take analysis and interpretation to a deeper level than the level that worked before. They also need people who can pitch their ideas persuasively, with good client empathy particularly valued.

Organizations also welcome those who thrive under change. Change is now much faster in the investment industry. The best talent works at speed, thinks in multiple strands and crosses disciplines with ease.

Compensation has been the strongest force in the war for talent so far. This is particularly evident in the alternative areas. The new culture of compensation focuses on payment by results. Such approaches align interests but effective implementation is crucial as they can also be divisive.

Compensation, however, is not the only consideration when it comes to where talent wants to work. The search for a better culture and more meaningful work is leading to a shift at the margin to smaller, more collegiate organizations. These days, the 'employer of choice' needs to excel not only in compensation but also in:

Work fulfillment - personal autonomy, stimulating, influencing, achieving something of importance.
Work culture - teamwork, independence, ethics, great colleagues, freedom from bureaucracy and politics.
Personal development - opportunities for broader and deeper personal growth.

Conclusion
The investment industry is at a crossroads. Change is fast and complex and affects funds, investment managers and consultants alike. Competition is likely to grow as boundaries between roles blur. Success will belong to the firms that think ahead and serve institutional funds with good listening skills, alignment of interests and investment talent.