Revenue Opportunities for Asset Owners
IN PRINT ARCHIVE CIR Fall 2008
Opportunities for Asset Owners
By Mark Fieldhouse, director, technical sales, North America, RBC Dexia Investor Services
The march toward convergence continues in the investment management industry.
Managers of all shapes and sizes are looking to incorporate both alpha and beta strategies into their portfolios. As a result, absolute returns (and not passive benchmark returns) are commanding more and more of the spotlight.
One of the more popular approaches to generating alpha over the past few years has been the 130/30 strategy, which entails investing 100% into a basket of shares such as those in a stock market index and selling short 30% in stocks that are expected to underperform the market.
The attraction for many institutional investors is the ability to capitalize on alternative investment strategies without taking on excessive risk. And with appropriate risk controls in place, 130/30 strategies can be viewed as an extension of traditional equity management, instead of a full-blown leap into the world of alternative assets.
130/30 strategies are gaining widespread acceptance among mainstream investment managers. In fact, Fidelity estimates that 63% of U.S. corporate defined benefit pension plans are already deploying or considering 130/30 strategy in place of long-only mandates.
And experts suggest there’s explosive potential for future growth. According to Spitalfields Advisors, the 130/30 strategy is currently estimated at approximately US$140 billion in assets under management. Some predict it has the potential to grow to more than $2 trillion in assets under management within the next three years.
Should the 130/30 strategy fulfill this ambitious investment target, it will generate an additional $600 billion of borrowing demand.
How will these strategies impact securities lending activities? It’s no secret that institutional investors are actively searching for profitable alpha and are prepared to be much more aggressive with their investment styles to achieve better returns. But enabling traditionally long-only institutional investors to execute alpha-based strategies will require robust value-at-risk reporting, coupled with dynamic, real-time collateral management. An advanced, Basel II compliant risk management framework and infrastructure would also be a key advantage in helping lenders to mitigate risk. In the end, it’s really about a “beginning-to-end” service proposition that spans from front to back office—and in many cases, custodians are the best-positioned parties to deliver on this proposition.
So what are custodians doing to prepare for the anticipated growth in popularity of 130/30 funds?
First, many of them are making significant investments in technology and capabilities in order to provide a complete suite of solutions to the alpha-seeking investment management community. These investments will also benefit traditional asset managers as they begin to embrace shorting, a trend that is also gaining acceptance on a wider basis.
Custodians are also working to better align the front, middle and back offices to make the transition to a new investment profile both painless and efficient, with securities lending as an integral part of that package. Securities that a long-only manager would traditionally have lent to earn extra revenue will in future be pledged as collateral for stock being borrowed as part of a long/short strategy.
And those custodians who can manage that collateral, as well as providing access to liquidity, will be positioned to offer a one-stop shop that other market participants simply cannot duplicate.
Indeed, the projected growth for 130/30 funds is significant. And while the potential benefits are considerable, there are also many challenges ahead. At the end of the day, institutional investors will be well served by partnering with service providers who can deliver an integrated service offering which not only maximizes revenue, but also manages risk while maintaining operational transparency.