The financial crisis reshaped the institutional investment landscape which has continued to evolve under the forces of new technologies, new macroeconomic realities and new concepts of ethical investing. Joining CoreData Research this month after 25 years in financial journalism, Matthew Craig shares a few observations and lessons from his time in the institutional investment market. The second part of this blog looks at the period 2007-2019.
Learnings from 25 Years in Financial Journalism
Who Saw the Financial Crisis Coming?
The Queen once asked why no-one saw the global financial crisis of 2008 coming. The financial press were among those who missed it, but two incidents stand out from this time for me. Firstly, before the crisis happened, I organised a briefing for a team of journalists with two representatives from a very large asset manager. They explained in mind-numbing detail the workings of a new financial instrument they were using called CLOs or collateralised debt obligations. We listened, tried to follow how these zeppelins of financial engineering worked, asked a few questions, and went back to our desks not much the wiser.
With hindsight, we can see that fiendishly complex instruments used on a huge scale created market risks that almost no-one, other than the most contrarian investor, appreciated. After the GFC, someone who worked on CLOs told me, “I can understand my own CLOs but not other people’s”, which rather summed it up. This meant that when the first CLOs started to go up in flames, market participants worried about who was exposed to such a hard-to-quantify risk.
The second incident was when, at the start of 2008, one interviewee for a feature presciently compared the shortage of trust and credit to an engine running out of oil; sooner or later, it – in this case the global economy – will seize up. He was right, as we saw when a variety of financial institutions from Northern Rock to Lehman Brothers ran out of funding.
As a freelancer, the financial crisis had a mixed impact. Some titles cut editorial budgets but in other cases freelancers were used to replace permanent staff. I learnt to cover a wide range of topics from trading to ETFs and platforms on top of pensions and investments. But in 2011, I moved back in-house, this time at Institutional Investor, part of Euromoney. Here, I worked on a new website aimed at meeting the needs of — surprise, surprise — institutional investors including pension funds, insurance companies and others controlling vast asset pools counted in the billions.
Institutional Investment Trends after the GFC
Seeing how the institutional investment market developed in the wake of the financial crisis was fascinating, especially as I had very good access to asset owners across Europe through Institutional Investor’s website and programme of conferences. A clear trend, particularly among large asset owners, was taking more direct control of investments. The financial crisis showed that listed markets can be extremely volatile and liquidity can disappear overnight when markets crash. As the head of one of Canada’s largest public pension funds explained at a UK event, big asset owners like him wanted to own infrastructure assets such as toll roads, airports or rail links in order to have stable sources of cash under their control should listed markets nosedive.
Another theme has been the widespread adoption of environmental, social and governance (ESG) practices by institutional investors. Here, there is a bifurcation between retail and institutional money. For retail investors, ESG is still an additional option based on personal ethical views. For institutional asset owners, ESG criteria are increasingly integrated into the investment process itself and form part of the investment principles and strategies of asset owners, much like views on risk and return.
Memorably, a Scandinavian fund CIO won a round of applause during his presentation at another event by announcing that his fund’s newest offshore wind farm had gone live as he spoke. This exemplified the shift to direct and sustainable investments among institutional investors diversifying away from listed assets. The latest trend gaining major market traction is impact investing, when investors seek socially positive outcomes from investments. While new labels, variants, trends and fads may come and go, it is clear that ethical or responsible investing is now firmly ingrained into the investment landscape.
It’s also noticeable that more asset managers are appointing heads of ESG or sustainability as they seek to boost their ethical credentials and in turn raise their profile. ESG is seen as something that can bolster brands and reinforce reputations.
A third big trend in the institutional market has been the rising interest in private market assets. Private debt and loans are increasingly important for investors seeking alternatives to ultra-low, if not negative, rates on core fixed income. While this entails risk — huge inflows could either lower returns or push money into riskier and more illiquid investments — it could also create new sources of financing for corporate borrowers.
Looking ahead, what might institutional investment look like in a few years’ time? Many DB pension funds are becoming cash flow negative, which places far more importance on managing income. Liquidity and cash generation will therefore be prioritised over long-term returns. Options to tackle this include consolidation, or de-risking through insurance buyouts. Pension funds in countries such as the UK and the Netherlands are starting to consolidate, but local circumstances will influence if and how this happens.
Asset owners still in the growth phase will be supplied by an asset management industry either offering low-cost, commoditized services, such as passive investing, or specialist providers offering niche products and services. This barbell structure means managers need scale or specialisms, or perhaps both, if they are to offer a range of investment strategies. Asset owners may also look to managers for strategic advice and co-investment opportunities in a departure from the traditional customer-vendor relationship.
Institutional investors face an uncertain geopolitical environment, while the end of quantitative easing threatens to destabilise markets. Investors will likely make significant tactical asset allocation tweaks in a bid to find that sought-after sweet spot between liquidity and taking a long-term view and between risk and return, all the while with an overlay of sustainability. The market is evolving from the conventional asset class allocation approach to something more nuanced, with some investors now allocating to type of risk premia and others according to the underlying liquidity of assets.
Switching from reporting on trends in institutional investment to looking at them through the lens of a researcher will allow me to delve into new depths and help CoreData clients gain richer insights into how the market is changing and how they can best respond.