Asset Managers Strengthen Risk Management
Chief Executive Officer of IBK SG Asset Management
What will be the next targets of the asset management industry?
Firstly, we have to adapt our offer to the new financial environment. The volatility of the equity markets is back and investors have to be more cautious when they choose an investment and we, as fund managers, are ready to accompany our clients in their decisions.
Track record and performance are important but they are not enough to choose a product when the financial environment is changing so quickly. So, the first think to focus on is the understanding of what is happening on the market through economic analysis.
Three main topics have to be scrutinized: the U.S. economy and the credit crunch turmoil; the weakness of the U.S. dollar; and oil prices.
In the U.S., since the beginning of August, the persistence of the money market tensions has been stoking fears of a private sector credit crunch. In this context, the results of the Fed's quarterly survey on credit conditions are worth noting.
This study suggests that a clear tightening would trigger a recession. Perhaps, but it is worth remembering that powerful internal buffers are in place.
Firstly, households have seen a sustained rise in disposable income (up 4 percent in real terms over the last year). This will continue to support consumer spending. Moreover, the unemployment rate remains low and the drop in house prices has been contained (household residential wealth has not yet started to fall).
Secondly, firms are in much better shape today than they were in 2000. They have recorded large profits over the last few years and, as a result, many companies have sufficient cash flow to self-finance the bulk of their investment spending needs.
Thirdly, liquidity remains high. The money market turmoil persists but thanks to the Fed's interest rate cuts, most market interest rates are now lower than they were at the beginning of August. As a result, in the absence of further reductions in liquidity, the current tightening of lending conditions may remain moderate. Hence, we continue to project a soft-landing for US domestic demand.
The plunging U.S. dollar is struggling to find a bottom. On a trade-weighted basis, the dollar has depreciated by more than 8 percent since the beginning of the year and by 20 percent in real terms since the beginning of 2002. Faced with the risk of recession in the U.S., dollar depreciation appears likely to continue, perhaps aided by a Federal Reserve that is more focused on preventing recession than on defending the currency.
During the last five years, the greenback's side has been most noticeable against the major currencies, with a notable exception of the Japanese yen. Dollar weakness has been less significant against many emerging currencies, in particular in Asia.
A barrel of Brent crude oil is currently trading at close to $97. In constant 2007-dollar terms, it is edging ever closer to all-time highs: $102 for WTI, set in 1980, and $115 for Brent, set in November 1979.
The biggest surprise has been the surge in prices since the subprime crisis burst onto the scene in early August. Brent has risen by nearly $20 per barrel over the period. Unquestionably, the re-emergence of geopolitical tensions has played some part in this.
The gains also owe much to a tight oil market, as OPEC has been slow to step up the production. But the main reasons behind the rise are probably the new role being played by the dollar and continuing robust demand from emerging markets.
After this global overview of the economy, you can understand that the visibility of the trend of U.S. growth is not so good and as investors don't like uncertainty, the equity market could stay very volatile.
So, after a long bullish trend on U.S. and Asian markets, we are moving into a period of time where the trend of the market is less clear. The simple strategy that consists of investing on the latest best performer is over.
As an example, Chinese equities are less attractive nowadays and investors have to be aware of the risk in their portfolios. And asset managers need to propose more diversified products and more risk control products.
This also means that distributors should check if clients understand the risk that is associated with the product they buy. Thus, the value added by distributors will increase when private bankers and sales teams spend more time to explain the products and also what is happening on the financial markets.
It will help prevent clients from redeeming their products at the wrong time, and instead help them understand what is going on and take a longer-term view. Being able to take a long-term view on equity investment is a main factor for the successful development of personal wealth.
From the side of the asset managers, risk management will become more strategic in posting better performance and more sustainable out-performance.
Risk management can be implemented in various ways in the fund management, in the marketing and even in the operations.
The most obvious example is risk control of the investment Process. This means being able to use high tech quantitative financial tools, and also having a high level mathematical background for new fund managers.
But this is not enough on its own, you also have to have strong capabilities in your risk management team to be able to challenge the risk tools that are used. Marketing has to adapt its offer and propose a wide range of products, giving access to every foreign market.
A worldwide diversification will help the investor through this less stable than usual period of time. The client will be able to diversify his portfolio and undertake arbitrage. It is helpful to be flexible when the market is less certain.
And at the final stage, the asset managers should concentrate on the quality of their operations team. They have to avoid any mistake in valuation and also to be able to provide access to many different financial markets all over the world.
As the market situation is more demanding for asset managers, it is possible that there will be further consolidation in the asset management industry. In fact, small and mid-size asset management companies might not be able to invest enough in risk management to prepare for times of high volatility on the markets.