The Northern Trust Experience Whats New in Asset Management?! Broad Asset Management Trends Todays Markets Building Winning Portfolios
The Northern Trust Experience Broad Asset Management Trends Moderating Long-term Expected Returns Underperforming Investment Capabilities *Source: Casey, Quirk and Associates A combination of investment developments is serving to expose shortcomings in how the investment industry serves our clients… Changing Retirement Needs & Expectations Regulatory Demands Under Saving & Inflexible Investment Products Shift to Individuals
The Northern Trust Experience Broad Asset Management Trends Investor Challenges *Source: Casey, Quirk and Associates …As a result, the individual investor – regardless of accumulated net worth – is facing an unprecedented set of challenges. Inadequate Investment Expertise Normalized Return Environment Concerns of Retirement Volatility Increased Personal Responsibility Potential Funding Gaps Investment managers must work with clients to help them adjust to this landscape, educate them on how to succeed, and invest for them in capabilities that will secure their future!
The Northern Trust Experience We are now facing a moment of historic change in the industry. Changing Investor Expectations and Needs Institutional clients are rethinking their pension strategy rather than rebalancing their asset allocation Plan sponsors are strategically re-evaluating the pension plan Shifting to DC from DB Growing number of under-funded plans Current and pending regulatory changes Personal clients are rethinking investment strategies as a result of an increased responsibility for their own financial security. Integrated solutions with full asset allocation Demand for best in class investments Increase in demand for fixed annuity streams Demand For Alpha & Alternatives Grows Focus changing to total return The importance of hedge funds and manager of managers A growing list of alternative asset classes are increasingly important Broad Asset Management Trends
The Northern Trust Experience Broad Asset Management Trends S&P 500 Historical January 1926 - December 2005 Annualized Return: +10.4% Cumulative Nominal Return (Logarithmic Scale, January 1990 = 1.0) Annualized S&P 500 Returns January 1990 - March 2000: +18.0% April 2000 - December 2005: (1.6%) January 1990 - December 2005: +10.6% Source: Standard & Poors; Casey, Quirk & Associates analysis. Late 90s out-performance and the subsequent reversion to a normalized return environment is one factor driving a generational shift in the asset management business.
The Northern Trust Experience Hedge Funds Fund of Funds Commodities Portable Alpha Liability Driven Investments Complexity 1970s First Generation: Limited Product Suites 1980s1990s Second Generation: Asset Allocation / Specialization 2000s Third Generation: The Total Firm Product Focused Sales Investment Solutions Equity Fixed Income Cash Value Equity Growth Equity Large Cap Mid Cap Geographic Allocation Private Equity Real Estate Small Cap Core Fixed Income High Yield Sector Allocation Shift in Pension Accountability Alternatives Are Mainstream Globalization Rapidly Aging Populations Vulnerable Competitors Under Funded Pensions Changing Pension Regulations The increased financial pressure, changing pension regulations, shifting demographics, and greater product choices are also driving the generational shift in asset management. Broad Asset Management Trends
The Northern Trust Experience Non-Traditional Benchmarks With an Outcome Focus Traditional Benchmarks Broad Asset Management Trends This generational shift is fundamentally changing the way that our clients will expect us to invest their assets. Second Generation Third Generation *Source: Casey, Quirk and Associates Risk Budgeting Alpha – Beta Separation Percentage Based Asset Allocation Manager Selection Based on Style Box Elimination of Style Bias Inclusion of Shorting Alternatives? Style Focus on value or growth Long Only Investing Traditional Asset Classes
The Northern Trust Experience Broad Asset Management Trends Traditional Active Management: The Deconstruction of a Classic Favorite! Alpha Return: Manager Skill Beta Return: Market Return Second Generation Approach One Price Unclear Return Sources Hard to Determine Manager Skill Third Generation Approach Beta Provider ETFs, Indexing, Derivatives Alpha Provider(s) Hedge Funds, Real Estate, Private Equity, Other Alts Absolute Return Focus Pay for Performance Identifiable Skill Efficient Exposure Minimal Cost Deconstruction *Source: Casey, Quirk and Associates
The Northern Trust Experience Broad Asset Management Trends These Trends Are Driving Fundamental Change in the Institutional AND Personal Market Place. Increased Individual Responsibility A Return To Normal Market Returns Demand For Increased Diversification Demand For Broader Access The Need For Investment Solutions Closing of DB Plans Demand To Put Plans On Auto Pilot Limit Financial Impact of Plans on P & L Reassessment of the Asset / Liability Equation & The Management of Assets The Need For Investment Solutions 3 rd Generation Firms Personal Market: Institutional Market :
The Northern Trust Experience Broad Asset Management Trends Third Generation Firm Characteristics Relative AND Absolute return orientation Dynamic solutions strategy orientation Alternative investment capabilities Financial engineering Alpha generation capabilities Appropriate fee strategies Investors need firms that have access to the component parts. *Source: Casey, Quirk and Associates
The Northern Trust Experience Todays Markets Equity Market Crash1987 Long Term Capital Management1998 Tech Bubble Bursting2000 Sub-Prime Crisis2007 The current crisis is not an isolated event, but another in a series of seemingly more frequent events.
The Northern Trust Experience Known Knowables Known Unknowables Unknown Knowables Unknown Unknowables Todays Markets We know the basics of each of these markets events, the more important question is how does risk management work and what breaks down in a market crisis? KnowableUnknowable Known Unknown Rational Participants
The Northern Trust Experience Todays Markets Complexity: Look to evolution to understand Tight Coupling: How close are the dominoes? There have been crises as long as there have been markets. Is anything different in todays market environment? In some views, part of the problem has been our quest for transparency and specificity. The other is fear. Transparency & Specificity Traders alter or hide behavior Increased information can increase instability Fear: The experimental neurosis example *Source: A Demon of Our Own Design – Richard Bookstaber 2007
The Northern Trust Experience Todays Markets We have a wave of vehicles that need to mature Losses are being recognized AND realized Final clarity on who has what and how much A resumption of normal function Time, risk management and liquidity heal all.
The Northern Trust Experience Building Winning Portfolios Investment Industry Dynamics Personal clients are becoming increasingly sophisticated and re-thinking their approach to investing as a result of increased responsibility for their financial security. Demand for diversified and risk managed portfolios Demand for best in class asset managers Increase in demand for fixed annuity streams Demand for total return that ensures net principal grows faster than inflation Personal Market Dynamics *Source: Casey, Quirk and Associates The separation of alpha and beta return The ascendancy of quantitative and alternative investments Increased use of derivative instruments and derivative strategies for risk management and investment The implementation of performance fees Loosening of benchmark restrictions
The Northern Trust Experience Building Winning Portfolios Personal market and investment industry trends are driving an evolution in the client conversation that is much more focused on liabilities, goals and investment outcomes. Old Paradigm Client Conversation Product Focused Proprietary Architecture Equity / Fixed Income Asset Allocation Individual Security Orientation Traditional Benchmarks New Paradigm Client Conversation Consultatively Focused Outcome Oriented Open Architecture Unconstrained Solutions Alpha / Beta Separation Risk Budgeting vs. Asset Allocation Alternatives Derivative Based Products Thought Leadership Increased Client Sophistication & Size *Source: Casey, Quirk and Associates
The Northern Trust Experience Asset managers must be prepared to deliver the investment capabilities that fulfill client needs from a menu of beta and open architecture alpha strategies. Building Winning Portfolios Structured Capabilities Active Extension Equity Strategies Hedge Strategies Risk Budgeted Asset Selection Beta Return Index Mutual Funds Exchange Traded Funds Synthetic Exposures Legacy Individual Securities Open Architecture Fixed Income Alpha Strategies Other Alternative Strategies
The Northern Trust Experience Building Winning Portfolios Needs, Aspirations, Dreams Investment Program Design Execution & Monitoring Financially Secure Clients! Targeted Financial Solutions One size does not fit all… financial solutions, and the manager value proposition depend on understanding client needs and delivering investments that reflect these considerations. 1. Objective Analysis: Liability Review Life Goals Fears/Dreams 2. Solutions Perspective: Best in Class Investments Optimizing the Efficient Frontier Tax Sensitivity 3. Implementation: Efficient Execution Rational Pricing Risk Monitoring/Mgmt. 4. The End Game: Growing Financial Security Generational Wealth Transfer Growing AuM