Diapositive 1

Presentation of the 2010 CFA Monograph authored by Frank Fabozzi (Yale University), Sergio Focardi (EDHEC Business School, Nice), Caroline Jonas (The Intertek Group, Paris)

Zurich, 25 January 2011Geneva, 26 January 2011Investment Management After the Global Financial Crisis1Investment Management After the Global Financial CrisisMy Objective Here TodayInvestment Management After the Global Financial Crisis2Present results of the study published by CFA Institute under the title Investment Management after the Global Financial CrisisDiscuss some of the things asset managers might want to do differently going forward

Context Leading to the MonographInvestment Management After the Global Financial Crisis3From mid 2007 through Q1 2009, financial markets were shaken by a series of shocksThe summer of 2007 saw liquidity dry up and the beginning of the subprime mortgage crisisFollowing the collapse of Lehman Brothers (Sept 2008), the financial markets began a slide which was to see major indexes such as the S&P 500 and the Morgan Stanley Composite Index (MSCI) lose more than half of their value compared to their highs of 2007By the end of Q1 2009, most investors had suffered serious losses; asset management firms were in survival mode

2009, 2010Investment Management After the Global Financial Crisis4Conventional assets under management in the global fund management industry were estimated to be 71trillion USD end 2009, a 14% increase over 2008 due essentially to the recovery in equity marketsThe S&P 500 reached a low of about 680 in Q1 2009, down 55% from its peak of about 1500 in 2007 but rebounded to 1150 by end 2010 And is now at 1280, the level it had reached five years agoTrends and Considerations Still ValidInvestment Management After the Global Financial Crisis5Though the equity markets have reboundedThe trends and considerations made remain validEssentially because the causes of the crisis have not been removedAnd many of the trends are long-term trends that could have been identified even prior to the crisis

The ObjectiveInvestment Management After the Global Financial Crisis6The Research Foundation of CFA Institute asked the authors to reveal how the financial crisis would impact investment management decisions and processes and the investment management industry itself

For everyone in asset management managers, consultants and institutional investors it is vital to do a lessons learned exercise. The industry failed to do so when the Internet bubble burst in 2000: everyone said that it was the investment banks and brushed it off, moved on. This time we need to do a lessons learned exercise at every level, we need to understand the 10 things that we need to do differently.CIO at a large Northern European institutional investor

The Research MethodologyInvestment Management After the Global Financial Crisis7A review of the literatureConversations with 68 industry players, industry observers, executive recruiters, and academics:17 institutional investors with a total of 570 billion in investable assets15 investment consultants and private wealth advisors with 5 trillion in assets under advisory15 asset and wealth managers with 4.5 trillion assets under management6 industry observers6 executive recruiters9 academicsThe geographical breakdown: Europe (roughly 2/3) and North AmericaNB: Most interviews were realized in H2 2009. Academics contributed their evaluations in early 2010

Finding #1: Asset Allocation Is BackInvestment Management After the Global Financial Crisis8The central role of asset allocation in generating returns and protecting the downside has been clearly re-establishedThe events of 2007-2009 highlighted the need for a top-down approach in which macroeconomics will play a bigger roleOne thing that strikes me is the growing client awareness that asset allocation drives everything. Investment Consultant

Allocating Assets More DynamicallyInvestment Management After the Global Financial Crisis9Given the high levels of volatility, asset allocation is also becoming more dynamic; timing asset-allocation decisions will play a big role in explaining returnsBut:Academics were skeptical as to investment managers ability to successfully time asset allocation decisionsNevertheless, academics pointed to evidence that suggests that it is easier to time parts of the market (for example large cap versus small cap or individual securities) than to time broad asset classes

Asset Allocation and DiversificationInvestment Management After the Global Financial Crisis10Investors are turning to greater diversification in asset classes to protect assets from market movements and generate higher returnsThe investable universe once centered around two asset classes equities and bonds has been expanded to include new strategies and asset classes including real estate, hedge funds, private equity, currencies, commodities, natural resources such as forests and agricultural land, infrastructure, and intangibles such as intellectual property rightsThe percentage of alternatives in the aggregate asset allocation of the pension funds in the seven countries with the largest pensions markets was estimated to be >16% by year-end 2008 (17% year end 2009)

Asset Allocation and Diversification, ctdInvestment Management After the Global Financial Crisis11But:Academics we talked to noted that there is not much history on the (risk-adjusted) performance of many of these alternative asset classesIn particular, academics were skeptical that private equity should generate more stable/better (risk-adjusted) returns than public equity: is it simply a question of lack of pricing information?Consequence of the Return of Asset AllocationInvestment Management After the Global Financial Crisis12With asset allocation re-established as the most important factor explaining returns:Asset-allocation products are expected to have strong growthIn particular, investment products with an element of active asset allocation are being engineered for defined-contribution plan members and retail investorsExample: lifestyle funds

Finding #2: Focus on Risk ManagementInvestment Management After the Global Financial Crisis13During the 2007-2009 market turmoil, investors attention shifted from returns to riskSources identified risk management as the area that has changed/will change the most following recent market turmoilWhat Is Changing in Risk Management?Investment Management After the Global Financial Crisis14In general, return expectations will have to be better aligned with the overall ability of markets and the economy to generate returnsIn addition to market risk, we can no longer ignore other risks such as liquidity risk, counterparty risk, systemic risk, and the effects of leverageInnovative products, such as the complex structured products introduced by investment banks, have added a new element of risk, calling not only for special methodologies for measuring their risk, but also a greater understanding of the products one is investing in and how they work in different economic contexts

New Tools for Analyzing RiskInvestment Management After the Global Financial Crisis15To gain a better appreciation of risk, methodologies such as Monte Carlo simulations, stress testing are being more widely adopted Conditional VaR is being used to measure risk in the presence of fat tails (i.e., large events such as large market movements)In the area of systemic risk, aggregation phenomena are being studied (for the moment by academia and central banks) using methodologies such as the theories of percolation and random networksNot All Risks Can Be Easily Estimated and HedgedInvestment Management After the Global Financial Crisis16Academics we talked to underlined the difficulty in hedging liquidity risk given the lack of data and the likely non-linear impact of liquidity shocksAs for new risks due to complex structured products a risk underlined by industry players academics cautioned on their use given the asymmetry of experience and lack of competition in the marketFinding #3: Growing Pressure on CostsInvestment Management After the Global Financial Crisis17Investors who saw their assets shrink as major indexes lost around half of their value in the crash of 2008-2009 are taking a hard look at management fees and other costs

If returns are low, the cost of producing them becomes more and more importantInstitutional Investor

Institutional Investors Strategies to Reduce Management CostsInvestment Management After the Global Financial Crisis18Renegotiating fees especially, but not only, in the alternatives arenaInvesting more assets in index fundsBringing management (increasingly) in-houseIncluding, for the larger funds, setting up in-house teams to manage alternative investments, and pooling assets to wring out layers of intermediariesIndividuals Strategies to Reduce Management CostsInvestment Management After the Global Financial Crisis19High-net-worth individuals are: moving towards simpler, more transparent products such as ETFs, and towards banks that offer more competitive fees, more competitive productsRetail investors are: reducing management fees by putting their investable assets into low-cost funds, a trend already underway for a number of years in some markets (93% of all new net purchases of S&P500 Index mutual funds concentrated in least costly funds 2000-2009)Trend towards equity index funds continued despite recovery of the market (13.7% of all US equity mutual fund assets year end 2009 up from 13% year end 2008)Finding # 4: Towards a Redistribution of RolesInvestment Management After the Global Financial Crisis20Redistribution of roles among investors, consultants, and asset and wealth managers has acceleratedLarge institutional investors are increasingly bringing asset allocation and asset management in-house and the largest are building platforms to service smaller fundsConsultants are moving into implemented or fiduciary management in an attempt to boost revenues that slumped as the value of assets under management fell and firms sought to control costs Finding # 4: Towards a Redistribution of Roles, ctdInvestment Management After the Global Financial Crisis21Asset managers are offering asset allocation advice, both in response to investor demand and to provide value over and above that added within the managers asset-class mandateAsset managers are also making inroads in asset allocation in the defined-contribution (DC) pension arena, offering all-weather portfolios for DC plan members as plan sponsors seek to give some sort of downside protection to plan membersOther Players : Investment Banks, InsurersInvestment Management After the Global Financial Crisis22Investment banks will continue to play an important role in assisting corporate pension plans, providing hedging of liabilities with interest rate derivatives and perhaps also, more generally, as a provider of swap-based exchange-traded funds (ETFs)Insurers will play a bigger role as small pension funds outsource the management of their assets, governments try to push down the cost of management, and retiring baby boomers demand principal-protection and risk-mitigation productsFinding # 5: A Greater Attention to Ethical BehaviorInvestment Management After the Global Financial Crisis23Consultants and investors are stepping up due diligence, especially in alternative investmentsLarger consultancies are building up their research teams, esp. in the area of operational riskInstitutional investors burned by hot money in hedge funds are taking a closer look not only at who is managing the money and how, but also who the co-investors areFinding # 5: A Greater Attention to Ethical Behavior, ctdInvestment Management After the Global Financial Crisis24In addition, continental European funds are taking a closer look at what activities are behind the profits of the firms in their portfoliosWhile investors in English-speaking countries are focusing more closely on governance and other ethical issues that bear on the value of the firm

Finding # 6: Biggest Challenge for All in the Industry: Regain Investor TrustInvestment Management After the Global Financial Crisis25Will require: More transparencyMore communication with investors, especially on riskBetter management of expectationsSome help from financial markets

Bubbles come and bubbles go and leave a lot of people angry. Asset managers need a trust propositionCIO, European asset management firmThe Challenge for Pension FundsInvestment Management After the Global Financial Crisis26The challenge: pay the pension promise in what many investors expect to be a highly uncertain, low-interest-rate, low-return environmentAmong the strategies: Get costs downMove more assets into in-house management wherever possibleTry to increase returns with greater diversification and more opportunistic, active asset allocation,While paying more attention to the macro environment26The Challenge for ConsultantsInvestment Management After the Global Financial Crisis27The challenge: add value as investment strategies pursued by institutional investors become more complexWill require: A bolstering of competencies in risk budgeting, asset allocation, and new asset classesMight include enlarging the service offerings to include, for example, fiduciary management Or merging (ex Towers Perrin/Watson Wyatt) or considering alliances with asset managers or institutional investors The Challenge for Investment ManagersInvestment Management After the Global Financial Crisis28The challenge: redefine the offering, aligning the promise with the ability to deliverStrategies:Play a bigger role in asset allocation advising institutional investors and engineering products for retail investors and in risk and liquidity managementRestructure: As investors move their assets increasingly into index funds on the one side and alternatives on the other, the industry is expected to restructure, with a few large firms with a comprehensive product offering including alternatives and advice, and a large number of specialized boutiquesSeparation of production and distribution: As the industry consolidates and the pensions market undergoes retailization, the industry is moving towards a separation of production and distribution in which revenue-sharing will be a major issue

Employment TrendsInvestment Management After the Global Financial Crisis29Mid 2009: 20-55% drop in overall recruitment mandates due to downsizing at large asset management firms as they tried to control costs in the face of falling assets under management and investors preference for lower-margin productsBy end 2010 recruitment firms reported that dramatic cost cutting was over and recruiting was up again though still not up to 2007 levelsCompensation TrendsInvestment Management After the Global Financial Crisis30Compensation in the industry was down 20-40% in 2009 compared to 2008, due essentially to a reduction of bonusesCompensation bounced back 10-15% in 2010 but it is still below 2007 levels Compensation structures are also being reviewed, with a larger percentage of compensation being deferred, performance evaluated over several years, and incentives aligned with the long-term performance of the firm

Recruited Most / Least in 2009

Investment Management After the Global Financial Crisis31Demand up for: Asset-allocation specialists and persons with multi-asset experience and quantitative skillsRisk managers, including counterparty and operational risk managersGlobal and emerging markets specialistsCredit specialists

Demand down for:Stock pickers, as investors moved assets into index fundsEquity portfolio managers for developed countriesRetail wholesaling staff, with the decline of the open-architecture modelWhat We Might Do DifferentlyInvestment Management After the Global Financial Crisis32For everyone in asset management managers, consultants and institutional investors it is vital to do a lessons learned exercise. The industry failed to do so when the Internet bubble burst in 2000: everyone said that it was the investment banks and brushed it off, moved on. This time we need to do a lessons learned exercise at every level, we need to understand the 10 things that we need to do differently.CIO at a large Northern European institutional investor#1 : More Effective DiversificationInvestment Management After the Global Financial Crisis33Consider correlations at the relevant time horizonsInstantaneous correlation between the returns of different assets and asset classes does not fully reflect the behavior of the returns of assets or asset classes in times of crisisDiversification based on correlations at short time horizon does not protect against crisesOne needs to understand trends at intermediate times and diversify trends Or equivalently diversify at the relevant time horizons and Understand cointegration that is the clustering of price processes around a small number of key trends

# 2 : Review Asset Allocation More FrequentlyInvestment Management After the Global Financial Crisis34Todays markets experience more large swings in valuations and change behavior in fundamental ways that affect the forecasts of entire asset classes and require dynamic asset allocationBut: while dynamic asset allocation holds the promise of higher returns, it is a source of risk given that it shifts assets dynamically from entire asset classes, leaving little margin for mistakes in the difficult task of timingTherefore the need to understand what asset subclasses can be forecasted most accurately#3 : Consider Extreme EventsInvestment Management After the Global Financial Crisis35Extreme events do occur more frequently than todays risk models forecastEmpirically, we know that returns distributions are fat-tailed In addition, there are hidden sources of extreme risk that have to be accounted for, e.g., 6 May2010 flash crashThe presence of fat tails implies that linear correlations do not reflect co-movement between asset returnsBut we still have to separate fat tails of short-term returns from prolonged market slidesAnd understand when extreme events are triggers of crises #4 : Consider Liquidity RiskInvestment Management After the Global Financial Crisis36Consider carefully the magnitude of losses should one need to unwind positions rapidlyRecent events have demonstrated that a sudden withdrawal of liquidity from markets might occur, leading to potentially very large losses on leveraged strategiesBut liquidity is difficult to understand Because it is a non linear phenomenon only partially explained by standard asset pricing theories#5 : Consider the Complexity of the Web of Relationships Between Agents, Investment ProductsInvestment Management After the Global Financial Crisis37The structure of market links has come to the forefront as a source of risk as complex derivative products might propagate losses throughout the economy well beyond what was believed realistic before the 2007-2009 crisisThe Bank of Englands Executive Director of Financial Stability Andy Haldane has proposed measures of market connectedness

#6 : ConsiderMacroeconomic QuantitiesInvestment Management After the Global Financial Crisis38The real economy does matterThough macroeconomic variables move slowly, they are important insofar as they can signal the building up of situations that might lead to large lossesFor example, the progressive building up of excessive mortgage exposure is a fact that could have been revealed by economic analysis

#6 : Look at Macroeconomic Quantities, ctdInvestment Management After the Global Financial Crisis39Financial returns must have an economic basisOne has to understand the sources of returnsAnd their sustainabilityThe economy, markets are finite,While classical finance theory essentially assumes infinite markets#6 : Look at Macroeconomic Quantities, ctdInvestment Management After the Global Financial Crisis40We know a lot about crises, in particular about the links between crises and the excess of money and creditStudies have underlined common characteristics of the economy in periods preceding a crisis (e.g., Minsky, Reinhart & Rogoff)But these forewarnings are often interpreted as signs of a favorable situation for generating returns#6 : Look at Macroeconomic Quantities, ctdInvestment Management After the Global Financial Crisis41The injection of money in the economy will have to be closely monitored It might be profitable to split inflation into an inflation vector with many components including asset inflationIn order to understand if the realignment of different sources of returns is likely to happen smoothly or through more frequent boom-bust cycles#7: Consider the Risk that Hedging Strategies Can FailInvestment Management After the Global Financial Crisis42The failure of Lehman Brothers demonstrated that apparently solid counterparties can and do failWith the crisis that started in 2007, hedging has acquired a new dimension as the possibility of failure of counterparties such as major banks and insurance firms has increased beyond what was considered likely before the crisisNeed to care not only about the reliability of counterparties but also of their environment, interconnectivity#8 : Build up Multi-asset and Multinational CapabilityInvestment Management After the Global Financial Crisis43Exposure to alternative asset classes among the seven largest pension markets has gone from 6% to 17% in the last ten years Markets are global and investors increasingly expect those who manage their money to have a global view on the investment environment

#9 : Build up the Quantitative CapabilityInvestment Management After the Global Financial Crisis44The size and complexity of todays (equity) market is enormousBy yearend 2010, worldwide regulated exchanges listed over 45,000 firms with a total market capitalization of 55 trillion USDOptimal execution increasingly calls for automation and quantitative capabilities# 10 : Align the Promise with What the Investment Management Industry Can DeliverInvestment Management After the Global Financial Crisis45Investors have been stunned by large swings in market valuations three times in the past 10 years (1997-1998, 2000-2002, 2007-2009) yearsThe industry needs to regain investors confidenceMore transparency will be neededInvestor confidence cannot withstand another crisis, markets cannot function correctly in the absence of a minimum level of trustA Final Word from Academics:Investment Management After the Global Financial Crisis46Dont forget that there really is a risk-return trade-off. If something looks too good to be true, it probably is.

Professor John Finnerty, Professor & Director of the MS in Quantitative Finance Program,Fordham Graduate School of Business