no. 14
perspecti v es
the future of finance
f e brua r y 2 013
Commentary from influential industry leaders, academics
and policymakers on relevant issues and trends
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table of contents
per spect i v esf e brua r y 2 013
no. 14
02/Generation NextHow the Millennial generation will reshape asset management
05/The New Depression How the dollar standard pushed the global economy to the brink
16/The Contributors
special report
08/The Game Changers Leaders discuss where finance is headed
14/Breakout Stars Frontier markets and the future of growth
the future of finance
It is time to look forward. To address some of the important questions that remain in the wake of the
Financial Crisis. Where do we go from here? How will Europe fare? Where can investors find returns
in this new era of low returns and low growth? This issue explores these important questions and
looks into the future for answers.
In Generation Next, we explore the Millennial generation, whose beliefs and behaviours are
fundamentally different from those of their Baby Boomer parents. Millennials are concerned about
catastrophic climate change and focused on making a real difference with their money. As they get
ready to save and invest, how will their new and different sets of demands and questions change
the investment space?
We also look at the next generation of global markets in Breakout Stars: Frontier markets and the
future of growth. From Nigeria to Vietnam, these nations defy labels and may represent some
important opportunities for investors able to tap into their potential.
In our special supplement, The Game Changers, we interview leaders from the investment world for
their insights into where the industry is heading. From Research Affiliates’ Rob Arnott to AIMCo’s
Leo de Bever and Jagdeep Singh Bachher, and ALFI’s Marc Saluzzi, these individuals have a lot to
say about the future of finance.
Finally, author Richard Duncan offers a somewhat darker vision of the future as we discuss his book,
The New Depression: The Breakdown of the Paper Money Economy. In this Q&A, Duncan explains why
the demise of the gold standard has led us to an unsustainable credit-driven economy and what he
thinks must be done to avoid a catastrophic global depression.
We hope you enjoy these insights and find them useful. As always, we welcome your suggestions for
topics and ideas for future issues.
taking st ock . what the future may hold for investment management and the gl obal economy.
josé pl acidoChief Executive Officer RBC Investor Services
How the Millennial generation will reshape asset management
GENERATIONNEXT
Author Jim Finkelstein says his son is worried about the future: and
for good reason. The 21-year-old college graduate and member of the
Millennial generation – those born between 1978 and 2000 – recently
came across research concluding that, by 2050, global warming will
have wrought calamitous changes on the planet. “We need to do
something about it now,” he told his dad over dinner. The message
resonated for Finkelstein, president and CEO of FutureSense Inc.,
who is himself a Baby Boomer and author of the book Fuse: Making
Sense of the New Cogenerational Workplace. He’s written and lectured
on how to bridge the divide between Boomers and the Millennial
generation in the workplace, but for him a key issue is their approach
to doing the right thing, not necessarily for the greater good of
mankind, but for their own “common sense of survival.”
Writers like Finkelstein have spent a lot of time helping people
understand the key differences between Millennials and their Baby
Boomer parents. This new generation is grappling with an incredibly
different world, as they graduate from college, move into the
workforce and begin to accumulate savings and assets. But perhaps
the most critical differentiator between these two generations rests
on their attitude toward money and investment. The concerns and
needs of Millennials are vastly different than those of Boomers.
They’re more focused on sustainability, dealing with the pressing
issues facing the planet (including climate change), and ensuring
the money they invest makes a meaningful impact on the world.
Experts say the asset management industry must quickly come to
terms with this to effectively meet Millennials’ needs.
Raul Pomares, senior managing director of Sonen Capital LLC in San
Francisco, is already responding to the evolving needs of Millennials.
He has been working with family offices since the 1990s and says the
kinds of things clients are asking for has changed drastically during that
time, particularly among younger people. “I had become accustomed
to dealing with families holistically, including all the generations in
discussions around wealth planning. But more clients started asking
how we could help them match their own values with the kinds of
investments that were being made,” he explains. While he had
previously used negative screens around specific kinds of investments,
like tobacco or gambling, it was clear his clients wanted more.
Today, Pomares’ firm is dedicated to seeking financial returns tied
to creating a lasting social impact, something which is increasingly
appealing to new and younger clients who are part of a generation
that no longer puts a wall between philanthropy and return-seeking
in their investments. “They realise you don’t have to sacrifice
returns to make an impact,” he says. “It can be done simply by
bringing the same rigour to impact investing as investors have
always brought to other investments.”
beyond negative screens
Dan Apfel agrees Millennials are pushing the investment industry
to make a positive impact on the world that goes beyond using
negative screens. Apfel is executive director of the Responsible
Endowments Coalition, an organisation that supports students and
other university community members in engaging with endowments
in their investment practices. “People in the Millennial generation
have a mindset that goes beyond not investing in things like
gambling or weapons,” he explains. There is a real desire to support
a new and emerging set of entrepreneurs creating innovative
solutions to existing problems.
perspectives: the future of finance | 3
“ People in the Millennial generation have a mindset that goes beyond not investing in things like gambling or weapons.”
“Millennials want to create positive change, not just stop investing
in bad things,” he says. “They want the ability to invest in solutions-
oriented alternatives that will improve the world. For example, they’re
not just saying, ‘I don’t want to use plastic bags’. They want to create an
alternative to them. This is what is driving their investment approach.”
Perhaps the biggest differentiator between Millennials and their
Boomer parents, however, is the fundamentally different state of the
world today. It extends beyond climate change: this generation faces
tremendous economic and social challenges as well. Millennials are
coming into adulthood loaded with student debt, unable to find a
well-paying job and, as a result, unable to find the money to save.
David Norman, founder of TCF Investment in the UK, believes
difficult economic conditions are creating a big gap between the
haves and have-nots among Millennials, with some benefiting from
the wealth of their Boomer parents and others going it alone. “In
the UK, for example, property has always been the great wealth
creator,” Norman explains. “But housing has become extremely
expensive and, as people live longer, they’ll be selling their house
to finance their retirement and care. In many cases, Boomers
won’t be leaving the family home to the next generation.”
Norman also points out that Boomers have represented a
demographic sweet spot, with many things working in their favour:
markets were buoyant, returns were high and pension schemes were
available, he says. Not so for Millennials, especially those in the UK
who face an uphill battle to accumulate assets and gain a foothold
in a challenging economy. The UK has been responding with
innovative savings schemes to help young people put money aside
more easily. The National Employment Savings Trust, for example,
is designed for younger Britons who tend to move from job to job
in a way the previous generation never did. It allows savers to
contribute to the same retirement pot even if they change employers
(no matter how big or small) and if they shift to self-employment.
Norman believes this is a positive move to help a generation that
is under tremendous financial pressure.
Finkelstein believes the asset management industry will need to
change the kinds of services and products it offers to meet the needs
of this generation. While Boomers have focused on investing to get
the highest rate of return, Millennials are focused on a completely
different set of values, where impact trumps returns. “It’s not about
investing for the long term anymore. It’s about making money work
for society,” Finkelstein says. “It’s a whole different pitch.” Young
investors will be looking to invest in companies that are socially
conscious, an important point given that research done by the
Social Welfare Research Institute at Boston College shows a record
USD 41 trillion is set to change hands in the US as the Boomer
generation passes on their legacy to their kids. Millennials who
inherit some of that wealth will probably do different things with it
than their parents did. “Boomers have always saved for retirement,
putting off things like travel until they finished working,” Finkelstein
explains. “Millennials want it now, not because they’re entitled but
because, for them, life is about experiences.” Hence, a Millennial
who inherits money might be more inclined to take a sabbatical from
work and travel instead of just squirreling it away in investments.
All this means Millennials are likely to have a profound impact on
where the investment industry is headed. At the most basic level,
they are the first generation to have grown up online with access
to a massive pool of information their parents never had. Jack
Bouroudjian, CEO of Chicago-based Index Futures Group, says that
access to information will put pressure on managers and advisors
to offer better value: “Who’s going to pay someone a 1% fee when
they think they have all the same information at their fingertips?
The industry is going to have to offer ideas and real direction rather
than just asset allocation and stock picking.”
Pomares believes Millennials are likely to start investing with an
impact lens sooner than most realise: “They gravitate towards
environmental and social justice issues as well as viable investment
solutions to challenges that were overlooked by previous
generations. We all live in this world and we can’t ignore what’s
happening elsewhere – it affects us all. The investment industry
will need to evolve and recognise that reality.”
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“ Millennials want it now, not because they’re entitled but because, for them, life is about experiences.”
How the dollar standard pushed the global economy to the brink
THE NEW DEPRESSION
In his book, The New Depression: The Breakdown of the
Paper Money Economy, Duncan discusses the new economic
paradigm that emerged in 1968 when gold was abandoned
and credit creation and consumption began to drive economic
growth. Today, he sees the world standing on the brink of a
massive global depression as the private sector remains unable
to take on any more debt. So what is the solution? Duncan
believes governments need to change their policy and start
thinking big about the future. We sat down with Duncan to
discuss his views on the global economy and his
recommendations for change.
You argue in your book that the US decision to stop backing gold in 1968 changed the nature of money forever. How? Prior to 1968, when dollars were backed by gold, there was a
very clear difference between money and credit. Money was
gold and credit was the obligation to repay money. In the old
days, when you took a dollar bill to the Treasury Department,
in theory, they had to give you some gold for it. Now, they just
give you another dollar. A dollar is now just another credit
instrument, just like a 10-year government bond. Why is this
significant? Because when dollars were backed by gold, there
was a limited amount of money that could be created. It put
binding constraints on how much credit could be created,
because credit is simply a multiple of the amount of money
that exists. Once the link between dollars and gold was
broken, it removed the constraints on how much money
could be created and has since allowed an explosion in
credit to occur. In the US, for example, credit ballooned from
USD 1 trillion in 1963, when the gold standard was still in
place, to USD 50 trillion in 2007, prior to the Financial Crisis.
That means it expanded 50 times when the gold standard
was removed. The problem today is that this credit boom
is in danger of collapse because credit can’t expand any
further, mainly because the private sector can’t repay the
debt it already has.
What do you consider to be the main flaws in the international monetary system today? When the Bretton Woods system broke down in 1971, it was more
or less a quasi-gold standard, replicating the best qualities of a
gold standard. Under the gold standard, trade between countries
had to balance and, if they didn’t, the deficit country had to pay
with gold. If a country lost a lot of gold due to an imbalance,
it would create a very severe recession in the deficit country.
That recession meant the deficit country would stop buying
some imports and that would restore the trade balance.
Today, without the gold standard, there is no inherent mechanism
to prevent big trade imbalances. Post–Bretton Woods, the US
started developing an enormous current account deficit with
the rest of the world, peaking at $800 billion in 2006. This was,
of course, highly beneficial to the rest of the world because it
allowed countries to expand their economies by exporting more
to the United States. They all boomed around this massive trade
deficit in the US. Right now, there is no mechanism to prevent
this and that is a major flaw.
A second flaw in the system we have now, which I call the
“dollar standard,” is that there is nothing that can prevent a
country from manipulating its currency. If we look at China,
for example, it has a USD 300 billion-a-year trade surplus with
Until 1968, your money was as good as gold, quite literally. Thereafter, the Bretton Woods system unravelled, sweeping the gold standard aside in favour of a fiat currency, with no gold-backed limits on how much money could be created by central banks. According to author and economist Richard Duncan, the elimination of the gold standard set the global economy on an uncharted course with an uncertain and potentially devastating destination.
richard duncan Author, The New Depression: The Breakdown of the Paper Money Economy
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perspectives: the future of finance | 7
the US. If that money were converted in the open market into
yuan, the local currency, it would put extreme pressure on the
yuan, causing it to appreciate drastically. This would cause
China’s exports to stop growing so rapidly and would slow
the growth of its economy. Instead, China can manipulate its
currency by having the central bank print its own money and
by buying all the dollars going into it at a fixed rate. This holds
down the value of its currency and allows it to continue to
have export-led growth and maintain a trade surplus with
the US.
The third flaw is that the banking industry over the past
several decades has been deregulated. The central banks and
governments lost control over credit creation and there doesn’t
seem to be any mechanism in this new system to limit the credit
that the banking system and the shadow banking system created.
All this credit can’t be repaid, so we’re in danger of collapsing
into what I call the “New Depression.”
Are we headed for the New Depression? I think we all need to realise that we’re in a completely new
situation. Back in the day, if the government spent a lot of money
it would push up interest rates and if the Fed printed a lot of
money, it would very quickly lead to high inflation rates. But
today something else is going on. Globalisation is putting extreme
downward pressure on wages as all the manufacturing jobs move
to developing countries where workers can be hired for between
$5 and $10 a day. Falling wages around the world are extremely
deflationary and the deflationary forces of globalisation are
offsetting the inflationary effects of money creation. So, for now,
we are in a nirvana-like world where governments can borrow
trillions of dollars for 1.6% interest. Governments should take
advantage of this nirvana-like space as a way to get out of this
disaster and create opportunity by borrowing trillions at those
low rates for 10 years and investing very aggressively in
transformative 21st-century industries and technologies.
What do you see as the solution? The US economy needs to be entirely restructured. Right now,
there are three possible ways to do this. We can do what the
US Tea Party wants and immediately balance the government’s
books and get rid of the deficit. That would immediately result in
depression. Or, we could do what Japan has done and run massive
government deficits year after year and waste the money building
bridges to nowhere. Doing this would keep the US on the same
track – borrowing massive amounts of money and spending it
all wastefully. In this scenario, the US would survive for another
five to 10 years and then collapse like Greece.
There is a third option, however. The US could learn from Japan
and allow governments to borrow aggressively, not to build
bridges to nowhere but to invest it in transformative 21st-century
technology and industries. This would generate massive returns
and pay for itself many times over. The US government should
invest a trillion dollars in solar energy, a trillion dollars in biotech
and a trillion dollars in nanotechnology over the next 10 years.
If it did this, it could completely restructure the US economy
and spark a technological revolution like the first industrial
revolution. And the US would never have to collapse into the
New Depression.
“Back in the day, if the government spent a lot of money it would push up interest rates and if the Fed printed a lot of money, it would very quickly lead to high inflation rates. But today something else is going on.”
special report
Leaders discuss where finance is headed
GAME CHANGERS
The Equalisers: rob arnot t
chairman and ceo, research affiliates ll c
In this age of low growth, investors have tempered their
expectations. With a best hope scenario of 4% to 5% annually in
returns, they are more focused than ever on products that can
boost efficiency, especially in the passive index space. Rob Arnott,
chairman and CEO of Research Affiliates LLC, has spent years
refining and improving the indexes investors rely on. As a
champion of fundamental indexing, he is leading a charge
that will help investors in the future.
What is the biggest challenge facing institutional investors today? Right now the two most dangerous threats to investors are an
expectations gap on GDP growth and an expectations gap on
market returns. Let’s start with the GDP gap. When we look
back on GDP growth through the century, we see 3% and
we think that’s normal. We expect our politicians and our
economic leadership teams to deliver 3% GDP growth. That’s
not realistic. GDP growth equals labour force growth plus
productivity growth. Labour force growth is going to be slower
in the US: just 1% a year over the next 30 years. We are also
facing a productivity slowdown that comes from an older
workforce. Wages peak when someone is in their 40s and 50s.
As Baby Boomers retire, we will lose our most productive
workers and this will lead to anemic growth. The 3% growth
we’ve been used to represents the effects of a demographic
sweet spot, from the 1920s to 1980s, where there wasn’t a
large roster of seniors and support ratios were low. Today,
we’re at the end stages of that and we’ve got to ratchet down
our forward-looking growth expectations.
If you put the pieces together – slower growth in the labour force,
an aging population and blossoming deficits and debt – our
forward-looking GDP growth will be more along the lines of 1%.
Why is this so important? Not because 1% is horrible: it’s still
growth. It’s horrible relative to expectations. We’ll kick out
politicians and business leaders who fail to deliver. And the
resulting revolving door will create an incentive for delivering
phony GDP growth, where deficit spending shows up as growth
even though it’s not. We could face a scenario where deficit
spending becomes endemic in the developed world and where
institutional support for continued deficit spending is led by the
voters’ demand for continued 3% growth even though it is no
longer plausible.
What about expectations on the investment side? There’s also a gap in return expectations. People look back over
the last 30 years and they see returns of 12% on stocks and 9.5%
on bonds. They wonder why it can’t continue. The expectation
gap in investments means that while investors expect to earn 8%
on a balanced portfolio, the reality is they will earn 4%, less than
half what they expect.
You’re recognised as the father of fundamental indexing. Given the challenges you see, both economic and investment-related, what future do you expect for indexing and passive investment in general? Indexing is changing the landscape. Right now, investors recognise
that indexes that are mainly market capitalisation–weighted
In the five years since the 2008 Financial Crisis, the investment space has shifted in fundamental ways. From sovereign wealth funds to cross-border funds, there are a few key trends that are going to shape the future of finance. In this feature, we interview leaders from three organisations that are helping to rethink and reshape the investment world.
perspectives: the future of finance | 9
have an Achilles heel. If you index stocks by market cap, you’re
getting the popular, trendy stocks: the safe havens, with valuations
that have been driven up as a result. In contrast, when you invest
in stocks that are proportional in size to their business, research
shows you do about 2% better on average over decades. That’s a
neat outcome. With forward-looking stock returns sitting at 4%,
boosting that return by 2% is huge.
The Achilles heel in cap-weighted indexes is even more
pronounced on the bond side. If you invest in a cap-weighted
bond index, you’re investing in bonds in direct correlation with
the debt appetite of the borrower. The more they want to borrow,
the larger their bond issues are and the more you must own.
It’s an excruciating and devastating problem. Take Greece, for
example. Before it reached junk status, Greece had four times the
debt of Australia. And Australia had four times the GDP of Greece.
If we were lending in proportion to the debt capacity of a nation,
we would want to have four times as much Australian debt as
Greek debt. But with cap weighting, the opposite would be true:
we would have had four times as much Greek debt as Australian
debt. Simply because Greece wanted to borrow more.
So the work we’ve done in non-cap-weighted indexes has
opened a door for a whole sweep of innovations related to the
use of mainstream broad market index assets that can add from
1% to 3% to returns, which is significant based on market return
expectations of 4%. This is a very important factor in helping
investors bridge the investment expectations gap over the
next decade.
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The Alberta Investment Management Corporation (AIMCo) has
made its mark in recent years as one of the most innovative
sovereign wealth funds in world. With CAD 70 billion in assets
under management, AIMCo invests on behalf of pension,
endowment and government funds in the energy-rich province
of Alberta. In the wake of the 2008 Financial Crisis, however,
AIMCo shifted its focus to the very long term, taking on more direct
investments like infrastructure and redefining its approach to risk.
What major changes has AIMCo made in the past few years to deal with the global financial and economic challenges that are affecting the investment landscape?
We are implementing or upgrading all the business systems we
need to value our holdings better and faster and to track risk more
accurately. This is becoming the foundation for a more robust
decision-making process. After we became a crown corporation in
2008 we witnessed a cultural shift, with a new focus on managing
for best risk-adjusted returns.
On the investment side, there is greater focus on direct
investments and managing more assets internally. In 2008, 80% of
costs came from 20% of externally managed assets. External costs
have since dropped to 60%. We have far fewer external managers
in public equities, infrastructure and private equity, but we
manage those relationships more intensively.
The Giants: leo de bever
president, the alberta
investment management
corporation (aimco)
jagdeep singh bachher
executive vice-president,
venture and innovation,
aimco
perspectives: the future of finance | 11
A big part of your mandate is to manage Albertans’ pension assets. Are you hopeful about the future of DB plans given the challenges they face?
Actuaries underestimated longevity. The nineties seemed to imply
that returns were higher, keeping everything affordable. The next
ten years showed otherwise. So, DB plans face huge funding
challenges. We are trying to earn an extra 1% to 2% to help close
the gap, but it would take decades to dig ourselves out with better
returns alone. Pension benefits behave like bonds, but with bond
returns very low, we need to find a better way to finance pensions
without taking on unreasonable risks. Really boring regulated
infrastructure (with stable real returns at risk between stocks
and bonds) has in many cases proven to be a better match for
long-term liabilities.
What needs to change to create a more accommodating environment for the pension promise on a global basis?
The promise behind government pay-as-you-go pensions funded
from tax revenues will be hard to keep in most OECD countries.
The Canada Pension Plan has been partially funded to reduce
that future budget pressure. The bigger solution for DB plans
will have to involve contributing longer, reducing pension
expectations and sharing risk better across active and retired
members. Employer guarantees will likely become rare. The DB
model is efficient from an investment perspective and shares
longevity risk. The main change will probably be the shift to a
“target pension” that will be periodically adjusted in light of
investment experience. That will be tough to accept. We need
more pooled DC plans to keep the economies of scale from
DB asset management.
What lessons can other pension systems learn from Canada – and what countries, investors or jurisdictions have you drawn lessons from?
Strong governance has helped the big Canadian pension plans
be more innovative in looking for diversified and lower-cost asset
management. We can attract good talent to organisations, which
helps create value. Direct investment programs also help to
reduce costs and allow pension funds to pursue investment
strategies that can deliver returns.
No one has a monopoly on new ideas. We have humility as a core
value because you can never assume that you know it all. We keep
a close watch on what goes on in the Netherlands and Australia,
both to see what seems to work and what is best to avoid.
What does leadership look like to you from an investment standpoint?
Mobilising as much and as diverse a pool of talent as you can.
Challenging people to try to figure out the future even marginally
better than others. Daring to stick your neck out and find novel
ways to make better risk-adjusted returns for clients. Allowing
people to experiment and occasionally make mistakes, because
that’s the only way to find out what works. Find investments
that don’t fit a neat asset class box. As long as we can figure out
risk and return, we will fit it in somewhere. Occasionally that
creates problems because unfamiliarity raises the inevitable
question “who else is doing it,” and the inevitable answer “very
few,” and that’s why the returns may be better than for the stuff
we already have.
“ No one has a monopoly on new ideas. We have humility as a core value because you can never assume that you know it all.”
The Globalisers: marc saluzzi
chairman, the association of the luxembourg fund
industry (alfi)
Europe has been a world leader in fostering the free flow
of capital across borders. With the introduction of the first
Undertakings for Collective Investment in Transferable Securities
(UCITS) directive in 1988, the vision was set out: a level playing
field whereby all European investors would have access to a
wealth of funds and products, without a lot of red tape. As
Chairman of the Association of the Luxembourg Fund Industry
(ALFI), Marc Saluzzi has been doggedly pursuing cross-border
fund distribution, working within Luxembourg’s industry to
ensure funds flow smoothly across Europe.
How has UCITS changed the fund distribution space in Europe and around the world? Up to the mid-1980s, the global asset management industry was
essentially a collection of domestically focused industries. With
the first UCITS directive, the ambition to create a truly cross-
border asset management industry was clearly articulated. More
than 25 years later, UCITS has become the global fund standard
not only in Europe but also in many other parts of the world.
Today, besides Europe, Asia and Latin America are now key
contributors in terms of net inflows.
What has Luxembourg’s role been and how has it evolved? Initially, fund promoters launching funds in Luxembourg had
only one objective: to crack the German market. Today, the
world ex-USA is the playground for our Luxembourg UCITS. It
requires an intense focus on promotion and education targeted
at institutional investors, fund managers and regulators in our
key distribution markets.
Getting to this point was clearly a challenge because regulators,
fund managers and distributors in each and every distribution
market had to be convinced of the relevance of the UCITS product
in a global context. Service providers also faced challenges
because they had to develop a whole set of solutions to support
fund managers in achieving their international ambitions.
But the efforts made since 1988 have largely paid off. Today,
Luxembourg is clearly recognised for its expertise in cross-border
distribution, with a 70% market share of all cross-border fund
registrations.
What barriers still exist for seamless fund distribution in the eurozone and around the world? Aside from cultural preferences, local marketing rules and local
tax regimes are not always easy to manage, especially when you
distribute in more than 50 different markets. It is also clear that,
since the beginning of the 2008 Financial Crisis, some countries
have been tempted to use taxes and/or regulations to limit local
investors’ access to UCITS.
Why is Luxembourg a model for other countries in increasingly globalised financial markets? Luxembourg believed very early in the emergence of a cross-
border distribution model and bet everything it had on it. Now,
although many countries aspire to become a fund distribution
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perspectives: the future of finance | 13
hub like Luxembourg, our first-mover advantage will be quite
difficult to replicate. This is especially true in regions where
there is no integrated or single market and there are no political
aspirations to build one.
How has the Financial Crisis affected fund distribution in the eurozone? First, in such dramatic circumstances, it is clear that investors
have a tendency to retrench at home. This makes cross-border
distribution more difficult. Nevertheless, it is quite interesting
to note that the combined market share of Luxembourg and
Ireland in total UCITS assets under management has more than
doubled from 20% to 45% over the last 10 years. The fact that
both countries are champions of cross-border distribution sends
a clear message to the industry. Second, regulations such as
Basel 3 and Solvency 2 will change or are already changing
the way these two distribution channels are consuming fund
products. In a country like France, the priority for banks is
no longer selling funds, it is boosting their deposit base.
Are you hopeful that financial systems in the eurozone can continue to harmonise, or are there potential barriers you see emerging, especially post-Crisis?I clearly believe that European financial systems will further
integrate and thus harmonise. Going forward, the banking
sector will be supervised by the European Central Bank, and
the EU Commission is pushing toward a single rulebook.
Both developments are the best evidence of this trend.
“ It is quite interesting to note that the combined market share of Luxembourg and Ireland in total UCITS assets under management has more than doubled from 20% to 45% over the last 10 years.”
Frontier markets and the future of growth
Ask an investor how they define the term “frontier markets” and
you’ll get varying responses. “I don’t use a definition,” insists
Nick Greenwood, pension fund manager with Royal County of
Berkshire Pension Fund in the UK and a fan of the frontier market
space. His reluctance to define these markets stems from the
impressive range of countries included under the frontier markets
banner by index leaders like MSCI, whose MSCI Frontier Markets
100 Index includes countries as diverse as Kenya, Vietnam and
Argentina. “I am not bothered by the label given to a country as
long as I know it fits the growth prospects we’re looking for,”
Greenwood says. Good GDP growth potential and solid
demographics to build on for the future are just some of
the factors that make these markets so compelling right now.
Indeed, today’s frontier markets represent a vast spectrum of
opportunities and markets. A few years ago, if you asked Jack
Bouroudjian, CEO of Chicago-based Index Futures Group, what
a frontier market was, he would have told you it was a country
without the economic and social conditions to make it an
emerging market. Not so now. Today, Bouroudjian sees frontier
markets as a set of very different countries with small, illiquid
markets that are generally being ignored by the investing public.
“Frontier markets aren’t dirt poor – that’s a misconception,” he
argues. “Especially when you consider that the per capita income
in some of these countries is relatively high. Take Panama, for
example. It’s an amazing country, with a higher per capita income
than China and India and where businesses are thriving. And yet
it’s considered a frontier market.” In fact, Bouroudjian believes
Panama is a global sweet spot as the canal zone becomes more
important and the country rises as a lucrative trade zone.
For Greenwood, frontier markets are one of the few places investors
can look for returns, especially on the pension side. “When you look
at developed markets like the US and Europe, where on earth are
the returns going to come from?” he asks. “Frontier markets offer
solid economic growth prospects and healthy demographics in
contrast to developed markets, where GDP growth is much lower
and it’s harder to invest in stocks and get value.”
That view is shared by Ramon Tol, fund manager with Netherlands-
based Blue Sky Group, which manages the pension assets of Dutch
airline KLM. He also thinks frontier markets are an excellent
opportunity for pension funds today because they offer diversification
at a time when it is getting harder to come by. “Frontier markets are
less correlated to developed markets than emerging markets,” Tol
explains. “Correlations are still high, but right now they’re inflated
because of the global crisis: whenever there is a crisis all correlations
move to one. However, over the longer term, correlations have been
much lower and we think they will ease up in the future.” Tol also
likes the look of frontier market currencies, which now trade at a
steep discount to other global currencies. Both Greenwood and Tol
say their allocations to frontier markets, at just 2%, are on the modest
side, although Tol says he is working to a target of 3%.
But an allocation to frontier markets is not easy to come by and
access to these markets is a big challenge. Equities and bonds aren’t
always the best way to tap into frontier markets argues Nigel Sillitoe,
CEO of Dubai-based Insight Discovery, adding that investors are
often better served by taking a direct approach to these markets
in partnership with a recognised company that is part of the local
establishment. “The more control an investor has over management
decisions, the better able he or she will be to limit or offset the
risks,” he explains. Greenwood also believes the direct approach is
important in frontier markets: “You can’t just say listed equities are
the only way to go in these countries,” he says, noting that his plan
holds small allocations to frontier markets’ infrastructure and private
equity. “You have to look at the whole opportunity set and find the
right manager,” which he admits can be a challenge.
These markets also face some formidable risks, including issues
with rule of law and political risk. These risks are fundamentally
different from the ones investors are used to dealing with in
developed markets where investor protection is more ingrained.
However, Sillitoe believes that a key opportunity in the frontier
space lies in the changing perceptions around the real risks of
some markets, where constant improvements are making them
more stable. As these countries change and evolve, they offer
opportunities for improved returns, especially in light of ongoing
poor economic growth prospects for many other countries.
As frontier markets continue to evolve, one thing is certain: you have to
be closely linked to them to succeed. “The only way you can really be in
a frontier market is to be there on the ground, buying the individual
companies,” says Bouroudjian. “You need to be living and breathing the
markets and know the customs. And the best way to do that is by being
there.” One good indicator of a market’s potential is who else is already
there. For Sillitoe, the presence of institutional banks and providers of
custody and securities services are good signs of a market’s ability to
handle investment. “Investors should ask up front who is there and
what they are doing,” he says. “The fact that major international banks
are operating in frontier markets should be a valuable source of
information. Market research firms with a local presence and strong
links to corporate decision-makers are also positive signs. Some of the
frontier markets are amazingly opaque: original and proprietary
research is the only way to find out what is really going on.”
Greenwood himself isn’t worried that more investors aren’t
flooding into frontier markets: he’d like to avoid a wall of cash that
could crowd out opportunities. Whether or not these markets will
be able to maintain their hidden gem status is up for debate –
especially as return-hungry investors continue to search the world
for new sources of growth.
perspectives: the future of finance | 15
“ The only way you can really be in a frontier market is to be there on the ground, buying the individual companies.”
the contribut ors
dan apfelExecutive DirectorResponsible Endowments CoalitionBrooklyn, NY
leo de beverPresidentAlberta Investment Management CorporationEdmonton
raul pomaresSenior Managing DirectorSonen Capital LLCSan Francisco
rob arnot tChairman and CEOResearch Affiliates LLCNewport Beach, CA
richard duncanAuthorThe New Depression: The Breakdown of the Paper Money EconomyBangkok
marc saluzziChairmanAssociation of the Luxembourg Fund IndustryLuxembourg
jagdeep singh bachherExecutive Vice-President, Venture and Innovation, Alberta Investment Management CorporationEdmonton
jim finkelsteinAuthorFuse: Making Sense of the New Cogenerational WorkplaceSan Rafael, CA
nigel sillit oeCEOInsight DiscoveryDubai
jack bouroudjianCEOIndex Futures GroupChicago
david normanFounderTCF InvestmentUK
ramon t olFund managerBlue Sky GroupNetherlands
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