Monthly Archives: October 2009

What will be the impact on IR of a move from Active to Passive?

Some say the move from Active to Passive investment strategies is inevitable because the cost/performance differential can’t be justified.

A recent survey by the IBM Institute for Business Value covering 2,750 investment industry executives, including those at endowments, foundations, and SWFs, predicts that passive investments will overtake actively managed funds.  Today 70% of global assets are in active funds, which charge 1.25% on average.  But over the next three years, 65% of respondents planned to move to passive strategies which charge less than 0.2%.  Extrapolating the data suggests that in 20 years, 85-90% of assets will be in passive strategies, with the remaining 10-15% in hedge funds, private equity and other alternative asset classes.

But just as the recent financial crisis has exposed the flaws in efficient-market hypothesis (EMH), so a move to more indexing could provide opportunities for active managers.

Talk of London-based hedge fund exodus to Switzerland is exaggerated

In our daily interactions with the Swiss investment community we see very little evidence of the arrival of London-based fund managers fleeing the UK to Switzerland so we don’t believe there will be much impact on the targeting efforts of IROs for the time being.

As Bill McIntosh of the Hedge Fund Journal points out in a recent article, as much as 90% of the European industry’s $300 billion plus in assets is managed, directly or indirectly, from London and it is likely to stay that way.  He explains that “There is a lot of talk, not too much action,” but points out that “anecdotal evidence suggests that many small-to-medium sized firms are also looking to enhance their operational flexibility.  One thing that is occurring, according to a leading prime broker, is that firms are exploring setting up a management company in a more tax efficient locale. This is seeing some funds set up a second leg in Switzerland but still keep London as the main operating centre. Though London is expected to be the top European financial services hub for the foreseeable future, hedge fund principals can decamp to build a second leg but still visit the UK weekly or fortnightly, thus escaping the clutches of the Inland Revenue.”

He goes on to point out that “Another spur for setting up a Swiss office is to take advantage of the light regulatory structure. At a time when regulatory upheaval is a certainty in both Europe and the US, the Swiss system’s use of referenda means that change, if it comes, will be slow. But it could be tricky to decamp completely from the UK in case the AIM directive puts heavy restrictions on non-EU funds. So it seems likely that firms will want to guard their EU regulatory optionality by keeping a London presence. Having dual offices thus gives a fund a regulatory toe-hold in each system.”

“Consultants and managers note that life style, too, is a key consideration. Firms that canvas their partners about moving abroad often find it difficult to convince wives and family to rip up their lifestyles and relationships. The Swiss Alps may be beautiful and have their fans, especially among partners with young families, but the cantons around Zurich can be tough socially for non-German speakers. And Zurich, whatever its charms, pales beside London as a cultural and entertainment centre.”

“Nor should it be forgotten that Switzerland is itself badly bruised from the credit crunch. Private bank customers in Geneva lost an estimated $7 billion in Madoff and many funds-of-funds in the city are still bleeding. The woes that have afflicted UBS have ensured that Zurich, too, has felt the pain. Moreover, capital is flowing out as tax amnesties in Italy and Germany encourage investors to bring money home.“

Talk of London-based hedge fund exodus to Switzerland is exaggerated.  Indeed, the fall of sterling against the euro and the Swiss franc even gives the UK a competitive cost advantage.

SWF invest $1 trillion in global equity markets – less than expected

Sovereign wealth funds invest about $1 trillion in international equities which is less than half the $2.2 trillion (end 2008) managed by the 10 largest SWFs, according to a report by RiskMetrics commissioned by the Investor Responsibility Research Center Institute (IRRC).

The report said: “The current total size of the SWFs and the percentage invested in international equities is less than the figures generally reported in the media. Consequently estimates of their potential impact on the international capital markets are exaggerated.”

The study found that the total capital available to SWFs has decreased as the global financial crisis has dampened demand for some of the exports these countries rely on to bolster their funds. As a result, their global equity exposures have decreased, while their bond allocations have increased.

Why Active Share is important for IROs

In 2006 two Yale academics (Cremers, M. and Petajisto) introduced the term Active Share as a measure of active portfolio management.  The term measures the degree of overlap in holdings at the stock level between the fund manager and their benchmark index.  An Active Share of 100% implies zero overlap with the benchmark while a pure index fund will have an Active Share of 0%.


Unfortunately, as shown in the chart below, Active Share has been declining over time which means that many funds are increasingly mirroring their index.  This is due to the increased use of passive investment techniques but also because of the widespread use of benchmarks by active managers.  The rise of these “Closet Indexers” is an issue for IROs when considering which investors to target.  This is especially important as many so-called “Active” fund managers may actually be “Closet Indexers” who will typically only overweight or underweight their positions very slightly.


Spending valuable management time with a “Closet Indexer” will have little impact on marginal additional purchases of stock.  Therefore, it is clearly very important for IROs to be able to identify the stock pickers with concentrated portfolios in order to achieve the most from their meetings.

The great exodus from equities?

Thanks to our friends at 2CG for highlighting the collapse in the levels of investments of European insurance and pension funds in quoted equities.  The bulls see this as confirmation of the wall of money sitting on the sidelines just waiting to get back into stocks.  But the worry is that some investors, particularly some insurance companies will not be back to the equity markets for some time at least.  The retail investor also appears to have capitulated.  Targeting the right investors might just be getting more difficult.



ECB’s latest data on asset allocation of Europe’s insurers

According to the ECB, the largest euro area insurers have been de-risking their balance sheets by reducing their exposure to equities and increasing their exposure to corporate and government bonds.  What is worrying about this chart is that it only shows the change from 2007 and 2008.  It will look much worse for equities when the 2009 data comes in!


Plus ça change, plus c’est la même chose – “The more it changes, the more it’s the same thing.”

A great deal has changed in the IR world over the last 15 years but we were surprised how much remains the same when our long-time client Mark Steinkrauss stumbled over an article from 1991 discussing European IR for U.S. companies.  The article (see below) highlights the difficultly in indentifying shareholders beyond the meager public filing information and the lack of European sell-side research coverage of U.S. stocks.  Interestingly enough, our biennial European Stock ID survey, according to the article, only identified around 50 UK and European funds holding U.S. stocks in those days.

Today we often identify more than 400 institutional holders of U.S. stocks in our biennial surveys, and it’s not unusual to find 10 – 15% of a company’s capital held by European investors. The one other major change has been the distribution of materials which was by post or fax in those pre-internet days.  Although the European single market has developed considerably, for IROs it remains a series of separate markets in many ways.

The article can be found here.