© 2008 northern trust corporation northerntrust.com the northern trust experience a c c e s s. e x...

© 2008 Northern Trust Corporation northerntrust.com

The Northern Trust ExperienceThe Northern Trust ExperienceA C C E S S . E X P E R T I S E . S E R V I C E .

What’s Happening in Asset Management?!

Chris CarlsonSenior Vice President and Head of Strategic Development Northern Trust Global Investments

The Northern Trust Experience

What’s New in Asset Management?!

Broad Asset Management Trends

Today’s Markets

Building Winning Portfolios



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



Investor Challenges


…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!


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




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1.0

10.0

Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08

S&P 500 HistoricalJanuary 1926 - December 2005 Annualized Return:

+10.4%

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Annualized S&P 500 ReturnsJanuary 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 90’s out-performance and the subsequent reversion to a normalized return environment is one factor driving a generational shift in the asset management business.


Hedge Funds

Fund of Funds

Commodities

Portable Alpha

Liability Driven Investments

Complexity

1970’s

First Generation:Limited Product Suites

1980’s 1990’s

Second Generation:Asset Allocation / Specialization

2000’s

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 PensionAccountability

Alternatives AreMainstream

Globalization

Rapidly AgingPopulations

VulnerableCompetitors

Under FundedPensions

Changing PensionRegulations

The increased financial pressure, changing pension regulations, shifting demographics, and greater product choices are also driving the generational shift in asset management.



Non-Traditional Benchmarks With an “Outcome” Focus

Traditional Benchmarks


This generational shift is fundamentally changing the way that our clients will expect us to invest their assets.

Second Generation Third Generation


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



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 ProviderETF’s, 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




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

3rd Generation

Firms

Personal Market: Institutional Market:



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.



Today’s Markets

Equity Market Crash 1987

Long Term Capital Management 1998

Tech Bubble Bursting 2000

Sub-Prime Crisis2007

The current crisis is not an isolated event, but another in a series of seemingly more frequent events.


Known Knowables

Known Unknowables

Unknown Knowables

Unknown Unknowables

Today’s 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?

Knowable Unknowable

Known

Unknown

Rational Participants


Today’s 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 today’s 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


Today’s 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.



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


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



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



Asset managers must be prepared to deliver the investment capabilities that fulfill client needs from a menu of beta and open architecture alpha strategies.


Structured Capabilities

Active Extension

Equity Strategies Hedge

Strategies

Risk Budgeted Asset Selection

Beta Return

Index Mutual Funds

Exchange TradedFunds

Synthetic Exposures

Legacy Individual Securities

Open ArchitectureFixed Income Alpha

Strategies

Other Alternative Strategies



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

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