@investment management 01
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INTRODUCTION:
Do you like following the financial
markets—whether it be reading The Wall Street Journal, watching CNBC, or
checking stock prices on the Internet?
Imagine an industry that rewards
individuals for working independently,
thinking on their feet and taking
calculated risks. Additionally, how many
industries can you think of that broadly
impact households all over the world?
Very few. That is one of the many
exciting aspects of the investment
management industry.
The investment management community seeks to preserve and grow
capital, and generate income for individuals and institutional investors
alike.
“Investment management is the professional management of
various securities (shares, bonds and other securities)
and assets (e.g., real estate) in order to meet specified
investment goals for the benefit of the investors. Investors may
be institutions (insurance companies, pension funds,corporations etc.) or private investors (both directly via
investment contracts and more commonly via collective
investment schemes e.g. mutual funds or exchange-traded
funds).”
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Investment Management vs. Asset Management
A quick note about the terms investment management and assetmanagement: these terms are often used interchangeably. They refer
to the same practice-the professional management of assets through
investment. Investment management is used a bit more often when
referring to the activity or career (i.e., “I’m an investment manager” or
“That firm is gaining a lot of business in investment management”),
whereas “asset management” is use’d more with reference to the
industry itself (i.e., “The asset management industry”).
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EVOLUTION:
To better understand why asset management has become such a
critical component of the broader financial services industry, we must
first become acquainted with its formation and history.
The beginnings of a separate industry
While the informal process of managing money has been around
since the beginning of the 20th century, the industry did not begin tomature until the early 1970s. Prior to that time, investment
management was completely relationship-based. Assignments to
manage assets grew out of relationships that banks and insurance
companies already had with institutions—primarily companies or
municipal organizations with employee pension funds—that had
funds to invest. (A pension fund is set up as an employee benefit.
Employers commit to a certain level of payment to retired employees
each year and must manage their funds to meet these obligations.
Organizations with large pools of assets to invest are called
institutional investors.)
These asset managers were chosen in an unstructured way—
assignments grew organically out of pre-existing relationships, rather
than through a formal request for proposal and bidding process. The
actual practice of investment management was also unstructured. At
the time, asset managers might simply pick 50 stocks they thought
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were good investments—there was not nearly as much analysis on
managing risk or organizing a fund around a specific category or
style. (Examples of different investment categories include small cap
stocks and large cap stocks. We will explore the different investment
categories and styles in a later chapter). Finally, the assets that were
managed at the time were primarily pension funds. Mutual funds had
yet to become broadly popular.
The rise of the mutual fund
In the early to mid-1980s, the mutual fund came into vogue. While
mutual funds had been around for decades, they were only generally
used by almost exclusively financially sophisticated investors who
paid a lot of attention to their investments. However, investor
sophistication increased with the advent of modern portfolio theory.
Asset management firms began heavily marketing mutual funds as a
safe and smart investment tool, pitching to individual investors the
virtues of diversification and other benefits of investing in mutual
funds. Many specialists responded by expanding their product
offerings and focusing more on the marketing of their new services
and capabilities.
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BUY-SIDE V /S SELL-SIDE OF INVESTMENT
MANAGEMENT:
If you’ve ever spoken with investment professionals, you’ve probably
heard them talk about the “buy-side” and the “sell-side.” What do
these terms mean, what are the differences in the job functions, and
how do the two sides of the Street interact with one another?
What’s the difference?
The sell-side refers to the functions of an investment bank.
Specifically, this includes investment bankers, traders and research
analysts. Sell-side professionals issue, recommend, trade and “sell”
securities to the investors on the buy-side to “buy.” The sell-side can
be thought of primarily as a facilitator of buy-side investments—the
sell-side makes money not through a growth in value of theinvestment, but through fees and commissions for these facilitating
services. Simply stated, the buy-side refers to the asset managers
who represent individual and institutional investors. The buy-side
purchases investment products (such as stocks or bonds) on behalf
of their clients with the goal of increasing its assets
On the surface, the roles of buy-side and sell-side analysts sound
remarkably similar. However, the day-to-day job is quite different.
Sell-side analysts not only generate investment recommendations,
they also need to market their ideas. This involves publishing
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elaborate and lengthy investment reports and meeting with their buy-
side clients. In contrast, the buy-side analyst focuses entirely on
investment analysis. Also, the buy-side analyst works directly with
portfolio managers at the same firm, making it easier to focus on the
relevant components of the analysis. The sell-side analyst is writing
not for a specific team of professionals, but for the buy-side industry
as a whole.
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Positions in sell-side
The hierarchy in a research department can be quite confusing since
the nomenclature differs with traditional investment banking. The
senior role in research is analyst (which is confusing since it is the
most junior role in investment banking).
RESEARCH INVESTMENT BANKING
DEPARTMENT DEPARTMENT
Analyst Management Director
Vice President
Associate Analyst(Junior Analyst)
Associate
Associate
Analyst
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Positions in buy-side
In general, buy-side firms have a three-segment professional staff
consisting of:
• Portfolio managers who invest money on behalf of clients
• Research analysts who provide portfolio managers with
potential investment recommendations and in some cases
invest money in their respective sectors
• Account and product managers who manage client
relationships and distribute the investment products to
individual and institutional investors
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Client
Portfolio Manager Account/ Project Manager
Portfolio Analyst/Associate
Research Analyst
ResearchAssociate
ResearchAssistant
AccountManagement
Associate
ProductManagement
Associate
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The Clients of Investment Managers:
Typically, asset management firms are categorized according to the
kind of clients they serve. Clients generally fall into one of three
categories: (1) mutual funds (or retail), (2) institutional investors, or
(3) high net worth. Some firms specialize in one of the three
components, but most participate in all three. Asset management
firms usually assemble these three areas as distinct and separate
divisions within the company.
It is critical that you understand the differences between these client
types; job descriptions vary depending on the client type. For
instance, a portfolio manager for high-net-worth individuals has an
inherently different focus than one representing institutional clients. A
marketing professional working for a mutual fund has a vastly
different job than one handling pensions for an investment
management firm.
1. Mutual Funds
Mutual funds are investment vehicles for individual investors who are
typically below the status of high net worth (we will discuss individual
high net worth investing later in this chapter). Mutual funds are also
sometimes known as the retail division of asset management firms.
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Mutual funds are structured so that each investor owns a share of the
fund— investors do not maintain separate portfolios, but rather pool
their money together. Their broad appeal can generally be attributed
to the ease of investing through them and the relatively small
contribution needed to diversify investments. Investment gains from
mutual funds are taxable unless the investment is through an
retirement plan. (If you take some money you’ve saved and invest in
a mutual fund, you’ll have to pay capital gains taxes on your
earnings.)
In the past 10 years, mutual funds have become an increasingly
integral part of the asset management industry. They generally
constitute a large portion of a firm’s assets under management
(AUMs) and ultimate profitability.
There are three ways that mutual funds are sold to the individuals
that invest in them—(1) through third-party brokers or “fund
supermarkets”; (2) direct to customer or (3) through company 401(k)
plans. The size and breadth of the asset management company
typically dictates whether one or two of the methods are used.
Third-party brokers and “fund supermarkets”:
Over the past five years, an increasingly popular distribution platform
for mutual funds has been to sell them through brokerage firms or
“fund supermarkets.” By selling through these channels, asset
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management companies can leverage the huge access to the clients
that the brokers maintain. In a classic broker relationship, a company
with a sales force partners with several investment management
firms to offer their investment products. Then, for instance, Merrill
Lynch and Morgan Stanley not only sell their own mutual funds, but
offer their clients access to mutual funds from
Vanguard, Putnam and AIM as well. This additional access to
multiple mutual fund products helps the brokers win business;
brokers earn a commission from the asset management companies
they recommend. Brokers develop relationships with individual
investors not only by executing trades, but also by dispensing advice
and research. Fund supermarkets, such as Charles Schwab, became
increasingly popular in the late 1990s. These firms are set up
similarly to brokerage houses, but the supermarkets carry virtually
every major asset management firm’s products, don’t expend as
much energy on providing advice and other relationship building
activities, and take lower commissions. The rise of the fund
supermarkets has forced conventional brokerage firms to open up
their offerings to include more than a few select partners. It has also
influenced the way mutual funds market themselves. Previously,
funds marketed to brokers, and expected brokers to then push their
products to individual investors. Now, mutual fund companies
increasingly must appeal directly to investors themselves.
Direct to customer:
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Through an internal sales force, asset management companies offer
clients access to the firm’s entire suite of mutual funds. This type of
sales force is very expensive to maintain, but some companies, such
as have been extremely successful with this method. Prior to the rise
of brokers and fund supermarkets, direct to customer was the primary
vehicle for investment in many mutual funds—if you wanted a Fidelity
fund, you had to open an account with Fidelity.
401(k) plans:
An increasingly popular sales channel for mutual funds is the 401(k)
retirement plan. Under 401(k) plans, employees can set aside pre-tax
money for their retirements. Employers hire asset management firms
to facilitate all aspects of their employees’ 401(k) accounts, including
the mutual fund options offered. By capturing the management of
these 401(k) assets, the firms dramatically increase the sale and
exposure of their mutual fund products. In fact, many asset
management companies have developed separate divisions that
manage the 401(k) programs for companies of all sizes.
2. Institutional Investors
Institutional investors are very different from their mutual fund
brethren.
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These clients represent large pools of assets for government pension
funds, corporate pension funds, endowments and foundations.
Institutional investors are also referred to in the industry as
“sophisticated investors” and are usually represented by corporate
treasurers, CFOs and pension boards.
More conservative:
Given their fiduciary responsibility to the people whose retirement
assets they manage, institutional clients are usually more
conservative and diversified than mutual funds.
Unlike investors in mutual funds, institutional clients have separately
managed portfolios that, at a minimum, exceed $10 million. Also
unlike mutual funds, they are all exempt from capital gains and
investment income.
3. High Net Worth
High-net-worth individuals represent the smallest but fastest growing
client type. Individual wealth creation and financial sophistication over
the past decade has driven asset managers to focus heavily in this
area.
What is high net?
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What is a high-net-worth investor? Definitions differ, but a good rule
of thumb is an individual with minimum investable assets of $5 to $10
million. These investors are typically taxable (like mutual funds but
unlike institutional investors), but their portfolio accounts are
managed separately (unlike mutual funds, but like institutions).
High-net-worth investors also require high levels of client service.
Those considering entering this side of the market should be
prepared to be as interested in client relationship management as in
portfolio management, although the full force of client relations is
borne not by a portfolio manager but a sell-side salesperson in a
firm’s private client services (PCS) or private wealth management
(PWM) division. Says one investment manager about PCS sales, “If
[clients] tell them they’re out of paper towels, they’ll probably go to
their houses and bring them.”
Clients and consultants:
An investment management firm’s internal relationship management
sales force typically sells high-net-worth services in one of two ways:
either directly to wealthy individuals or to third parties called
investment consultants who work for wealthy individuals. The first
method is fairly straightforward. An investment manager’s sales force,
the PCS unit, pitches services directly to the individuals with the
money. In the second method, a firm’s internal sales force does not
directly pitch those with the money, but rather pitches
representatives, often called investment consultants, of high-net-
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worth clients. In general, investment consultants play a much smaller
role in the high-net-worth area than the institutional side; only
extremely wealthy individuals will enlist investment consultant firms to
help them decide which investment manager to go with.
The Investment Consultant
Not to be confused with retail brokers, investment consultants are
third party firms enlisted by institutional investors, and to a lesser
extent by high-net-worth individuals, to aid in the following: devising
appropriate asset allocations, selecting investment managers to fulfill
these allocations, and monitoring the chosen investment managers’
services.
An investment consultant might be hired by a client to assist on one
or all of these functions depending on certain variables, such as the
client’s size and internal resources.
For example, McKinsey & Company.
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Financial R esearch Breakdown:
For this, there is research required. Here, there are several
distinctions between types of research—breaking it down by style,
capital structure and firm. While the main focus will be on
fundamental equity and fixed income research, it will also discuss the
other types of research as well as the functional roles analysts play at
different types of firms.
1. Research Styles
Fundamental research:
Fundamental research takes a deep dive into a company’s financial
statement as well as industry trends in order to extrapolate buy andsell investment decisions. There is no clear cut way in conducting
fundamental research but it normally includes building detailed
financial models, which project items such as revenue, earnings,
cash flows and debt balances. Some asset managers may focus
solely on earnings growth while others may focus on returns on
invested capital (ROIC). It is important for the candidate to
understand the firm’s investment philosophy. This can usually be
achieved by doing research on the company’s web site. It is important
to note that while some firms have clear cut investment philosophies,
others may not. Aside from building a financial model, the
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fundamental research analyst will talk to company management as
well as sell-side analysts, and visit company facilities in order to get a
complete perspective of the potential investment. Again, the way
analysts go about this often differs. Some researchers feel
comfortable with only the resources at their desk—their computer,
internet, and phone—while others refuse to make investment
decisions without face-to-face management meetings and visiting
manufacturing facilities (which is often referred to as “kicking the
tires”).
Quantitative research:
Quantitative research is built on algorithms and models, which seek
to extrapolate value from various market discrepancies or
inefficiencies. The key difference between fundamental and
quantitative research is where the analyst puts in the work. The
majority of work for a quantitative analyst rests within choosing the
parameters, inputs, and screens for the computer generated model.
These models can take on a multitude of forms. For example, a
simple model that seeks to take advantage of price discrepancies in
the S&P 500 may split the 500 stocks between those that are
“undervalued” as determined by a low price-to-book multiple from
those that are “overvalued” as determined by a high price-to-book
multiple. The quantitative analyst would build a model that would
screen for these parameters and would buy (or go long) the
undervalued stocks while simultaneously sell (or short) the
overvalued stocks. In reality, quantitative models are much more
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complex than the example provided and often screen for thousands
of securities across a multitude of exchanges. It is not a surprise to
learn that the “brains” behind these models often have PhDs in fields
such as finance and physics.
Technical research:
Technical research or analysis is the practice of using charts and
technical indicators to predict future prices. Technical indicators
include price, volume and moving averages. Technical analysts are
sometimes known as “chartists” because they study the patterns in
technical indicator charts in order to extrapolate future price
movements. Over time, technical analysts try to identify patterns and
discrepancies in these charts and use that knowledge to place trades.
While fundamental analysts believe that the underlying fundamentals
(revenue, earnings, cash flow) of a company can predict future stock
prices, technical analysts believe that technical indicators can predict
future stock prices. The skill set for technical research is very different
than fundamental research. Some technical analysts rely solely on
their eyes to spot trading opportunities while others use complex
mathematical indicators to identify market imbalances.
2. Capital Structure: Equity vs. Fixed Income
Across the buy-side and sell-side, fundamental analysts often focus
on either equities or fixed income (debt). What are the differences
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between a fundamental equity and fixed income investor? The
differences primarily lie within the fundamental financial analysis and
breadth of coverage.
Fundamental financial analysis:
Fundamentals affect equity prices and bond prices in similar fashions.
If a company is generating strong revenue and earnings growth,
improving its balance sheet, and is gaining market share in its
industry, both its stock and bond prices will likely increase over time.
Most equity analysts and stock investors are focused on net income
per share or earnings per share (EPS), as this represents the amount
a company earns and is available per share of common stock.
Another factor that equity investors are concerned about is how
management deploys its excess cash. Analysts are constantly
looking for earnings accretion, or the ability to increase earnings per
share. If company management uses excess cash to make a smart
acquisition or repurchase its own stock, equity investors are generally
pleased as the transaction increases EPS.
For fixed income analysts and bond investors, the emphasis is not
necessarily on earnings but more so on “earnings before interest and
taxes” or EBIT. Bond holders are primarily focused with receiving
interest payments and the return of principal. Therefore, they often
only follow the income statement up until the point where interest is
paid. Another key focus for fixed income investors is the amount of
debt (or leverage) a company has on its balance sheet. Since debt
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holders have claims on a firm’s assets, the more debt there is, the
less of a claim each debt holder may have on a given amount of
assets.
Fixed income analysts and investors are often focused on two metrics
—the leverage ratio (debt/EBITDA) and interest coverage ratio
(EBITDA/interest expense). EBITDA stands for earnings before
interest taxes depreciation and amortization, and is generally used as
a proxy for cash flow. Fixed income analysts like a decreasing
leverage ratio as it signifies less debt on the balance sheet and a
greater ability to repay it, and an increasing interest coverage ratio as
it signifies the greater ability to service the outstanding debt.
Breadth of coverage:
Breadth of coverage refers to the amount of companies and
securities an analyst covers. Most companies usually issue only one
type of equity security but could have several pieces of debt
outstanding. The fixed income analyst usually would cover all of
these debt instruments, which may each have separate and distinct
provisions that could alter their individual performances.
Additionally, a company may have convertible bonds, which the fixed
income analyst would typically cover.
Sell-side equity analysts typically cover between 15 and 20 stocks
and are expected to know even the most minutiae of details about
each company. Buy-side equity analysts typically follow 40 to 70
companies. While they may not know as much detail as a sell-side
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analyst, if they make a sizable investment in a stock, they are
expected to know just as much if not more detail than their sell-side
counterpart.
While coverage for equity analysts is typically broken down into
industry subsectors (for example, airlines would be a subsector of the
transportation industry), fixed income analysts often cover the entire
industry (which could equate to over 100 companies). So while there
can be several equity analysts covering the transportation industry,
there may only be one fixed income analyst. Debt markets are often
less liquid than equity markets and do not trade on small pieces of
information. Therefore, the fixed income analyst does not need to
know as much detail about each particular company. However,
should the buy-side fixed income analyst make a sizable investment
in a company, it would not be surprising for him to know as much
detail as an equity analyst.
3. Research Roles: Traditional vs. Alternative Asset
Managers
While fundamental analysts generally perform the same function
regardless of the type of firm, the role can be slightly different and is
mainly driven by the investment time horizon.
Traditional:
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Traditional asset managers often hire analysts and put them in
charge of becoming “experts” in certain industries. Achieving this
status takes years of diligent research and the traditional asset
managers are often patient with their analysts as they build up
industry knowledge. The research process for a particular company
could take months before an investment is made. However, since
both analysts and clients at traditional asset managers are typically
long-term investors, they are very patient and will often wait years to
capitalize on certain themes.
Alternative:
Alternative asset managers typically have a shorter time horizon as
their clients depend on positive returns every year. They often do not
have the luxury of waiting several years for investments to “pay off”
as do traditional asset managers. Therefore, analysts at hedge funds
often have to act quickly and decisively. They are not always
categorized by industry but may cover several industries (and are
then referred to as “generalists”). Oftentimes, a portfolio manager at a
hedge fund may tell his analyst to research a particular industry in the
morning and get back to him with the best investments by the
afternoon. The day is often intense. One hedge fund analyst
remarked, “I spent the early morning looking at airline stocks, the
afternoon looking at retail stocks, and finished the day looking at
credit card processors.”
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Investment Styles:
“Investment style” is often a loosely used term in the industry and is a
reference to how a portfolio is managed. These styles are typically
classified in one of three ways:
1) The type of security (i.e., stocks vs. bonds)
2) The risk characteristics of the investments (i.e., growth vs. value
stocks)
3) The manner in which the portfolio is constructed (i.e., active vs.
passive funds)
It is important to note that each of these styles is relevant to all the
client types covered in the previous chapter (mutual fund, institutional
and high net- worth investing).
The drive for diversification
The investment industry’s maturation over the last 20 years has been
led by the power of portfolio theory and investors’ desire for
diversification of investments. During this period, investors have
grown more sophisticated, and have increasingly looked for multiple
investment styles to diversify their wealth.
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Typically, investors (whether they are individual or institutional)
allocate various portions of their assets to different investment styles.
If you think of the overall wealth of an individual or institution as a pie,
you can think of each slice as investing in a different portfolio of
securities—this is what’s called diversification. The style of a portfolio,
such as a mutual fund, is clearly indicated through its name and
marketing materials so investors know what to expect from it.
Adherence to the styles marketed is more heavily scrutinized by
institutions and pension funds than by mutual fund customers.
Institutional investors monitor their funds every day to make sure that
the asset manager is investing in the way they said they would.
Types of Security
Type of security is the most straightforward category of investment
style. For the most part, investment portfolios invest in either equity or
debt. Some funds enable portfolio managers to invest in both equity
and debt while other funds focus on other types of securities, such as
convertible bonds. However, for the purpose of this analysis, we will
focus on straightforward stocks and bonds.
Stocks
Equity portfolios invest in the stock of public companies. This means
that the portfolios are purchasing a share of the company—they are
actually becoming owners of the company and, as a result, directly
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benefit if the company performs well. Equity investors may reap these
benefits in the form of dividends (the distribution of profits to
shareholders), or simply through an increase in share price.
Bonds
Fixed income portfolios invest in bonds, a different type of security
than stocks. Bonds can be thought of as loans issued by
organizations like companies or municipalities. (In fact, bonds are
often referred to simply as “debt.”) Like loans, bonds have a fixed
term of existence, and pay a fixed rate of return. For example, a
company may issue a five-year bond that pays a 7 percent annual
return. This company is then under a contractual obligation to pay this
interest amount to bondholders, as well as return the original amount
at the end of the term. While bondholders aren’t “owners” of the bond
issuer in the same way that equity shareholders are, they maintain a
claim on its assets as creditors. If a company cannot pay its bond
obligations, bondholders may take control of its assets (in the same
way that a bank can repossess your car if you don’t make your
payments).
Although bonds have fixed rates of return, their actual prices fluctuate
in the securities market just like stock prices do. (Just like there is a
stock market where investors buy and sell stocks, there is a bond
market where investors buy and sell bonds.) In the case of bonds,
investors are willing to pay more or less for debt depending on how
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likely they think it is that the bond issuer will be able to pay its
obligations.
Types of Stocks and Their Risk Profiles
Most equity portfolios are classified in two ways:
1) By size, or market capitalization, of the companies whose stocks
are invested in by the portfolios
2) By risk profile or valuation of the stocks
Market capitalization of investments
The market capitalization (also known as “market cap”) of a company
refers to the company’s total value according to the stock market. It is
simply the product of the company’s current stock price and the
number of shares outstanding. For example, a company with a stock
price of $10 and 10 million outstanding shares has a market cap of
$100 million.
Companies (and their stocks) are usually categorized as small-, mid-
or large capitalization. Most equity portfolios focus on one type, but
some invest across market capitalization.
While definitions vary, small-capitalization typically means any
company less than $2 billion, mid-capitalization constitutes $2 to $10
billion, and large-capitalization is the label for firms in excess of $10
billion. As would be expected, large capitalization stocks primarily
constitute well-established companies with longstanding track
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records. While this is generally true, the tremendous growth of new
technology companies over the past decade has propelled many
fledgling companies into the ranks of large-capitalization. For
instance, Google has a market-capitalization of around $200 billion
and is one of the largest companies in the world. In the same way,
small- and medium-capitalization stocks not only include new or
under-recognized companies, but also sometimes include established
firms that have struggled recently and have seen their market caps
fall. Some good examples of this would be Ford or Eastman Kodak,
both of which use to be some of the largest companies, but are now
much smaller in size. Most recently, there has been the advent of the
micro-cap (under $200 million) and mega-cap (over $50 billion) funds,
each with the stated objective of investing in these very small or very
large companies.
Risk profiles: “value” vs. “growth” investing
Generally, equity portfolios are defined as investing in either “value”
or “growth”—terms that attempt to express expected rates of return
and risk.
There are many ways that investors define these styles, but most
explanations center on valuation. Value stocks can be characterized
as relatively well established, high dividend paying companies with
low price to earnings and price to book ratios. Essentially, they are
“diamonds in the rough” that typically have undervalued assets and
earnings potential. Classic value stocks include pharmaceutical
companies like Pfizer and banks such as J.P.
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Morgan Chase.
Growth stocks (or “glamour” stocks) are companies that investors
believe will expand at rates that exceed their respective industries or
market. These companies have above average revenue and earnings
growth and their stocks trade at high price to earnings and price to
book ratios. Technology companies such as Yahoo! and Apple are
good examples of traditional growth stocks.
Types of Bonds and Their Risk Profiles
Just like stock portfolios, fixed income (bond) portfolios vary in their
focus.
The most common way to classify them is as follows
1) Government bonds
2) Investment-grade corporate bonds
3) High-yield corporate bonds
Government bonds
Government bond portfolios invest in the debt issues from the U.S.
Treasury or other federal government agencies. These investments
tend to have low risk and low returns because of the financial stability
of the U.S. government.
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Investment-grade corporate bonds
Investment-grade corporate bond portfolios invest in the debt issued
by companies with high credit standings. They rate debt based on the
likelihood that a company will meet the interest obligations of the
debt.
The returns and risks of these investments vary along this rating
spectrum. Many corporate bond portfolios invest in company debt
that ranges the entire continuum of high-grade debt.
High-yield corporate debt
In contrast to investment grade debt, high-yield corporate debt, also
called “junk bonds,” is the debt issued by smaller, unproven, or high-
risk companies. Consequently, the risk and expected rates of return
are higher.
Many variations of growth and value portfolios exist in the
marketplace today. For instance, “aggressive growth” portfolios invest
in companies that are growing rapidly through innovation or new
industry developments. These investments are relatively speculative
and offer higher returns with higher risk. Many biotechnology
companies and new Internet stocks in the late 1990s would have
been classified as aggressive growth. Another classification is a “core
stock” portfolio, which is a middle ground that blends investment in
both growth and value stocks.
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Also, there are other types of risks influencing the
portfolio:
• Systematic Risk - Systematic risk influences a large number of
assets. A significant political event, for example, could
affect several of the assets in your portfolio. It is virtually
impossible to protect yourself against this type of risk.
• Unsystematic Risk - Unsystematic risk is sometimes referred
to as "specific risk". This kind of risk affects a very small
number of assets. An example is news that affects a specificstock such as a sudden strike by employees. Diversification is
the only way to protect yourself from unsystematic risk. (We will
discuss diversification later in this tutorial).
Now that we've determined the fundamental types of risk, let's
look at more specific types of risk, particularly when we talk
about stocks and bonds.
• Credit or Default Risk - Credit risk is the risk that a company
or individual will be unable to pay the contractual interest or
principal on its debt obligations. This type of risk is of particular
concern to investors who hold bonds in their
portfolios. Government bonds, especially those issued by the
federal government, have the least amount of default risk
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and the lowest returns, while corporate bonds tend to have the
highest amount of default risk but also higher interest rates.
Bonds with a lower chance of default are considered to
beinvestment grade, while bonds with higher chances are
considered to be junk bonds. Bond rating services, such as
Moody's, allows investors to determine which bonds are
investment-grade, and which bonds are junk.
• Country Risk - Country risk refers to the risk that a country
won't be able to honor its financial commitments. When a
country defaults on its obligations, this can harm the
performance of all other financial instruments in that country as
well as other countries it has relations with. Country risk applies
to stocks, bonds, mutual funds, options and futures that are
issued within a particular country. This type of risk is most often
seen in emerging markets or countries that have a severe
deficit.
• Foreign-Exchange Risk - When investing in foreign countries
you must consider the fact that currency exchange rates can
change the price of the asset as well. Foreign-exchange
risk applies to all financial instruments that are in a currency
other than your domestic currency. As an example, if you are a
resident of America and invest in some Canadian stock in
Canadian dollars, even if the share value appreciates, you may
lose money if the Canadian dollar depreciates in relation to the
American dollar.
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• Interest Rate Risk - Interest rate risk is the risk that an
investment's value will change as a result of a change in
interest rates. This risk affects the value of bonds more directly
than stocks.
• Political Risk - Political risk represents the financial risk that a
country's government will suddenly change its policies. This is a
major reason why developing countries lack foreign
investment.
• Market Risk - This is the most familiar of all risks. Also referredto as volatility, market risk is the the day-to-day fluctuations in a
stock's price. Market risk applies mainly to stocks and options.
As a whole, stocks tend to perform well during a bull market
and poorly during a bear market - volatility is not so much a
cause but an effect of certain market forces. Volatility is a
measure of risk because it refers to the behavior, or
"temperament", of your investment rather than the reason for
this behavior. Because market movement is the reason why
people can make money from stocks, volatility is essential for
returns, and the more unstable the investment the more chance
there is that it will experience a dramatic change in either
direction.
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Portfolio Construction
All portfolios, whether they are stock or bond portfolios, are compared
to benchmarks to gauge their performance; indices or peer group
statistics are used to monitor the success of each fund.
As composites, the indices can be thought of as similar to polls: a
polling firm that seeks to understand what a certain population thinks
about a certain issue will ask representatives of that cross-section of
the population. Similarly, a stock or bond benchmark that seeks tomeasure a certain portion of the market will simply compile the values
of representative stocks or bonds.
Portfolio construction refers to the manner in which securities are
selected and then weighted in the overall mix of the portfolio with
respect to these indices. Portfolio construction is a fairly recent
phenomenon, and has been driven by the advent of modern portfolio
theory.
Passive investors or index funds
Portfolios that are constructed to mimic the composition of various
benchmarks are referred to as index funds. Investors in index funds
are classified as passive investors, and investment managers who
manage index funds are often called “indexers.” These funds are
continually tinkered with to ensure that they match the performance of
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the index. For equities, the S&P 500 is the benchmark that is most
commonly indexed.
Active investors
Portfolios that are constructed by consciously selecting securities
without reference to the index are referred to as active portfolios.
Active portfolios adhere to their own investment discipline, and
investment managers actually invest in what they think are the best
stocks or bonds. They are then compared, for performance purposes
only, to the pre-selected index that best represents their style. For
instance, many large-capitalization active value portfolios are
compared to either the S&P 500 Value index.(It is important to note
that while active portfolios are still compared to indices, they are not
designed specifically to mimic the indices.)
Alternative methods
Variations of active and passive portfolios are present throughout the
marketplace. There are enhanced index funds that closely examine
the benchmark before making an investment. These portfolios mimic
the overall characteristics of the benchmark and make small bets that
differentiate the portfolio from its index. Another type of popular
portfolio construction method is sector investing. This is essentially a
portfolio that is comprised of companies that operate in the same
industry. Common sector portfolios include technology, health care,
biotechnology and financial services.
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Summary of Investment Styles
Ultimately, the various investment styles discussed above translate
into various investment products. Mutual fund, institutional and high-
net-worth investors select the appropriate product that best matches
their risk and diversification needs.
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Therefore, in this way, the Functions involved in
investment Management can be summarized in the
following way (Using the Modern Portfolio Theory )
Modern Portfolio Theory (MPT) is also called “portfolio theory” or
“portfolio management theory.” MPT is a sophisticated investment
approach first developed by Professor Harry Markowitz of the
University of Chicago, in 1952. Thirty-eight years later, in 1990, he
shared a Nobel Prize with Merton Miller and William Sharpe for what
has become the frame upon which institutions and savvy investors
construct their investment portfolios!
Modern Portfolio Theory allows investors to estimate both the
expected risks and returns, as measured statistically, for their
investment portfolios. In his article “Portfolio Selection” (in the Journal
of Finance, in March 1952), Markowitz described how to combine
assets into efficiently diversified portfolios. He demonstrated that
investors failed to account correctly for the high correlation among
security returns. It was his position that a portfolio’s risk could be
reduced and the expected rate of return increased, when assets with
dissimilar price movements were combined. Holding securities that
tend to move in concert with each other does not lower your risk.
Diversification, he concluded “reduces risk only when assets are
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combined whose prices move inversely, or at different times, in
relation to each other.”
Diversification reduces volatility more efficiently than most people
understand: The volatility of a diversified portfolio is less than the
average of the volatilities of its component parts.
There are four basic steps involved in portfolio
construction:
-Security valuation
-Asset allocation
-Portfolio optimization
-Performance measurement
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THE CAPITAL ASSET PRICING MODEL:
Birth of a Model
The capital asset pricing model was the work of financial economist(and, later, Nobel laureate in economics) William Sharpe, set out inhis 1970 book "Portfolio Theory And Capital Markets". His modelstarts with the idea that individual investment contains two types of risk:
Systematic Risk
Unsystematic Risk
Modern portfolio theory shows that specific risk can be removed
through diversification. The trouble is that diversification still doesn'tsolve the problem of systematic risk; even a portfolio of all the shares
in the stock market can't eliminate that risk. Therefore, when
calculating a deserved return, systematic risk is what plagues
investors most. CAPM, therefore, evolved as a way to measure this
systematic risk.
TheFormula
Sharpe found that the return on an individual stock, or a portfolio of
stocks, should equal its cost of capital. The standard formula remains
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the CAPM, which describes the relationship between risk and
expected return.
Here is the formula:
CAPM's starting point is the risk-free rate - typically a 10-year
government bond yield. To this is added a premium that equity
investors demand to compensate them for the extra risk they accept.
This equity market premium consists of the expected return from the
market as a whole less the risk-free rate of return. The equity risk
premium is multiplied by a coefficient that Sharpe called "beta".
Beta
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According to CAPM, beta is the only relevant measure of a stock's
risk. It measures a stock's relative volatility - that is, it shows how
much the price of a particular stock jumps up and down compared
with how much the stock market as a whole jumps up and down. If a
share price moves exactly in line with the market, then the stock's
beta is 1. A stock with a beta of 1.5 would rise by 15% if the market
rose by 10%, and fall by 15% if the market fell by 10%.
Beta is found by statistical analysis of individual, daily share price
returns, in comparison with the market's daily returns over precisely
the same period. In their classic 1972 study titled "The Capital Asset
Pricing Model: Some Empirical Tests", financial economistsFischer
Black, Michael C. Jensen and Myron Scholes confirmed a linear
relationship between the financial returns of stock portfolios and their
betas. They studied the price movements of the stocks on the New
York Stock Exchange between 1931 and 1965.
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Beta, compared with the equity risk premium, shows the amount of
compensation equity investors need for taking on additional risk. If
the stock's beta is 2.0, the risk-free rate is 3% and the market rate of
return is 7%, the market's excess return is 4% (7% - 3%).
Accordingly, the stock's excess return is 8% (2 X 4%, multiplying
market return by the beta), and the stock's total required return is
11% (8% + 3%, the stock's excess return plus the risk-free rate).
What this shows is that a riskier investment should earn a premiumover the risk-free rate - the amount over the risk-free rate is
calculated by the equity market premium multiplied by its beta. In
other words, it's possible, by knowing the individual parts of the
CAPM, to gauge whether or not the current price of a stock is
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consistent with its likely return - that is, whether or not the investment
is a bargain or too expensive.
Conclusion
The capital asset pricing model is by no means a perfect
theory. But the spirit of CAPM is correct. It provides a usable
measure of risk that helps investors determine what return
they deserve for putting their money at risk.
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Investment Management and India :
According to the latest report, asset management business in India is
going to increase at least 33% annually. And without wasting any
time, Indian asset management companies are getting prepared to
cash in the scenario. The main growth is expected in the retail
segment (an estimated growth of 36%). Also in the list is investor
segment (as estimated growth of 29%). According to the McKinsye
study, this growth will lead AUM (Assets Under Management) to US$
440 billion.
List of Top Asset Management Companies in India
UTI Asset Management Company Ltd.
Name UTI Asset Management Company Ltd.
Income / Debt Oriented Schemes 1,935,985
Growth / Equity Oriented Schemes 6,817,477
Balanced Schemes 1,028,613
Exchange Traded Funds 29,046
Fund of Funds Investing Overseas -
Grand Total 9,811,121
Reliance Capital Asset Management Ltd.
Name Reliance Capital Asset Management Ltd.
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Income / Debt Oriented Schemes 172,612
Growth / Equity Oriented Schemes 6,389,925
Balanced Schemes 1,074,839
Exchange Traded Funds 41,343
Fund of Funds Investing Overseas -
Grand Total 7,678,719
SBI Funds Management Private Ltd.
Name SBI Funds Management Private Ltd.
Income / Debt Oriented Schemes 87,184
Growth / Equity Oriented Schemes 5,730,085
Balanced Schemes 72,437
Exchange Traded Funds 2
Fund of Funds Investing Overseas -
Grand Total 5,889,708
HDFC Asset Management Co. Ltd.
Name HDFC Asset Management Co. Ltd.
Income / Debt Oriented Schemes 247,240
Growth / Equity Oriented Schemes 3,097,662
Balanced Schemes 308,655
Exchange Traded Funds -
Fund of Funds Investing Overseas 55
Grand Total 2,448,913
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ICICI Prudential Asset Management Co. Ltd.
NameICICI Prudential Asset Management Co.
Ltd.
Income / Debt Oriented Schemes 276,928
Growth / Equity Oriented
Schemes2,660,902
Balanced Schemes 16,862
Exchange Traded Funds 899
Fund of Funds Investing
Overseas-
Grand Total 2,955,591
Franklin Templeton Asset Management (India) Pvt. Ltd.
Name Franklin Templeton Asset Management (India)Pvt. Ltd.
Income / Debt Oriented
Schemes193,977
Growth / Equity Oriented
Schemes2,231,995
Balanced Schemes 22,886
Exchange Traded Funds -Fund of Funds Investing
Overseas55
Grand Total 2,448,913
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Birla Sun Life Asset Management Co. Ltd.
Name Birla Sun Life Asset Management Co. Ltd.
Income / Debt Oriented Schemes 158,366
Growth / Equity Oriented Schemes 2,140,298
Balanced Schemes 36,831
Exchange Traded Funds -
Fund of Funds Investing Overseas -
Grand Total 2,335,495
Sundaram BNP Paribas Asset Management Co. Ltd.
NameSundaram BNP Paribas Asset Management
Co. Ltd.
Income / Debt Oriented
Schemes
26,749
Growth / Equity Oriented
Schemes2,155,301
Balanced Schemes 8,890
Exchange Traded Funds -
Fund of Funds Investing
Overseas42,319
Grand Total 2,233,259
Tata Asset Management Ltd.
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Name Tata Asset Management Ltd.
Income / Debt Oriented Schemes 39,745
Growth / Equity Oriented Schemes 1,617,471
Balanced Schemes 94,576
Exchange Traded Funds -
Fund of Funds Investing Overseas -
Grand Total 1,751,792
DSP BlackRock Investment Managers Pvt. Ltd.
NameDSP BlackRock Investment Managers Pvt.
Ltd.
Income / Debt Oriented
Schemes37,081
Growth / Equity Oriented
Schemes1,370,767
Balanced Schemes 28,052
Exchange Traded Funds -
Fund of Funds Investing
Overseas136,300
Grand Total 1,572,200
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Asset Management in India
A roundtable discussionBy Spencer Stuart
Spencer Stuart is one of the world’s leading executive search consulting firms.
Privately held since 1956, Spencer Stuart applies its extensive knowledge of
industries, functions and talent to advise select clients — ranging from major
multinationals to emerging companies to nonprofit organisations — and address
their leadership requirements. Through 51 offices in 27 countries and a broadrange of practice groups, Spencer Stuart consultants focus on senior-level
executive search, board director appointments, succession planning and in-
depth senior executive management assessments.
2008 gained a permanent place in the history of
financial markets, albeit not a good one.
Once admired financial institutions disappeared, economies of entire
countries were shaken and, in the blink of an eye, the world became
a different place. As the year drew to a close, uncertainty over the
future cast a shadow over the aspirations of individuals, companies
and countries.
Despite this grim picture and the anxieties of the present, businesses
must focus on the long term. This is easy to say but extremely difficult
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to do in an environment where there is really only one goal —
survival. But history has shown that the savviest leaders realised that
a period of great uncertainty, with sudden changes in the financial
and competitive landscape, can be the ideal time to make important
strategic gains.
The discussion at the Spencer Stuart roundtable on asset
management was directed towards the future. It revealed ideas and
solutions that could enable companies to draft a blueprint for the next
phase of growth — growth that may not be around the corner but is
inevitable in a country like India, where assets under management
(AUM) are a mere eight percent of GDP, compared with 79 per cent
in the US and 39 per cent in Brazil1. This one statistic speaks
volumes about the opportunities that abound in this industry and it
would be imprudent to lose sight of this even in the current extremely
challenging environment.
The transformation of an industry
The asset management industry in India is a prime example of the
success of free competition in the country. From an industry that had
one dominant player in the early 1990s, there are now over 30 active
players, reflecting how the world of asset management in India has
changed. Today, it is an industry of choice for customers and
employees, with a range of products available, the presence of
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almost every large global player and a growing focus on investor
education. It is also a highly dynamic industry, where significant
change is commonplace.
What contributed to this sea change in India? Without doubt, the
primary driver has been deregulation, coupled with free competition.
The world’s best brands were given an entry ticket with majority
ownership if they so wanted, the result of which was the creation of a
high-quality industry that incorporated global best practices.
Regulatory support in the initial crucial years was also exceptional,
with a focus on continuous dialogue and openness to change.
A big driver of growth in the late 1990s was institutional business,
which has grown to become a major contributor to profit margins of
mutual fund companies as well as playing a large role in product
innovation and growth of AUM. Most recently, financial advisory and
retail distribution have attractedthe attention of the sector.
However, according to Vimal Bhandari, Aegon India, more recently
the Indian asset management industry has been grappling with the
challenges of becoming an international business both through feeder
funds in India for investing in offshore funds and mobilising funds
offshore for investing in India. This twoway flow is likely to increase in
the coming years and could become a serious component in the
industry in India. It will act as a valuable buffer to augment the AUMs
which are mobilised from the domestic market for investing in the
local market. The key challenge would principally be to create a
robust framework of governance and management, given the multiple
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country jurisdiction which such business would necessarily entail. Key
management personnel would need to be well versed in developing
this business on an international platform.
In many ways, the huge opportunity that the industry foresaw in the
1990s is still there. Only 4–5 per cent of household assets are in
mutual funds and the top eight cities in terms of households
penetrated account for 75 per cent of retail AUMs./.
The industry should be asking what it has done to capitalise on earlier
opportunities, what the new opportunities are and what can be done
to capitalise them?
Competitive landscape
With its potential for high growth, asset
management in India has been an attractive sector
for Indian and foreign companies. According to
research by McKinsey & Co, the asset management
business has grown 47 per cent annually since
2003, taking the total AUM in India in 2008 to USD
92 billion.
However, as Sanjay Sachdev of Shinsei Bank
pointed out, there are only about 35 fund ‘families’
in India, as compared to the global numbers like
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700-odd fund ‘familes’ in the US, 60 fund ‘families’
in China and around 70 in Japan.
“As more people come into this industry, the opportunity is
there to expand the pie rather than cut it into smaller slices
— that’s the attitude existing players in the industry need to
take.”
Ajay Srinivasan, Aditya Birla Group
The Indian landscape is highly dynamic and is set to
remain so in the near future. Competitive advantage
lasted for six months a few years back; today the
time frame is less than 90 days. Ajay Srinivasan,
Aditya Birla Group, explains:
“As more people come into this industry, the
opportunity is there to expand the pie rather than
cut it into smaller slices — that’s the attitude existing
players in the industry need to take.” However, this
expansion will take time and a lot will depend on
how the industry and regulators tackle key issues,
such as awareness, education, distribution and
product positioning. Furthermore, barriers to entry
have also become increasingly high, with BostonConsulting Group estimating that a firm would need
at least USD 2.5 billion under management to break
even now, twice as much as was needed two or
three years ago. Technology is also set to become
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a key differentiating factor. It will be interesting to
observe what happens to the market share of the
top 10 or the top 12 players over the next few years.
In spite of some exits and the current challenging
environment, global players still find India an
attractive market, and this bodes well for the
industry. As Simon Fenton, Spencer Stuart, pointed
out: “If you are sitting outside India and considering
the prospects for a long-term asset management
business, you will find them here in India, and in
China, because of the fantastic demographic
situation in both countries. The asset management
industry will have to brace itself for more
competition.” However, according to Vijai Mantri,
DLF Pramerica, what may tip the scales in favour of
Indian companies is that they have a clear
advantage in understanding the Indian market.
The critical success factor will be the long-term
objective of the players that enter the asset
management industry. Vimal Bhandari says, “In
competition, there are three categories — those
who want to build a sizable business, those who
only want to have a presence in India, and those
who are coming as price warriors, to create value in
the business.” Good business practices will only get
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reinforced by the entry of long-term players who are
driven by asset enhancement and market growth
rather than by a focus on valuations. The one major
difference between the competitive landscape in
India and Europe is the absence of banks with asset
management interests such as Dresdner.
“In competition, there are three categories — those
who want to build a sizable business, those who only
want to have a presence in India, and those who are
coming as price warriors, to create value in the
business.”
Vimal Bhandari, AEGON N.V.
Being competitive in India has been characterised
as “being everywhere, doing everything”. Although
no player can afford to neglect any aspect of the
business in the current environment, true
competitive advantage will only be possible through
excellence in three main areas — execution of
strategy, distribution and investment performance
— and this is where companies will need to focus
their efforts.
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The Key Issues
As we enter a period of realistic valuations in the asset management
market, it would serve companies well to analyse past performance
and identify the key issues that will determine success in the future.
Some of these are discussed below:
Distribution focus
Ajay Srinivasan points out: “There are probably two
options for turbocharging growth of this industry.
One is the regulatory approach, such as in the US
where the 401k led to a change in the growth of the
industry. The other option is what you have seen in
countries like Japan and Korea where the focus has
been on areas such as distribution and productinnovation.” The market in
Japan changed when banks got into distribution,
especially since this was a distribution channel that
customers could trust, after years of mistrust with
the broking industry.
“In an environment where competition is stiff and
margins are tight, the tied agency channel is no longer
the most profitable one, whether for mutual funds,
insurance or anything else”
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Anjali Bansal, Spencer Stuart
India’s unique demographic and geographic
characteristics make distribution a key focus issuefor asset management companies. The industry’s
expansion has commenced only in the last few
years and has been driven by advances in
distribution. With the enormous potential of the
market and the continued entry of new players, one
can expect significant change in the way investors
are provided for.
At the same time, the fact remains that the Indian
asset management industry has grown
tremendously over the past few years in spite of not
having much constructive regulation on the
distribution side. In recent years, one of the most
debated issues has been the ‘tied agency’ concept.
“In an environment where competition is stiff and
margins are tight, the tied agency channel is no
longer the most profitable one, whether for mutual
funds, insurance or anything else,” says Anjali
Bansal, Spencer Stuart. In many parts of the world
where there has been insurance reform — Europeor Asia, for example — there has been a move
away from the tied agency channel. For growth to
be taken to the next level, the gaps in distribution
will need to be addressed.
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Creating a long-term growth strategy
Challenging market conditions have also brought
into focus the need for a long-term growth strategy,
especially for new entrants. Given the new valuation
expectation, equity buybacks could outstrip the
initial commitment made for a venture, especially
since a company might need 8–10 years before it
becomes an entity that drives growth in the market.
Add in the effects of changes in revenue structure(margins have reduced considerably over the last
few years), account inflation and capital expenditure
and an effective strategy for the next 10 years
becomes imperative.
As Ved Chaturvedi, Tata Mutual Fund, says: “There
needs to be some reflection on the fact that we
have not been able to scale up effectively despite
superior fund performance, superior returns,
increase in investors and high-quality service.” The
strategy will also need to address the impact on
talent retention through stock options, especially if
the payback were to get further delayed.
“There needs to be some reflection on the fact that
we have not been able to scale up effectively despite
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superior fund performance, superior returns, increase
in investors and high-quality service.”
Ved Chaturvedi, Tata Mutual Fund
Another critical component of strategy will have to
be product innovation, especially since the asset
management industry is now competing with bank
deposits, insurance plans and even postal savings
for disposable income. Creating and marketing the
right products for customers that are oriented
towards long-term financial planning will be
essential. Introducing more internationally- oriented
products could broaden revenue streams and
positioning products effectively will be essential if
competitive advantage is to be achieved.
Understanding the consumer
Over the past few years, institutional business has
been a significant contributor to the profitability of
asset management companies. However, growth is
expected to come from retail investors in future.
Sanjay Sachdev, Shinsei Bank, attributes this to the
high average aging of the assets that investors
invest in an equity fund. “Average aging of assets,
from what I understand, is about nine years in India,
which is substantially high compared to the rest of
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the world,” he says. Thus, while deals maybe done
on the basis of 15 years or so, the fact remains that
if someone sticks with a company for nine years on
average, it builds a highly positive picture for the
future. Establishing a long-term retail platform can
therefore be a key success factor.
“In 2000, a study revealed that 67 per cent of people felt
that their children would take care of them. By 2008, that
number had reduced to 33 per cent.”
Vijai Mantri, DLF Pramerica
Asset management companies will also need to take
into account the changing consumer mindset in India.
On the one hand, the younger generation is far more
aggressive about investments, which means there is
now a large part of the country’s population with an
increasing appetite for risk — wanting higher returns
along with effective risk management. On the other
hand, the older generation is actively looking towards
independent planning for retirement. Vijai Mantri, DLF
Pramerica, shares an interesting statistic: “In 2000, a
study revealed that 67 per cent of people felt that their children would take care of them. By 2008, that number
had reduced to 33 per cent.”
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How effectively companies capitalise on these
opportunities will be a function of a number of things —
awareness, reach and distribution, product evolution
over a period of time, and above all else, experience.
Ved Chaturvedi says: “If people understand these
products, and companies come up with new products
that give investors the appropriate returns, the rewards
will be tremendous.”
Investor education
One of the biggest drivers for growth in the asset
management industry will be the comparatively low
real rate of return from the usual investment
products. Today, when individuals look at the safety
of capital, they immediately turn to bank deposits
and insurance products. Capital markets are usually
looked upon as avenues for high-yields and are
therefore considered high-risk. This is why mutual
funds turn into a transitory rather than a long-term
investment product for many people. This is a
mindset that needs to change and investor
education is the only way to achieve this
Given the potential for growing the investor base,
the need for education becomes critical, more so
since a large part of the retail investor population in
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India still equates mutual funds with equities. This
was a key finding of a DLF Pramerica survey of
125,000 investors over 80 towns, who were asked
about where they would direct their investments: 70
per cent said houses, 40 per cent said credit cards,
40 per cent said life insurance products, 38 per cent
said bank deposits, and only 6 per cent chose
dematerialised
(demat) accounts and/or mutual funds. So what
needs to be done?
Advisory services will need to address customer
education in order to be of value. Companies will
need to rise above selling their own products to sell
asset management products, thus communicating
to the investor the benefits of different product
categories, whether for retirement, children, family
and so on. “The key challenge for us is to sell
products that are outward-looking, rather than just
talking about absolute performance, meeting the
benchmark or being the top-performing fund,” says
Vijai Mantri. The important thing is to present mutual
funds as a category of products rather than defining
them by the end benefits. There needs to be a
conscious effort to avoid selling on the basis of day-
to-day performance, shifting the focus instead to the
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long term, be it a 3-year, 6-year or 10-year horizon
— just as the insurance industry is doing.
Financial advisory services also need to be
marketed and communicated effectively to the retail
investor. In real terms, India needs 1.5 million IFAs
(independent financial advisors) who need to take
on the mantle of creating awareness among retail
investors of the benefits of asset management
products. This will be the first step towards creating
an industry that has the recognition of the
regulators, policymakers and the government.
The regulator can also play a role here, by
supporting initiatives that include financial services
as part of school curriculums. This would help
children understand their savings’ needs and how
they could achieve them. The first generation of
regulation in the asset management industry was
extremely farsighted and built the foundation of the
industry. In order to take this growth to the next
level, companies will need to maintain a dialogue
with the regulator, set a clear vision (much like the
IT industry did for 2015–2020) and create a
blueprint for the future.
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A Question of Leadership
Turbulent environments are perfect testing grounds
for leadership. Successful leaders harvest the
benefits of the “highs” but always plan for the “lows”.
For the asset management industry in India, the
biggest challenge is to find mature CEOs. As Vimal
Bhandari points out: “We find sufficient
professionals, but not professional leaders. Being10 years old, this industry should have nurtured a
pipeline of CEOs who could take over new
leadership positions.
Unfortunately, this pipeline does not exist.” As a
result, finding people who can lead businesses is
difficult; there are plenty of excellent people
operating on the ground, but those with the ability to
take on leadership roles are few and far between.
Nevertheless, a good management cadre is being
created; many universities now offer specific
financial planning and wealth management courses
and there are some high-quality training
programmes within organisations. As a result, better
talent is coming into the industry and new leaders
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will emerge from that group. At the present moment,
though, broader leadership talent is scarce in India.
How will companies be able to create leadership
advantage? A primary factor will be the ability to
attract, retain, nurture and employ high-quality
talent.
Investing in globalising the business will also be
important for both Indian and international players.
Companies will need to create an effective growth
strategy in the face of extreme price competition
and find ways to capture value. They will also need
to be at the cutting edge of innovation in terms of
product, technology and service. Last but not the
least will be a consistent focus on risk management,
where one failure can significantly erode faith in the
entire system — a loss that the industry would find
difficult to recover from. It is a responsibility of
senior leadership to make sure that the business
has strong risk management practices.
The Role of Culture in Leadership
While leadership development should be a critical
area of focus for asset management companies,
there is a growing appreciation that there is a direct
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correlation between company culture and talent
retention — more so today when uncertainty and
poor communication can cause talented people to
walk away from organisations where they have had
successful careers.
“A lot of things contribute to culture … everyone is inclined
to think that their experience is the norm, but it’s not until
you start looking at other businesses that you realise how
different they are.”
Simon Fenton, Spencer Stuart
What exactly is a culture and how is it created?
Simon Fenton, says: “A lot of things contribute to
culture — values, career progression, hierarchy,
attitude, compensation. What is interesting is that
everyone is inclined to think that their experience is
the norm, but it’s not until you start looking at other
businesses that you realise how different they are.”
It can become more complicated in the case of
mergers and acquisitions, since one needs to figure
out which culture to adopt, or whether a completely
new culture needs to be created. As Rajan Krishnansays: “Time is critical. You need time to create
culture because you can import policies that have
been done well, but the local leadership/ founding
team needs to support that with a lot of home-grown
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wisdom. The successful global businesses are the
ones that recognise this and do have some
overarching themes, but allow different cultures in
different offices.”
“You need time to create culture because you can import
policies that have been done well, but the local
leadership/founding team needs to support that with a lot
of home-grown wisdom.”
Rajan Krishnan , Baroda Pioneer Asset Management Company
Companies are thus realising that, at a certain level,
compensation is only one factor in attracting and
retaining talent. The real attraction is the profile of
the role, the quality of leadership, growth potential,
openness in decision making and, importantly,
organisational culture.
Conclusion
In the past couple of years, the asset management
industry has seen more movements, more growth
and perhaps more new entrants than any other
sector. It is a cautious environment and business
has only now started to scale up in terms of
competition and products. It will be interesting to
see how the dynamic shifts -whether it is leadership,
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scaleability or brand that will drive the change at the
top five.
The leadership challenge in the Indian market will
remain for some time.
However, the ability to think about the future, the
need to innovate profitably and the focus on teams
and culture will be the factors that provide
companies with the much required competitive
advantage.
Without doubt, the opportunity is huge and the best
is yet to come for the asset management industry in
India. The key to success will be finding the best
people and developing high-quality leaders who
have the vision to take the industry to new heights.
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BIBLIOGRAPHY:
Investopedia.com
Wikipedia.com
“Vault Career Guide to Investment Management”- Adam Epstein
Asset Management in India (2009 Report)- Spencer Stuart