Managers adjust for newly uncertain business environment

Money managers are grappling with their most uncertain business environment in recent memory, a wrenching change after years where extraordinary monetary policy support helped them fight through every period of market turbulence.

“We’ve been through a long period of favorable conditions for traditional long exposure to equities and bonds, with unprecedented monetary and fiscal support and decades of benign inflation,” said Simon Coxeter, Mercer’s Singapore-based director of strategic research for Asia, Middle East and Africa and Latin America.

Going forward, though, spiking inflation, Federal Reserve rate hikes and wild cards such as the Russia-Ukraine war will challenge asset managers that have “benefited from inflows buoyed by strong market performance, particularly those with undifferentiated products and unremarkable net-of-fees alpha,” Mr. Coxeter said.

Quantitative easing and low interest rates effectively made investing a “one-way bet and put a floor on volatility,” agreed Amin Rajan, CEO of CREATE-Research, a London-based consulting firm for the global money management industry.

Now with the Fed becoming very hawkish in response to surging inflationary pressures and huge disruptions to global supply chains like the war in Ukraine, the risks of recession or stagflation can’t be ignored, he said.

Money managers, accustomed to supportive monetary policy, say the challenges facing the Fed in taming inflation remain top of mind. Saira Malik, San Francisco-based chief investment officer at Nuveen LLC, the $1.26 trillion New York-based money manager, said her firm’s clients now are most concerned with how resilient the U.S. economy and earnings growth will prove as the Fed forges ahead with further interest rate hikes this year.

With the Fed clearly behind the curve in fight inflation, “a central bank policy error” is clients’ biggest worry, agreed R. Burns McKinney, managing director and senior portfolio manager with NFJ Investment Group LLC, a Dallas-based value equity boutique with AUM of $8.4 billion.

Meanwhile, Timothy C. Murray, capital markets strategist in Baltimore-based T. Rowe Price Group Inc.’s multiasset division, said the rising correlation between stock and bond prices this year — a disappointment for asset owners counting on rising bond prices to cushion equity market declines — is yet another concern. T. Rowe Price had $1.42 trillion in AUM as of Dec. 31, a figure that dropped to $1.42 trillion as of April 30.

Against that backdrop, with the monetary policy tailwind that made “buying the dips” a profitable strategy becoming a headwind now and a prolonged period of volatility dawning, buying the dip could prove “very dangerous” going forward, Mr. Rajan said.

Money managers concede the industry will continue to face short-term pressures this year. The spectrum of opinion on how manageable those challenges will be remains wide.

To the extent money managers were projecting a continuation of recent industry trends, they’ll be facing pressure to amend their business plans and control costs, said Andrew Hendry, Singapore-based head of distribution for Asia (ex-Japan) with Janus Henderson Investors.

And if in years past money managers could discount sharp market declines in anticipation of fairly rapid recoveries, this time around they could also find clients potentially shifting allocations to lower-risk, lower-fee assets instead — a double whammy for manager revenues, he said.

Fabrice Chemouny, Hong Kong-based head of Asia-Pacific at Natixis Investment Managers, likened the challenges facing money management firms now to dealing with a drug addiction.

Fed liquidity in response to the COVID crisis, said Mr. Chemouny, has made you “feel better and better and better but you know at some point you need to live your life without the medicines, right?”

“We knew at the end of the day somebody will switch off the music,” Mr. Chemouny said. “Some people are still dancing but there is no more music and definitely we need to face that,” because inflation is here and it’s going to be very complicated for central banks to bring it under control, he said.

That prospect has left managers predicting 2022 will remain a difficult year, even as some insist they should be able to spy light at the end of the proverbial tunnel before too long.

The current year is absolutely going to be tough, but it’s not likely to be the start of a multiyear period in the investment wilderness, said Gregory A. Ehret, CEO and executive director of PineBridge Investments LLC, a New York-based money management firm with global AUM of $148.7 billion as of Dec. 31.

“No elected government ever wants to deal with a long-term recession,” said Mr. Ehret. “They’ve found a way of helping us get out of recessions in the past by monetary policy” and there’s no reason to believe they won’t do so going forward, he added.

Justin George Muzinich, president and CEO of $39.4 billion New York-based credit boutique Muzinich & Co., likewise predicted a “normal recession” rather than anything that will change the asset management industry in a fundamental way.

What markets are pricing in at this point, based on the yield curve, is “we’ll be in a rising rate world for a short period of time,” said Mr. Muzinich, adding “the Fed will do what’s necessary to tackle inflation.”

Such expectations have found money managers tweaking their business plans rather than rewriting them.

“I’m certainly not investing as fast in certain types of initiatives that have a long cash burn,” Pinebridge’s Mr. Ehret said. “But there are certain places where we can see shorter cash burns as being good investments and so … we continue to look feverishly for opportunities to invest in smart investment teams,” focused on private market strategies as well as Asia-Pacific-related opportunities, he said.

Meanwhile, the prospect of a bumpy, directionless market should bring opportunities as well as challenges, market participants say.

In this year’s newly volatile environment, “it may be easier to demonstrate the value proposition of active management after many years of market share gains for lower-fee passive products,” Mercer’s Mr. Coxeter said.

“Skill-based returns could be more important contributors to total portfolio outcomes over the coming years than they have been over the last decade, with the potential to enhance returns and diversify risks against a backdrop of lower returns from traditional betas,” he said.

Money managers are making similar arguments now.

Because of the volatility and the uncertainty, “you’ve got to be active, because no one is going to be able to call the bottom … and it’s going to be really difficult to be passive and kind of buckle up and be along for the ride,” said Kimberley Stafford, managing director and global head of product strategy with Newport Beach, Calif.-based Pacific Investment Management Co. LLC.

With all of the risks at present, “you just don’t want to be tied to an index,” she said.

Natixis’ Mr. Chemouny struck a similar tone. “This is a wonderful period of time for active managers … because if you’re buying the indices, there’s only one way that the direction of travel is, volatile and at this stage negative,” he said.

“When it’s bumpy, we need to determine when I should come in, when I should come out and what is the quality of the stocks that I have,” a challenging backdrop for maintaining passive exposures, he said.

Still, CREATE-Research’s Mr. Rajan noted that in the prior two periods of extreme market volatility — the global financial crisis of 2008-2009 and the pandemic sell-off of 2020 — active managers failed to distinguish themselves.

In both of those instances, however, extraordinary policy support led to powerful market rallies, effectively bolstering beta over alpha. It’s unclear whether the anticipated absence of such support this year, amid continued inflationary pressures, will give alpha-focused managers a more sustained boost.