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Active response

It has not gone unnoticed that active management has struggled in recent years – the Investment Management Association UK all companies sector has, for example, underperformed the FTSE All Share by 3.46 per cent in 2007 and 2.29 per cent in 2008 compared with a 10-year annualised return that has been pretty much in line with the market.

It has also been a difficult time for fund pickers. Not only have some very good mana-gers had their worst year ever (from which they will recover) but scandals surrounding the likes of Madoff have highlighted that some due diligence processes have been insufficiently robust.

Some investors have turned their backs on active manage-ment in favour of cheaper passive funds and exchange traded funds. While I symp- athise with their rationale, it is the wrong thing to do. Indeed, we may be entering a real renaissance in active management.

We have just been through a period of indiscriminate buying and selling caused by (often highly leveraged) hot money chasing returns, with little attention paid to valuation or quality, and the subsequent post-bubble deleveraging and wave of fund redemptions. While some “market savvy” active mana-gers have been able to benefit from this, many more fundam-ental managers have found their portfolios being battered by unpredictable forces.

From here we can expect there to be much greater discrimination in the markets. The difference between the winners and losers will be much more marked. For the skillful manager able to distinguish one from the other, there are some fantastic buying opportunities offering the potential for very significant gains.

While active managers may be about to enjoy a reversal of fortunes, it is clear that they also face significant challenges created by the ongoing financial crisis. The next couple of years are likely to see profound changes within the fund management industry.

The most crushing impact will be felt in the alternatives sector, where we could see up to two-thirds of hedge funds close. Many will struggle to perform as financing for leverage dries up and hitherto lucrative niche asset classes effectively close for business. With many funds below unobtainable high water marks, revenues dependent on performance fees will be severely eroded, leaving many businesses unviable.

Traditional managers are unlikely to escape unscathed, particularly those that are equity biased. A 40 per cent fall in markets typically means a 40 per cent fall in revenues and we are already seeing the resultant cost-cutting and consolidation. Asset managers that are part of troubled banking groups may find themselves up for sale and small boutiques may not be strong enough to survive.

One of the biggest challenges in this environment will be retaining the most talented investment managers.

Yet well-resourced privately owned asset managers that can ride the current storm without short-term pressures from external shareholders will prosper.

Those firms that survive the next 18 months will come out stronger and take greater market share in a rapidly consolidating industry.

It is clear that manager selection and monitoring will become even more important. Investors will need to determine not only whether a manager is sufficiently skillful to navigate tough markets but also whether their business models are viable. Unfortunately, this means more work. The case for multi-management now looks perhaps more compelling than ever before.

Jason Collins is a partner at Maia Capital


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