By Lizzy Buss, Executive Director, MUFG Investor Services
I sometimes think about the global investment universe as a vast, deep blue ocean. Liquidity (pardon the pun) decreases with depth. Risk increases with depth. At the surface we have a shiny plane of, let’s say, government bonds (USD 69tn1). A light-reflecting and colourful kaleidoscope of T-bills, JGBs, Bunds, Gilts and more. Cash (USD 37tn2) froths about alongside these government-backed fixed income instruments, waves come and go in a variety of currencies, and money market funds bob up and down like colourful boats.
Under the surface we have listed equities (USD 90 tn3) and bonds (USD 13.5tn in non-financial corporate bonds alone4), accessible to any fisherman and highly impacted by the conditions on the surface – the weather – the daily fluctuations of the global markets. Volatile, choppy, quiet, calm – never completely predictable. As we go deeper we get into the private markets, much less transparent and much harder to access. Less affected by the weather due to their private nature, but by no means immune. Specialist equipment is needed to access these depths, no ordinary Jo(sephine) can play in these waters. The deeper you go, the more interesting and unusual things you will find. The majority lays undiscovered.
We can think of the constantly changing direction of the tide as being analogous to the regular contractions and expansions of the global markets. Consistent in rhythm but unknown in precise amplitude and never, ever staying still. We also have the occasional tsunami of a financial crisis, wreaking havoc and creating long-lasting ripple effects around the world. And let’s put our ocean into the context of the planet, of which it covers more than 70%5. Earth’s temperature is rising roughly ten times faster than the average rate of ice-age-recovery warning6. Our oceans are under threat and the call to action has hit us all.
Risk/ reward ratios are changing as sea levels continue to decrease. Investors need to look deeper into the ocean, deeper down the liquidity spectrum, to achieve the returns they are looking for. The deep-sea zone contains some of the world’s most elusive and unique animals, and deeper still is vastly unexplored. This requirement for deeper fishing applies to all types of investors, all durations of investment horizons, and across the entire governance spectrum – from highly regulated pension funds to secretive family offices. Preqin estimate 60% growth in global AUM of alternatives in the next five years, far outpacing global GDP and inflation7. Deep sea fishing is becoming the norm.
With this comes additional risks, increased complexity, different regulations, and indeed different skillsets. Oftentimes this deeper fishing is not a replacement for the shallower waters, the more familiar depths. Instead, it is a way of diversifying, managing risk budgets, and ultimately meeting return targets at the portfolio level. It’s easy to see how the owners and managers of the world’s capital have become, and will continue to become, more complex and unwieldy ships to steer.
There are vast nets of service provider relationships which are required to support these increasingly complex investment activities. Niche, expert, specialist providers who can help firms navigate their way quickly and safely to the depths of the ocean are worth their weight in gold. For example the specialist law firms, the hosting platforms, the third party distributors, the data pipes and the technology plumbing; they are like solid gold anchors, providing vital connectivity with the venture capital unicorns and hedge fund legends. Similarly, the all-round service providers are crucial partners to enable firms to cover large areas of ocean and keep their complex navigation systems on track.
After the Global Financial Crisis of 2008, there was a natural tendency to seek comfort in both size and unity. There has been a prevailing assumption that risk (i.e. the magic trio of investment risk, operational risk and reputational risk) would be reduced “if we are in this together”. Capital flocked away from the many and was sucked up by the few. There was a renewed faith (arguably entirely fuelled by fear) that collective judgement, collective power, collective ability to succeed, would be far greater than the sum of the parts. In other words: the big got bigger; and on the other side of the trade, “skin in the game” became crucial.
Where are we now? 2020 has been an exceptional year by almost every measure. We are living through a historic global pandemic, right at a time where connectivity (via our ability to read, publish and communicate information online) is peaking. At the click of a button we have the ability to utilise experts and dive deep into the ocean of investments to deliver decent returns to our shareholders, our investors, our pension holders, our families. Without even raising to the surface, we can directly monitor the weather upcoming at any time, from anywhere, by many means.
The biggest challenge for many asset managers and asset owners has become “interface management”. In other words: how do I navigate these waters efficiently, delivering my desired outcomes without creating a suffocating net of cost and complication along the way.
My advice is simple. Do not be afraid of complexity but make sure you don’t lose sight of the end game – don’t trade on a promise, keep a tight rein. Do not shy away from diversification – deeper into the ocean, navigating around the continents, be open. Seek as many opinions as you can find and listen hard. Have conviction in your strategic decisions and pick a service provider who can handle this. A partner who you trust, who can work through the complexity for you, alleviating the burden and proactively seeking constant optimisation at every depth. Pick a partner who can support you in as many ways as possible and who can be there for you in both the rough and the smooth sailing. Build your safety framework to navigate the deep blue ocean. Reduce the noise of interface management by choosing a multi-talented service partner. Dive deep and surf the waves.