Long-term asset holders, such as pension funds, sovereign wealth funds and insurers, hold their capital – and with it the retirement, security and educational dreams of their customers – in conservative financial instruments in perceptually safe markets. These investments are closely pegged to underlying asset classes that have historically proven to be safe, somewhat predictable and almost entirely held in mature, highly liquid advanced economies. Whether these are municipal bonds, commercial property or blends of mature domestic stocks, long-term asset managers are prized for their steady hands and unflinching commitment to a long-term investment horizon. This much is required by the investment mandate to protect, preserve and build wealth. This patient investment model, however, is being tested by the convergence of two broad trends for which long-term asset managers are ill equipped to address using today’s tools and investment yardstick.
The first trend is caused by the diseconomies of scale under which long-term asset holders are laboring. Over the last 30 years’ long-term asset holders have amassed more than $35 trillion in assets under management. This is more money than they are effectively deploying on a long-range risk-adjusted basis, as evidenced by the historically low or insidiously negative yields over the last 10 years. They also labor under a numerator so large that these asset holders have a shrinking number of places to hide from the long arms of risk and uncertainty and the anemia inducing effects of low interest rates.
The return of economic nationalism in Europe and the U.S. only confounds the job of the long-term asset manager creating a sense vulnerability to shock events like Brexit, the election of President Trump and the growing drum beat of war. This not only makes this class of investor too big to fail, troublingly, it makes them too big to hide. The second broad trend assailing the asset management industry is the fact that risk and uncertainty are no longer relegated to developing and emerging markets, but are now firmly ensconced in the advanced economies with profoundly vexing consequences. The convergence of these trends and the desperate search for yield (and shelter) call for novel approaches to rebalancing the traditional risk-reward tradeoff. In short, it is time for long-term asset managers to take some risks.