Despite having around $540bn (€484.4bn) under management, AIG Global Investment Group (AIGGIG) is rarely mentioned among the world’s largest asset management houses. This lack of recognition has much to do with the fact that most of the assets managed by the company are coming from clients within the American International Group (AIG) – a conglomerate that includes insurance, financial services and asset management businesses.
Significantly, the vast majority of assets under management, around $440bn, are invested in fixed income, making AIGGIG one of the largest investors in this asset class.
Expanding expertise
Richard Mercante, the firm’s head of US fixed income, is responsible for some $400bn of assets under management in the firm’s US fixed income operations as well as the public, taxable, high grade fixed income and emerging market debt groups in London. Mr Mercante also manages the global securities lending group and sits on the company’s global asset allocation committee.
He explains how over the last decade the firm has worked hard to leverage an ‘investor to investor’ platform to bring its management expertise to external clients.
“This [decision] was a bit risky at the time because there are many investors out there who are perhaps a little unsure about investing with a firm that is so big and manages its own assets,” he says. “We established this platform because we are providing investment solutions to our own affiliated clients who have the same goals, constraints and needs as many other investors.”
So far, plans for external expansion have worked out well and today external assets represent some $90bn with room for further growth in the near future. As Mr Mercante explains the philosophy is not to do anything for external clients that they wouldn’t do for themselves.
“Anything that we offer to our external clients is something that we are already doing for ourselves, and something that we will be investing in alongside them,” he notes. “I think in the marketplace today a lot of investors are taking comfort from that.”
Mr Mercante explains that one of the advantages of the firm is its “truly global” outlook. “We have a fully integrated global fixed income team.” This includes portfolio managers, research analysts and traders, working in different geographic regions and different industries, speaking to each other frequently. “There are a lot of investment managers out there that claim they are a global company, but I am not sure there is anyone who is truly as global as we are.”
“We have worked hard over the years to create this global platform and it’s really across three main disciplines – portfolio management, research and trading.”
Fixed income investing has changed considerably over the recent past, with significant compression in spreads within and between asset classes. “Within asset classes, five or 10 years ago, you did have bigger distinctions around where electrical utilities in the US trade versus where telecom names in the US trade.” Today, spreads between industries have compressed significantly, making it more difficult to take a view from an investment perspective. At the same, between asset classes, the spread compression between public and private companies has also increased. “So it has been very difficult over the last few years to source alpha or excess return opportunities,” he adds.
To overcome this more challenging environment, AIGGIG has been working on developing new investment solutions and strategies to help create returns that included being early investors in the synthetic credit market. “We started incorporating credit default swaps in our portfolios on a leveraged basis to add incremental yield to those portfolios that needed it. We began to build out more our CDO business and we are co-investors in all these structures.”
He explains that in many cases the company created synthetic CDOs specifically on behalf of its own portfolios which were not distributed or marketed to outside firms. “We started by creating synthetic CDOs in the high grade market on behalf of just our own companies. We were one of the early managers to bring structures to the market where we were managing the underlined collateral.” At that point, he said most deals in the market were static. “We were never believers in static. We are managers of risk.”
Increasing commitments
With this in mind, the company started to structure synthetic deals which attracted a management fee for managing the underlying collateral. “We did that for ourselves and now we have three deals that we have distributed to external managers.”
Commitments to emerging markets have also increased during the last few years. First the firm increased its allocation to hard currency or US dollar denominated debt on behalf of some other client portfolios that didn’t have that type of exposure. “Then, at the beginning of 2005, we decided to build a portfolio for existing clients in local currency emerging market debt,” he says. Now, AIGGIG manages a hybrid fund in Japan, half in hard currency and half in local currency. “We expect that fund to be around $500m by the end of the year. So, again, we started doing it for our own affiliated customers and the next thing you know, we were marketing and selling it to other investors as well.”
Mr Mercante says that this approach means that the creation of new strategies and investment products within the firm is not a response to demand from a particular region or client type. Instead, it is the return potential that drives the decisions made. It is then the job of the business development team and distributors to find clients that might find the propositions interesting.
“I think more and more of our brand is out there and our reputations as top level managers is bringing clients who want to talk to us and hear about what we are doing,” he says.
Today, the need for innovation within fixed income investment is more evident than ever before to overcome the limited beta opportunities across the more traditional markets. Pensions funds and other institutions are moving more into bonds out of necessity and they demand strong performance. “They are not going to move into fixed income if that is going to put them further in a hole. You have to come up with ideas to help them close their funding gaps,” he says.
“Right now we are on the wrong side of the peak of the credit cycle, that was some time in late 2004. We went to our clients before they even had this potential need and said ‘Listen, the credit cycle is going to deteriorate and we think it would be prudent for you as an investor to be able to make money on the short side of credit’,” he comments. Two years ago AIGGIG started a long-short credit hedge strategy for their own portfolios. “There are always far greater opportunities in the short side in credit than on the long side, particularly in down credit cycles.”
The strategy attracted interest from an investment bank that wanted to bring to the market a long/short principal protected note. “We are now managing a long-short hedge strategy for $500m worth of external customers assets who bought into this principal protected note, but it was the banker who targeted the client. We didn’t develop this alpha strategy to meet this demand for principal protected notes that might have been out there. It was the strategy first and the market second,” he explains. In his opinion, this highlights how the firm is trying to source innovative ideas and how this leads to clients as opposed to the other way round.
Although acceptance of their different strategies varies across countries and type of clients. Mr Mercante comments that in Europe, for instance, there is a lot of demand for leveraged loans and collateralised loan obligations (CLOs). “A lot of our European clients are investing in our dollar CLOs and are also interested in euro-denominated or sterling CLOs. At the same time our businesses in Europe are growing so we have more and more of a need for euro-denominated assets as well.” The firm decided to create a European leveraged loans team whose head was hired back in April this year. In August, only four months later, its first European CLO, Euro-Galaxy was priced. He says they now have around €350m of external and internal money invested in it. “We have been doing more and more leveraged beta type of strategies which makes sense in a lower beta type of environment.”
Primary driver
Mr Mercante is positive about the future growth of assets under management and highlights the firm’s scalable infrastructure.
“One of the things that distinguishes us from most is that, for all the different strategies that we manage, our primary source of return or alpha is securities selection, and our primary driver for these selections is fundamental research.
“I believe, by a large margin, that we have more credit analysts around the world than any other investment manager and that’s really the driver of our performance.”
As AIGGIG moves into new markets, it will continue increasing resources. “We are looking into Africa and the Middle East, the new emerging economies. Even though Mexico and Hungary might have run their respective courses, there are other opportunities and we will make sure we have the resources to continue to the next opportunities.”
RICHARD MERCANTE: THE ROUTE TO HEAD OF US FIXED INCOME
BS in Finance from the Pennsylvania State University and an MBA in Finance from Fordham Graduate School of Business
1985 Begins his career accountant and a foreign exchange analyst at Smith Barney Harris Upham and Salomon Brothers, respectively.
1986 Senior portfolio manager, Dean Witter InterCapital
1994 Joins AIGGIG as senior portfolio manager for investment grade credit
2005 becomes head of US fixed income
