The future of active asset management lies in being more open and transparent about how fund managers deliver outperformance or alpha. So says Rupert Clarke, chief executive officer at Hermes, as he spells out how he aims to attract £25bn (€29.8bn) of new third-party money within the next five years.
“As a house, we’ve committed to being very transparent both on portfolio construction and on the delivery of alpha from a risk-adjusted return point of view. We call it responsible asset management.”
The guiding principles of transparency and responsibility, notes Mr Clarke, have long been espoused and promoted by Hermes’ owner and chief client, the BT Pension Scheme (BTPS). Hermes, he adds, has been engaging since the mid-1990s in environmental, social and governance issues with the companies owned by BTPS, voting its shares at annual general meetings. This engagement activity on behalf of BTPS led to the formation of Hermes Equity Ownership Services in 2004, which today has more than £60bn of pension fund assets under advice.
Hermes Fund Managers runs about £18bn of BTPS’s £35bn of assets, plus around £8.6bn of third-party funds managed for 180 clients, the majority of whom are invested in the firm’s property unit trust.
The strategic decision to target third-party business was taken back in 2007, when Hermes felt it had fulfilled its investment mandate for BTPS. “Over the past 10 years, we have delivered about 100 basis points of outperformance annually, relative to their benchmarks.”
But to make Hermes a more attractive home for third-party money, BTPS saw a need for significant investment to strengthen existing asset management capabilities, acquire new ones and build a supporting operational and risk management infrastructure.
“We had some very good investment managers but they did not have the support around them to be robust enough from a third-party point of view,” says Mr Clarke. “And we were starting to ask ourselves: if we are not set up to attract third-party money, have we even got the right infrastructure to serve our principal client?”
When considering which investment capabilities to invest in, Hermes decided against beefing up its passive investment capability in a bid to compete with fast-growing, dedicated index managers. Instead, BTPS’s entire £14.5bn passive portfolio was outsourced to Legal & General Investment Management (LGIM).
“Logically, if we’d had more of a third-party approach during the early 2000s, we would have invested heavily in the infrastructure needed to run passive mandates and we would have attracted a large amount of passive money,” claims Mr Clarke. “But we did not make that investment and in the meantime, LGIM came into the market and started putting a huge amount of resources into that area and became a natural home for passive money.
“So effectively the train had left the station and we were never going to look to build a passive business from that point. It was a sensible business decision because the cost of passive management is counted in single basis points.”
Additional resources were ploughed into those investment strategies that were shown to have a strong track record. This included the hiring of four new fund managers to double the size of the global emerging markets equity team, which runs £1.5bn of assets.
Both the hedge fund and private equity investment teams were deemed to be lacking in depth and breadth of expertise. So in 2008, a team of fund-of-hedge fund managers was recruited from Olympia Capital Management and Pioneer Alternative Investments to bolster the hedge fund offering. And in April of this year, Gartmore’s private equity fund-of-funds business was merged with Hermes to create a new joint venture, Hermes GPE, with £4.1bn in private equity assets under management.
But the strengthening of existing strategies was just the start. To maximise its appeal to third-party investors, Hermes set out to expand its range of investment capabilities. Last year saw the recruitment of a US-based global equity investment team from Fortis and the acquisition of Sourcecap International, a growth-oriented active European equity manager.
This year has seen the creation of a global credit asset management boutique to augment a small inflation-linked bond team.
The choice of new investment capabilities was informed by where BTPS was seeking alpha to supplement the returns generated by its passive equity and bond investments. BTPS, says Mr Clarke, provided the “cornerstone” investment for the new boutiques. For instance, the fund-of-hedge funds business is currently running £900m of assets, all of which has been invested by BTPS. The scheme has also made an initial investment of £400m in the new global credit asset management boutique.
The main reason for choosing to build a multi-boutique structure was the belief that “high conviction” investment teams offer the best chance of generating sustainable alpha.
