In a world in which the largest asset managers, such as BlackRock or Vanguard, control more assets than any bank or (re)insurance group (with the total stock of assets under management now estimated at some USD 74TN, or even more by some counts); in which many banks are struggling with the demands of regulators that impinge upon their ability to earn an adequate return on equity; and in which traditional (re)insurers also struggle with the impact of commoditization of pricing and alternative capital, it is not surprising that the thoughts of many Boards and senior executives are turning to the attractions of asset management.
In the banking space, banks are focusing on building (or re-building) their asset-gathering and managing businesses to emulate the long-standing “Swiss model” and are also beginning to enter into partnerships with asset managers to co-lend; and there are the usual signs of herding and concerns about conflicts of interest if a bank adopts a “closed-architecture” model, as opposed to the increasingly prevalent “open-architecture” model, trying to restrict its clients to funds managed in-house, because, after all, their investment management skills are all “above average”.
While in the (re)insurance industry, there is much debate about the attractiveness and sustainability of the so-called “hybrid model”, in which more risk is taken on the investment side than have traditionally been the case, or capital allocated from the underwriting/liability side of the balance sheet to the asset/investment side if returns or volumes in underwriting are seen as unacceptable.
In any business, rationally, capital should be allocated to where it can generate the best risk-adjusted returns consistent with the enterprise’s business model and management capabilities. However, to us at Awbury the key phrase is “consistent with…management capabilities”. Not everyone has the capital-allocation skills and deep rationality of a Warren Buffett. We suspect that many managements may be deluding themselves that they can and will have the discipline to carry such an approach to its logical conclusion and refuse to write unprofitable insurance business or, conversely, not “reach” for returns that are only achievable because they carry with them risk that no (re)insurer concerned about its ability to meet all valid claims when due should be willing to accept.
And, of course, all the funds gathered by these asset managers have to be invested prudently and in accordance with the mandate provided by the investor providing them, whether a Sovereign Wealth Fund, or a manager pooling investments on behalf of individuals saving for retirement. This begs the question of where and how investable assets are to be generated if everyone is focusing on asset-gathering and not origination.
So, whether you are a direct investor in a bank, or in a (re)insurance company, it may be wise to keep an eye on whether or not its business model is mutating into an “asset management” paradigm and becoming indistinguishable from the rest of the herd and giving “style drift” a whole new meaning.
The Awbury Team