By now, most asset management executives have seen the predictions that large-cap growth will be the way to go in 2008. But digging deeper than mere asset class predictions, MME spoke with two industry leaders to tease out nuances of what fund managers can expect this year.

Peter Delano, co-author of the Tower Group's "2008 Top 10 Business Drivers, Strategic Responses, and IT Initiatives in Investment Management," said one new challenge for the fund management industry will be dealing with the effects of the subprime debacle and the resulting credit crunch.

While the drying up of liquidity will create some pressure for more conservative risk management techniques, some managers will use counter-pressures to goose returns beyond beta by employing derivatives as performance-enhancing tools.

Beta is returns that are based on systematic rise, while alpha is the superior returns that result from individualized strategies.

In fact, Delano sums up the first three business drivers indentified in the report, namely, the search for alpha and low-cost beta, the search for liquidity in a fragmented market and the impact of sophisticated clients as increasing the pressure on firms to seek alpha returns even as they try to avoid the speculative bets that helped cause the subprime meltdown.

"There is still pressure to perform from pension funds and other investors and it may be that beta strategies alone will not get firms where they need to be," Delano said.

He pointed to the challenge of firms finding the liquidity they need as trading continues to take place across more venues including public exchanges, "black pools," and crossing networks.

Asset management firms will also have to addresses the increasingly complex demands from sophisticated customers who will demand alpha performance levels from the employment of relatively new asset classes such as alternative investments, 130/30 funds and infrastructure funds.

The effect of the U.S. presidential election will also be felt in the managed funds industry this year. Initially, Delano said, the Tower Group researchers thought that the possibility of U.S. election results having much impact on the global asset management industry was a parochial expectation.

But in talking with European and Asian investors, the researchers learned that a number of non-U.S. based organizations felt that the world economy is interdependent enough that changes in the U.S. government are still capable of having far-reaching effects. Foreign market participants were particularly interested in how the U.S. presidential election may affect the taxes and the level of regulation in the financial services industry.

Another factor that will affect the managed funds industry this year, according to the Tower Report, is the after-effects of mergers and acquisitions activity in the sector.

The report cites data from Putnam Lovell that indicates there were 191 asset management purchases in 2006, up from 143 in 2005. As of November 2007, last year's total stands at 208 global transactions.

Among the most visible deals were the acquisition of the Putnam mutual funds business by Power Financial and the buyout of Nuveen Investments Inc. by private equity fund Madison Dearborn Capital Partners.

"The challenge is for managers to determine the best way to tackle issues such as combining reporting structures, client services and ensuring the same levels of transparency," Delano said.

Actively Managed ETFs To Be A Hot Category

Another industry consultant, Bruce Harrington, managing director at Celent, predicted that this year will see a huge shift in actively managed exchange-traded funds. He argued that the problem with traditional ETFs is that they are passive, but if the instrument is modified so that it benefits from a hands-on direction by professional managers, it will become that much more compelling a choice for investors.

Actively managed ETFS will pose formidable competition for actively managed mutual fund products.

A broader trend Harrington expects to see emerge this year is the widespread acceptance of a number of other emerging products. He pointed to hedge funds, REITs, other real estate products and 130/30 funds.

These new products, along with actively managed ETFs, will become more common because clients are looking for more personalized experience. The mutual fund industry will come to more closely resemble the actively managed funds sector so that investors can use mutual funds as building blocks in creating unique portfolios, he said.

Also in the new products category, but coming at the investor from a different perspective, will be an increase in activity in retirement income products, Harrington said. Whether they are target date funds, annuities or target risk instruments, clients will be increasingly interested in how to set up their pay-outs. Meeting these needs will be an imperative for the mutual fund industry.

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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