Northern Trust Global Investments Sets Growth Course Around Multi-Manager, Quant and Alternative Products

Originally published June 9, 2008

Northern Trust Global Investments (NTGI), with $778 billion in assets under management, emphasizes a quantitative approach to money management, with over $280 billion of assets under management focused on the quant space. Its investment strategies include using an array of internally managed products and multiple manager solutions to expose clients to well-researched work by boutique “alpha generators.” At the same time, NTGI is widening the cross-border aspect of its investment approach, portraying itself more as a global company that “just happens to be headquartered in Chicago,” rather than a Chicago-based firm that invests worldwide. Global Investment Technology spoke with Stephen N. Potter who recently took over the helm as President of Northern Trust Global Investments.

GIT: What are some of the key trends shaping the asset management business worldwide which as yet are not widely noticed?

SP: Markets are difficult, and the liabilities for pension funds and demands for countries to be able to maintain or develop wealth are key drivers of change. We see risk avoidance being a key part of the business and therefore a series of strategies are unfolding. We see pension funds being sold into new entities that are financed solely for that purpose. We see pension funds merging with one another in the Netherlands and we see a trend toward liability driven investment. In the Netherlands, several large established pension funds are converting into commercial enterprises, either by leveraging their core competencies or buying other pension funds to gain scale, essentially turning themselves into multi-manager pension factories. This really says that the way we operated in the past is not the way we will operate in the future. I can’t predict if any of these will truly be successful in the long run, but they all represent dynamic change at an accelerated pace.

GIT: How has the pace of technological change changed money management?

SP: Risks and obligations in the pensions market and the acceleration of capital development and wealth creation have changed the way markets operate. Investors’ needs have changed. The opportunity to invest has been somewhat constrained by supply and expected returns of traditional markets. We have seen a very strong movement toward alternative asset classes, including commodities and infrastructure-type products.

There’s a need to gain absolute return, not just trundle along with the benchmarks of traditional equity indices, for example. The opportunity set has to broaden and value creation needs to be looked at, both in the assets that are invested and the asset allocation, but also the positions that are taken, whether long or short. Fundamentally, the dramatic change in this universe all goes back to research by Gary Brinson and others on asset allocation, well-constructed investment programs, and the ability to control and monitor risks. The programs that have been successful have those common elements. More simply, just having a good idea of your investment objective allows you to construct portfolios that clearly achieve that objective or can be measured and re-corrected when they need to be.

GIT: What are your biggest challenges and opportunities as president of a leading global asset management firm?

SP: Making sure I stay focused on areas where we excel, such as quantitative management. We’re excellent at short-duration fixed-income and we’re excellent at multi-manager solutions. We will continue to invest significant resources in those. They are the building blocks of the solutions that our clients seek in their investment programs. So again, it’s about focus and truly being a market leader in areas where we seek to compete. On the other hand, it’s very powerful to create product solutions with a broad platform with the kind of integrity, trust and reputation that Northern Trust has. So I expect to continue to support the build-out of our investment businesses off that strong foundation and increasingly stronger global franchise. Our delivery of product and achieving our clients’ objectives does require incredible focus. As we know, even with the best of focus, sometimes the markets can take us into some unusual places.

GIT: Can you comment on your business priorities for 2008?

SP: First and foremost is execution and ensuring that we’re excellent at the areas we are addressing. When we aren’t excellent, we’ll seek to remedy that. Beyond that, we have a clear strategy around multi-manager, quant and short-duration fixed-income. I want to ensure that those products are well-received and continue to be positioned the right way in the marketplace. As part of that, we will enhance our position in alternative assets.

We have a very good capability for hedge fund of funds and private equity products, but I would like those to be of greater scale. I’d like them to have broader market applicability into other jurisdictions. That suggests a build or a buy in that space. The other area, which ties into our existing relationship orientation and platform, is building more quantitative-related products, such as enhanced, quant products. Even though current markets have not been favorable for those strategies, I believe there is a very important place for them. Also, building additional structured products could [create] more customized solutions for wealth management or large additional institutional investors.

GIT: What has been the impact of the US sub-prime loans crisis on enhanced money market funds that invest in asset-backed securities?

SP: There is a clear mismatch between current valuation and what someone can actually trade at if they can trade at all, and what the models would have told us those assets were worth. This is part of an inevitable cycle of product and market dissonance. This is a correction period for those who are left holding these assets. They have a challenge ensuring that they have proper valuations and proper governance of their funds and can therefore assure their investors that in the long run those products will return to where the models said they were. Many market participants have a bigger problem because of mark-to-market rules. It’s a dynamic problem for the banks and fund managers that have significant fixed income holdings. Fortunately, Northern Trust’s long-term conservative philosophy has let us work through this from a position of strength. We own some asset-backed securities, but they are a small percentage of our total, and much less so than our competitors.

GIT: What are some of the risk management challenges that have been flagged for which IT solutions need to be overhauled or re-engineered?

SP: Asset-backed securities that were marked to model as opposed to marked to market present a challenge. The lesson there is unless something really trades, it’s pretty hard to know what it’s truly valued at, no matter what the model says. So that’s a philosophical question rather than a technology question. But it does instruct us in how we look at the assets that we put into client portfolios or onto our own balance sheet as a bank. We’ve always been skeptical of anything that we can’t really feel, touch and understand, and we have a little more conservative approach. Technology is valuable to properly construct portfolios and manage risk — it hasn’t failed us, or the industry — but some take too much comfort in value-at-risk and other risk management methodologies and the numbers those systems produce.

Market participants may have become too comfortable given the growth happening at that time, or incentives were improperly established. So I don’t blame technology, but hubris and a lack of attention to classic risk management discipline. Investing based on momentum and fads often leads to this sort of correction.

GIT: What prevents specialized asset managers from executing strategies that work in one market for them and their clients in another market?

SP: The local sub-custody market for us is uneven in the quality that we seek in market settlement and information flows. That’s part of the problem, but the other side of it is the availability of quality equities and supply in those markets, especially in the hot emerging markets, to keep up with demand. In some strategies, we may want to have more supply and more opportunity to go into a market, but suddenly because of supply it’s constrained and therefore you can’t get the right value points in your investment strategy. What might work in the larger, float-type market doesn’t work in the smaller emerging markets.

GIT: Are custodians meeting the needs of asset managers in an increasingly complex investment arena? How much does Northern Trust outsource compared to what it keeps in-house?

SP: I broadly define asset servicing as including fund administration, middle office and back-office outsourcing. Through outsourcing arrangements with Insight Investment Management, Julius Baer and several other notable fund managers, we actually have become the back office and middle office of four top fund managers. We work with them to move products into new markets and create new wrappers. In the past, when Northern Trust Global Investments launched new products, we used quality third-party providers, but often, given the strategies, we then build our own asset services support. For example, we now are doing our own hedge fund administration and private equity administration. We will build our own exchange-traded funds operations over time and are well positioned in that space.

GIT: Five years from now, where do you see the asset management business and where do you see NTGI?

SP: For a well-run business in these markets, the objective is to double every five years, so I envision being at $1.5 trillion in assets under management in five years, with a strong focus on short duration, quant and multi-manager. The beauty of these products is that they are perpetually in demand, and they are flexible platforms that support growth. They can morph with the changing demands of investors with different indices and different domiciles. Both the quant business and the multi-manager business are easily adaptable. We’re increasingly global in outlook and more sophisticated in our portfolio construction.

I expect us to both listen to the market and react and build product to meet its needs, but also bring more of our own opinions of the markets to bear in how we work with clients to seize the opportunities ahead.           


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