2.1.6. The Low Interest Rate Environment and the Demand

The low interest rate environment and the related over-supply of liquidity inflated

several asset values and as a result the return of these assets fell to often historically

lows.

In such an environment different types of institutional investors

got more

and

more desperate to generate higher returns.

Managers of institutional and retail funds as well as hedge funds are under

constant pressure to out-perform their respective benchmarks because they are

operating in an industry dominated by economies of scale which forces all players

to grow

in size, seek to survive

as a niche-player

or ultimately leave

the market.

Hence asset managers are generally facing stiff competition to retain old and

win

new

clients and to generate more and more assets under management. In the

absence

of any other transparent quality measure the relative

out-performance

of

a

respective

fund therefore serves

as the key

marketing

argument to attract new

 

money.

This

pressure could be an incentive

for fund managers to implement more

risky

investment

strategies than the fund would

otherwise pursue.

 

Another reason is that many asset managers, especially hedge funds, are not

only rewarded based on a fixed fee or a percentage of total assets. In addition they

often claim a performance related fee that has to be paid on the out-performance

over a certain minimum defined return. This mechanism naturally incentivises the

asset manager to enter into excessively risky investments because in an up-side

scenario the investor has to share the potentially huge out-performance with the

manager while in a down-side scenario any losses are exclusively borne by the investor.

Besides another type of investor is the life insurance and pension fund indus-

try. These institutional financiers often have contractual commitments to deliver a

guaranteed minimum return to their clients every year. Insurance companies and

pension funds are usually investing in very liquid and very safe AAA-rated securities

with long maturities like

government

bonds or covered

bonds. Investments

in

lower

rated asset classes, like

investment

grade corporate bonds or even

high-yield

bonds

or equity,

are normally restricted by law

to a small percentage of the total

portfolio

and monitored by a regulator.

 

 

Source : Perguruan Tinggi Kedinasan