no. 14

perspecti v es

the future of finance

f e brua r y 2 013

Commentary from influential industry leaders, academics

and policymakers on relevant issues and trends

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table of contents

per spect i v esf e brua r y 2 013

no. 14

02/Generation NextHow the Millennial generation will reshape asset management

05/The New Depression How the dollar standard pushed the global economy to the brink

16/The Contributors

special report

08/The Game Changers Leaders discuss where finance is headed

14/Breakout Stars Frontier markets and the future of growth

the future of finance

It is time to look forward. To address some of the important questions that remain in the wake of the

Financial Crisis. Where do we go from here? How will Europe fare? Where can investors find returns

in this new era of low returns and low growth? This issue explores these important questions and

looks into the future for answers.

In Generation Next, we explore the Millennial generation, whose beliefs and behaviours are

fundamentally different from those of their Baby Boomer parents. Millennials are concerned about

catastrophic climate change and focused on making a real difference with their money. As they get

ready to save and invest, how will their new and different sets of demands and questions change

the investment space?

We also look at the next generation of global markets in Breakout Stars: Frontier markets and the

future of growth. From Nigeria to Vietnam, these nations defy labels and may represent some

important opportunities for investors able to tap into their potential.

In our special supplement, The Game Changers, we interview leaders from the investment world for

their insights into where the industry is heading. From Research Affiliates’ Rob Arnott to AIMCo’s

Leo de Bever and Jagdeep Singh Bachher, and ALFI’s Marc Saluzzi, these individuals have a lot to

say about the future of finance.

Finally, author Richard Duncan offers a somewhat darker vision of the future as we discuss his book,

The New Depression: The Breakdown of the Paper Money Economy. In this Q&A, Duncan explains why

the demise of the gold standard has led us to an unsustainable credit-driven economy and what he

thinks must be done to avoid a catastrophic global depression.

We hope you enjoy these insights and find them useful. As always, we welcome your suggestions for

topics and ideas for future issues.

taking st ock . what the future may hold for investment management and the gl obal economy.

josé pl acidoChief Executive Officer RBC Investor Services

How the Millennial generation will reshape asset management

GENERATIONNEXT

Author Jim Finkelstein says his son is worried about the future: and

for good reason. The 21-year-old college graduate and member of the

Millennial generation – those born between 1978 and 2000 – recently

came across research concluding that, by 2050, global warming will

have wrought calamitous changes on the planet. “We need to do

something about it now,” he told his dad over dinner. The message

resonated for Finkelstein, president and CEO of FutureSense Inc.,

who is himself a Baby Boomer and author of the book Fuse: Making

Sense of the New Cogenerational Workplace. He’s written and lectured

on how to bridge the divide between Boomers and the Millennial

generation in the workplace, but for him a key issue is their approach

to doing the right thing, not necessarily for the greater good of

mankind, but for their own “common sense of survival.”

Writers like Finkelstein have spent a lot of time helping people

understand the key differences between Millennials and their Baby

Boomer parents. This new generation is grappling with an incredibly

different world, as they graduate from college, move into the

workforce and begin to accumulate savings and assets. But perhaps

the most critical differentiator between these two generations rests

on their attitude toward money and investment. The concerns and

needs of Millennials are vastly different than those of Boomers.

They’re more focused on sustainability, dealing with the pressing

issues facing the planet (including climate change), and ensuring

the money they invest makes a meaningful impact on the world.

Experts say the asset management industry must quickly come to

terms with this to effectively meet Millennials’ needs.

Raul Pomares, senior managing director of Sonen Capital LLC in San

Francisco, is already responding to the evolving needs of Millennials.

He has been working with family offices since the 1990s and says the

kinds of things clients are asking for has changed drastically during that

time, particularly among younger people. “I had become accustomed

to dealing with families holistically, including all the generations in

discussions around wealth planning. But more clients started asking

how we could help them match their own values with the kinds of

investments that were being made,” he explains. While he had

previously used negative screens around specific kinds of investments,

like tobacco or gambling, it was clear his clients wanted more.

Today, Pomares’ firm is dedicated to seeking financial returns tied

to creating a lasting social impact, something which is increasingly

appealing to new and younger clients who are part of a generation

that no longer puts a wall between philanthropy and return-seeking

in their investments. “They realise you don’t have to sacrifice

returns to make an impact,” he says. “It can be done simply by

bringing the same rigour to impact investing as investors have

always brought to other investments.”

beyond negative screens

Dan Apfel agrees Millennials are pushing the investment industry

to make a positive impact on the world that goes beyond using

negative screens. Apfel is executive director of the Responsible

Endowments Coalition, an organisation that supports students and

other university community members in engaging with endowments

in their investment practices. “People in the Millennial generation

have a mindset that goes beyond not investing in things like

gambling or weapons,” he explains. There is a real desire to support

a new and emerging set of entrepreneurs creating innovative

solutions to existing problems.

perspectives: the future of finance | 3

“ People in the Millennial generation have a mindset that goes beyond not investing in things like gambling or weapons.”

“Millennials want to create positive change, not just stop investing

in bad things,” he says. “They want the ability to invest in solutions-

oriented alternatives that will improve the world. For example, they’re

not just saying, ‘I don’t want to use plastic bags’. They want to create an

alternative to them. This is what is driving their investment approach.”

Perhaps the biggest differentiator between Millennials and their

Boomer parents, however, is the fundamentally different state of the

world today. It extends beyond climate change: this generation faces

tremendous economic and social challenges as well. Millennials are

coming into adulthood loaded with student debt, unable to find a

well-paying job and, as a result, unable to find the money to save.

David Norman, founder of TCF Investment in the UK, believes

difficult economic conditions are creating a big gap between the

haves and have-nots among Millennials, with some benefiting from

the wealth of their Boomer parents and others going it alone. “In

the UK, for example, property has always been the great wealth

creator,” Norman explains. “But housing has become extremely

expensive and, as people live longer, they’ll be selling their house

to finance their retirement and care. In many cases, Boomers

won’t be leaving the family home to the next generation.”

Norman also points out that Boomers have represented a

demographic sweet spot, with many things working in their favour:

markets were buoyant, returns were high and pension schemes were

available, he says. Not so for Millennials, especially those in the UK

who face an uphill battle to accumulate assets and gain a foothold

in a challenging economy. The UK has been responding with

innovative savings schemes to help young people put money aside

more easily. The National Employment Savings Trust, for example,

is designed for younger Britons who tend to move from job to job

in a way the previous generation never did. It allows savers to

contribute to the same retirement pot even if they change employers

(no matter how big or small) and if they shift to self-employment.

Norman believes this is a positive move to help a generation that

is under tremendous financial pressure.

Finkelstein believes the asset management industry will need to

change the kinds of services and products it offers to meet the needs

of this generation. While Boomers have focused on investing to get

the highest rate of return, Millennials are focused on a completely

different set of values, where impact trumps returns. “It’s not about

investing for the long term anymore. It’s about making money work

for society,” Finkelstein says. “It’s a whole different pitch.” Young

investors will be looking to invest in companies that are socially

conscious, an important point given that research done by the

Social Welfare Research Institute at Boston College shows a record

USD 41 trillion is set to change hands in the US as the Boomer

generation passes on their legacy to their kids. Millennials who

inherit some of that wealth will probably do different things with it

than their parents did. “Boomers have always saved for retirement,

putting off things like travel until they finished working,” Finkelstein

explains. “Millennials want it now, not because they’re entitled but

because, for them, life is about experiences.” Hence, a Millennial

who inherits money might be more inclined to take a sabbatical from

work and travel instead of just squirreling it away in investments.

All this means Millennials are likely to have a profound impact on

where the investment industry is headed. At the most basic level,

they are the first generation to have grown up online with access

to a massive pool of information their parents never had. Jack

Bouroudjian, CEO of Chicago-based Index Futures Group, says that

access to information will put pressure on managers and advisors

to offer better value: “Who’s going to pay someone a 1% fee when

they think they have all the same information at their fingertips?

The industry is going to have to offer ideas and real direction rather

than just asset allocation and stock picking.”

Pomares believes Millennials are likely to start investing with an

impact lens sooner than most realise: “They gravitate towards

environmental and social justice issues as well as viable investment

solutions to challenges that were overlooked by previous

generations. We all live in this world and we can’t ignore what’s

happening elsewhere – it affects us all. The investment industry

will need to evolve and recognise that reality.”

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“ Millennials want it now, not because they’re entitled but because, for them, life is about experiences.”

How the dollar standard pushed the global economy to the brink

THE NEW DEPRESSION

In his book, The New Depression: The Breakdown of the

Paper Money Economy, Duncan discusses the new economic

paradigm that emerged in 1968 when gold was abandoned

and credit creation and consumption began to drive economic

growth. Today, he sees the world standing on the brink of a

massive global depression as the private sector remains unable

to take on any more debt. So what is the solution? Duncan

believes governments need to change their policy and start

thinking big about the future. We sat down with Duncan to

discuss his views on the global economy and his

recommendations for change.

You argue in your book that the US decision to stop backing gold in 1968 changed the nature of money forever. How? Prior to 1968, when dollars were backed by gold, there was a

very clear difference between money and credit. Money was

gold and credit was the obligation to repay money. In the old

days, when you took a dollar bill to the Treasury Department,

in theory, they had to give you some gold for it. Now, they just

give you another dollar. A dollar is now just another credit

instrument, just like a 10-year government bond. Why is this

significant? Because when dollars were backed by gold, there

was a limited amount of money that could be created. It put

binding constraints on how much credit could be created,

because credit is simply a multiple of the amount of money

that exists. Once the link between dollars and gold was

broken, it removed the constraints on how much money

could be created and has since allowed an explosion in

credit to occur. In the US, for example, credit ballooned from

USD 1 trillion in 1963, when the gold standard was still in

place, to USD 50 trillion in 2007, prior to the Financial Crisis.

That means it expanded 50 times when the gold standard

was removed. The problem today is that this credit boom

is in danger of collapse because credit can’t expand any

further, mainly because the private sector can’t repay the

debt it already has.

What do you consider to be the main flaws in the international monetary system today? When the Bretton Woods system broke down in 1971, it was more

or less a quasi-gold standard, replicating the best qualities of a

gold standard. Under the gold standard, trade between countries

had to balance and, if they didn’t, the deficit country had to pay

with gold. If a country lost a lot of gold due to an imbalance,

it would create a very severe recession in the deficit country.

That recession meant the deficit country would stop buying

some imports and that would restore the trade balance.

Today, without the gold standard, there is no inherent mechanism

to prevent big trade imbalances. Post–Bretton Woods, the US

started developing an enormous current account deficit with

the rest of the world, peaking at $800 billion in 2006. This was,

of course, highly beneficial to the rest of the world because it

allowed countries to expand their economies by exporting more

to the United States. They all boomed around this massive trade

deficit in the US. Right now, there is no mechanism to prevent

this and that is a major flaw.

A second flaw in the system we have now, which I call the

“dollar standard,” is that there is nothing that can prevent a

country from manipulating its currency. If we look at China,

for example, it has a USD 300 billion-a-year trade surplus with

Until 1968, your money was as good as gold, quite literally. Thereafter, the Bretton Woods system unravelled, sweeping the gold standard aside in favour of a fiat currency, with no gold-backed limits on how much money could be created by central banks. According to author and economist Richard Duncan, the elimination of the gold standard set the global economy on an uncharted course with an uncertain and potentially devastating destination.

richard duncan Author, The New Depression: The Breakdown of the Paper Money Economy

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perspectives: the future of finance | 7

the US. If that money were converted in the open market into

yuan, the local currency, it would put extreme pressure on the

yuan, causing it to appreciate drastically. This would cause

China’s exports to stop growing so rapidly and would slow

the growth of its economy. Instead, China can manipulate its

currency by having the central bank print its own money and

by buying all the dollars going into it at a fixed rate. This holds

down the value of its currency and allows it to continue to

have export-led growth and maintain a trade surplus with

the US.

The third flaw is that the banking industry over the past

several decades has been deregulated. The central banks and

governments lost control over credit creation and there doesn’t

seem to be any mechanism in this new system to limit the credit

that the banking system and the shadow banking system created.

All this credit can’t be repaid, so we’re in danger of collapsing

into what I call the “New Depression.”

Are we headed for the New Depression? I think we all need to realise that we’re in a completely new

situation. Back in the day, if the government spent a lot of money

it would push up interest rates and if the Fed printed a lot of

money, it would very quickly lead to high inflation rates. But

today something else is going on. Globalisation is putting extreme

downward pressure on wages as all the manufacturing jobs move

to developing countries where workers can be hired for between

$5 and $10 a day. Falling wages around the world are extremely

deflationary and the deflationary forces of globalisation are

offsetting the inflationary effects of money creation. So, for now,

we are in a nirvana-like world where governments can borrow

trillions of dollars for 1.6% interest. Governments should take

advantage of this nirvana-like space as a way to get out of this

disaster and create opportunity by borrowing trillions at those

low rates for 10 years and investing very aggressively in

transformative 21st-century industries and technologies.

What do you see as the solution? The US economy needs to be entirely restructured. Right now,

there are three possible ways to do this. We can do what the

US Tea Party wants and immediately balance the government’s

books and get rid of the deficit. That would immediately result in

depression. Or, we could do what Japan has done and run massive

government deficits year after year and waste the money building

bridges to nowhere. Doing this would keep the US on the same

track – borrowing massive amounts of money and spending it

all wastefully. In this scenario, the US would survive for another

five to 10 years and then collapse like Greece.

There is a third option, however. The US could learn from Japan

and allow governments to borrow aggressively, not to build

bridges to nowhere but to invest it in transformative 21st-century

technology and industries. This would generate massive returns

and pay for itself many times over. The US government should

invest a trillion dollars in solar energy, a trillion dollars in biotech

and a trillion dollars in nanotechnology over the next 10 years.

If it did this, it could completely restructure the US economy

and spark a technological revolution like the first industrial

revolution. And the US would never have to collapse into the

New Depression.

“Back in the day, if the government spent a lot of money it would push up interest rates and if the Fed printed a lot of money, it would very quickly lead to high inflation rates. But today something else is going on.”

special report

Leaders discuss where finance is headed

GAME CHANGERS

The Equalisers: rob arnot t

chairman and ceo, research affiliates ll c

In this age of low growth, investors have tempered their

expectations. With a best hope scenario of 4% to 5% annually in

returns, they are more focused than ever on products that can

boost efficiency, especially in the passive index space. Rob Arnott,

chairman and CEO of Research Affiliates LLC, has spent years

refining and improving the indexes investors rely on. As a

champion of fundamental indexing, he is leading a charge

that will help investors in the future.

What is the biggest challenge facing institutional investors today? Right now the two most dangerous threats to investors are an

expectations gap on GDP growth and an expectations gap on

market returns. Let’s start with the GDP gap. When we look

back on GDP growth through the century, we see 3% and

we think that’s normal. We expect our politicians and our

economic leadership teams to deliver 3% GDP growth. That’s

not realistic. GDP growth equals labour force growth plus

productivity growth. Labour force growth is going to be slower

in the US: just 1% a year over the next 30 years. We are also

facing a productivity slowdown that comes from an older

workforce. Wages peak when someone is in their 40s and 50s.

As Baby Boomers retire, we will lose our most productive

workers and this will lead to anemic growth. The 3% growth

we’ve been used to represents the effects of a demographic

sweet spot, from the 1920s to 1980s, where there wasn’t a

large roster of seniors and support ratios were low. Today,

we’re at the end stages of that and we’ve got to ratchet down

our forward-looking growth expectations.

If you put the pieces together – slower growth in the labour force,

an aging population and blossoming deficits and debt – our

forward-looking GDP growth will be more along the lines of 1%.

Why is this so important? Not because 1% is horrible: it’s still

growth. It’s horrible relative to expectations. We’ll kick out

politicians and business leaders who fail to deliver. And the

resulting revolving door will create an incentive for delivering

phony GDP growth, where deficit spending shows up as growth

even though it’s not. We could face a scenario where deficit

spending becomes endemic in the developed world and where

institutional support for continued deficit spending is led by the

voters’ demand for continued 3% growth even though it is no

longer plausible.

What about expectations on the investment side? There’s also a gap in return expectations. People look back over

the last 30 years and they see returns of 12% on stocks and 9.5%

on bonds. They wonder why it can’t continue. The expectation

gap in investments means that while investors expect to earn 8%

on a balanced portfolio, the reality is they will earn 4%, less than

half what they expect.

You’re recognised as the father of fundamental indexing. Given the challenges you see, both economic and investment-related, what future do you expect for indexing and passive investment in general? Indexing is changing the landscape. Right now, investors recognise

that indexes that are mainly market capitalisation–weighted

In the five years since the 2008 Financial Crisis, the investment space has shifted in fundamental ways. From sovereign wealth funds to cross-border funds, there are a few key trends that are going to shape the future of finance. In this feature, we interview leaders from three organisations that are helping to rethink and reshape the investment world.

perspectives: the future of finance | 9

have an Achilles heel. If you index stocks by market cap, you’re

getting the popular, trendy stocks: the safe havens, with valuations

that have been driven up as a result. In contrast, when you invest

in stocks that are proportional in size to their business, research

shows you do about 2% better on average over decades. That’s a

neat outcome. With forward-looking stock returns sitting at 4%,

boosting that return by 2% is huge.

The Achilles heel in cap-weighted indexes is even more

pronounced on the bond side. If you invest in a cap-weighted

bond index, you’re investing in bonds in direct correlation with

the debt appetite of the borrower. The more they want to borrow,

the larger their bond issues are and the more you must own.

It’s an excruciating and devastating problem. Take Greece, for

example. Before it reached junk status, Greece had four times the

debt of Australia. And Australia had four times the GDP of Greece.

If we were lending in proportion to the debt capacity of a nation,

we would want to have four times as much Australian debt as

Greek debt. But with cap weighting, the opposite would be true:

we would have had four times as much Greek debt as Australian

debt. Simply because Greece wanted to borrow more.

So the work we’ve done in non-cap-weighted indexes has

opened a door for a whole sweep of innovations related to the

use of mainstream broad market index assets that can add from

1% to 3% to returns, which is significant based on market return

expectations of 4%. This is a very important factor in helping

investors bridge the investment expectations gap over the

next decade.

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The Alberta Investment Management Corporation (AIMCo) has

made its mark in recent years as one of the most innovative

sovereign wealth funds in world. With CAD 70 billion in assets

under management, AIMCo invests on behalf of pension,

endowment and government funds in the energy-rich province

of Alberta. In the wake of the 2008 Financial Crisis, however,

AIMCo shifted its focus to the very long term, taking on more direct

investments like infrastructure and redefining its approach to risk.

What major changes has AIMCo made in the past few years to deal with the global financial and economic challenges that are affecting the investment landscape?

We are implementing or upgrading all the business systems we

need to value our holdings better and faster and to track risk more

accurately. This is becoming the foundation for a more robust

decision-making process. After we became a crown corporation in

2008 we witnessed a cultural shift, with a new focus on managing

for best risk-adjusted returns.

On the investment side, there is greater focus on direct

investments and managing more assets internally. In 2008, 80% of

costs came from 20% of externally managed assets. External costs

have since dropped to 60%. We have far fewer external managers

in public equities, infrastructure and private equity, but we

manage those relationships more intensively.

The Giants: leo de bever

president, the alberta

investment management

corporation (aimco)

jagdeep singh bachher

executive vice-president,

venture and innovation,

aimco

perspectives: the future of finance | 11

A big part of your mandate is to manage Albertans’ pension assets. Are you hopeful about the future of DB plans given the challenges they face?

Actuaries underestimated longevity. The nineties seemed to imply

that returns were higher, keeping everything affordable. The next

ten years showed otherwise. So, DB plans face huge funding

challenges. We are trying to earn an extra 1% to 2% to help close

the gap, but it would take decades to dig ourselves out with better

returns alone. Pension benefits behave like bonds, but with bond

returns very low, we need to find a better way to finance pensions

without taking on unreasonable risks. Really boring regulated

infrastructure (with stable real returns at risk between stocks

and bonds) has in many cases proven to be a better match for

long-term liabilities.

What needs to change to create a more accommodating environment for the pension promise on a global basis?

The promise behind government pay-as-you-go pensions funded

from tax revenues will be hard to keep in most OECD countries.

The Canada Pension Plan has been partially funded to reduce

that future budget pressure. The bigger solution for DB plans

will have to involve contributing longer, reducing pension

expectations and sharing risk better across active and retired

members. Employer guarantees will likely become rare. The DB

model is efficient from an investment perspective and shares

longevity risk. The main change will probably be the shift to a

“target pension” that will be periodically adjusted in light of

investment experience. That will be tough to accept. We need

more pooled DC plans to keep the economies of scale from

DB asset management.

What lessons can other pension systems learn from Canada – and what countries, investors or jurisdictions have you drawn lessons from?

Strong governance has helped the big Canadian pension plans

be more innovative in looking for diversified and lower-cost asset

management. We can attract good talent to organisations, which

helps create value. Direct investment programs also help to

reduce costs and allow pension funds to pursue investment

strategies that can deliver returns.

No one has a monopoly on new ideas. We have humility as a core

value because you can never assume that you know it all. We keep

a close watch on what goes on in the Netherlands and Australia,

both to see what seems to work and what is best to avoid.

What does leadership look like to you from an investment standpoint?

Mobilising as much and as diverse a pool of talent as you can.

Challenging people to try to figure out the future even marginally

better than others. Daring to stick your neck out and find novel

ways to make better risk-adjusted returns for clients. Allowing

people to experiment and occasionally make mistakes, because

that’s the only way to find out what works. Find investments

that don’t fit a neat asset class box. As long as we can figure out

risk and return, we will fit it in somewhere. Occasionally that

creates problems because unfamiliarity raises the inevitable

question “who else is doing it,” and the inevitable answer “very

few,” and that’s why the returns may be better than for the stuff

we already have.

“ No one has a monopoly on new ideas. We have humility as a core value because you can never assume that you know it all.”

The Globalisers: marc saluzzi

chairman, the association of the luxembourg fund

industry (alfi)

Europe has been a world leader in fostering the free flow

of capital across borders. With the introduction of the first

Undertakings for Collective Investment in Transferable Securities

(UCITS) directive in 1988, the vision was set out: a level playing

field whereby all European investors would have access to a

wealth of funds and products, without a lot of red tape. As

Chairman of the Association of the Luxembourg Fund Industry

(ALFI), Marc Saluzzi has been doggedly pursuing cross-border

fund distribution, working within Luxembourg’s industry to

ensure funds flow smoothly across Europe.

How has UCITS changed the fund distribution space in Europe and around the world? Up to the mid-1980s, the global asset management industry was

essentially a collection of domestically focused industries. With

the first UCITS directive, the ambition to create a truly cross-

border asset management industry was clearly articulated. More

than 25 years later, UCITS has become the global fund standard

not only in Europe but also in many other parts of the world.

Today, besides Europe, Asia and Latin America are now key

contributors in terms of net inflows.

What has Luxembourg’s role been and how has it evolved? Initially, fund promoters launching funds in Luxembourg had

only one objective: to crack the German market. Today, the

world ex-USA is the playground for our Luxembourg UCITS. It

requires an intense focus on promotion and education targeted

at institutional investors, fund managers and regulators in our

key distribution markets.

Getting to this point was clearly a challenge because regulators,

fund managers and distributors in each and every distribution

market had to be convinced of the relevance of the UCITS product

in a global context. Service providers also faced challenges

because they had to develop a whole set of solutions to support

fund managers in achieving their international ambitions.

But the efforts made since 1988 have largely paid off. Today,

Luxembourg is clearly recognised for its expertise in cross-border

distribution, with a 70% market share of all cross-border fund

registrations.

What barriers still exist for seamless fund distribution in the eurozone and around the world? Aside from cultural preferences, local marketing rules and local

tax regimes are not always easy to manage, especially when you

distribute in more than 50 different markets. It is also clear that,

since the beginning of the 2008 Financial Crisis, some countries

have been tempted to use taxes and/or regulations to limit local

investors’ access to UCITS.

Why is Luxembourg a model for other countries in increasingly globalised financial markets? Luxembourg believed very early in the emergence of a cross-

border distribution model and bet everything it had on it. Now,

although many countries aspire to become a fund distribution

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perspectives: the future of finance | 13

hub like Luxembourg, our first-mover advantage will be quite

difficult to replicate. This is especially true in regions where

there is no integrated or single market and there are no political

aspirations to build one.

How has the Financial Crisis affected fund distribution in the eurozone? First, in such dramatic circumstances, it is clear that investors

have a tendency to retrench at home. This makes cross-border

distribution more difficult. Nevertheless, it is quite interesting

to note that the combined market share of Luxembourg and

Ireland in total UCITS assets under management has more than

doubled from 20% to 45% over the last 10 years. The fact that

both countries are champions of cross-border distribution sends

a clear message to the industry. Second, regulations such as

Basel 3 and Solvency 2 will change or are already changing

the way these two distribution channels are consuming fund

products. In a country like France, the priority for banks is

no longer selling funds, it is boosting their deposit base.

Are you hopeful that financial systems in the eurozone can continue to harmonise, or are there potential barriers you see emerging, especially post-Crisis?I clearly believe that European financial systems will further

integrate and thus harmonise. Going forward, the banking

sector will be supervised by the European Central Bank, and

the EU Commission is pushing toward a single rulebook.

Both developments are the best evidence of this trend.

“ It is quite interesting to note that the combined market share of Luxembourg and Ireland in total UCITS assets under management has more than doubled from 20% to 45% over the last 10 years.”

Frontier markets and the future of growth

Ask an investor how they define the term “frontier markets” and

you’ll get varying responses. “I don’t use a definition,” insists

Nick Greenwood, pension fund manager with Royal County of

Berkshire Pension Fund in the UK and a fan of the frontier market

space. His reluctance to define these markets stems from the

impressive range of countries included under the frontier markets

banner by index leaders like MSCI, whose MSCI Frontier Markets

100 Index includes countries as diverse as Kenya, Vietnam and

Argentina. “I am not bothered by the label given to a country as

long as I know it fits the growth prospects we’re looking for,”

Greenwood says. Good GDP growth potential and solid

demographics to build on for the future are just some of

the factors that make these markets so compelling right now.

Indeed, today’s frontier markets represent a vast spectrum of

opportunities and markets. A few years ago, if you asked Jack

Bouroudjian, CEO of Chicago-based Index Futures Group, what

a frontier market was, he would have told you it was a country

without the economic and social conditions to make it an

emerging market. Not so now. Today, Bouroudjian sees frontier

markets as a set of very different countries with small, illiquid

markets that are generally being ignored by the investing public.

“Frontier markets aren’t dirt poor – that’s a misconception,” he

argues. “Especially when you consider that the per capita income

in some of these countries is relatively high. Take Panama, for

example. It’s an amazing country, with a higher per capita income

than China and India and where businesses are thriving. And yet

it’s considered a frontier market.” In fact, Bouroudjian believes

Panama is a global sweet spot as the canal zone becomes more

important and the country rises as a lucrative trade zone.

For Greenwood, frontier markets are one of the few places investors

can look for returns, especially on the pension side. “When you look

at developed markets like the US and Europe, where on earth are

the returns going to come from?” he asks. “Frontier markets offer

solid economic growth prospects and healthy demographics in

contrast to developed markets, where GDP growth is much lower

and it’s harder to invest in stocks and get value.”

That view is shared by Ramon Tol, fund manager with Netherlands-

based Blue Sky Group, which manages the pension assets of Dutch

airline KLM. He also thinks frontier markets are an excellent

opportunity for pension funds today because they offer diversification

at a time when it is getting harder to come by. “Frontier markets are

less correlated to developed markets than emerging markets,” Tol

explains. “Correlations are still high, but right now they’re inflated

because of the global crisis: whenever there is a crisis all correlations

move to one. However, over the longer term, correlations have been

much lower and we think they will ease up in the future.” Tol also

likes the look of frontier market currencies, which now trade at a

steep discount to other global currencies. Both Greenwood and Tol

say their allocations to frontier markets, at just 2%, are on the modest

side, although Tol says he is working to a target of 3%.

But an allocation to frontier markets is not easy to come by and

access to these markets is a big challenge. Equities and bonds aren’t

always the best way to tap into frontier markets argues Nigel Sillitoe,

CEO of Dubai-based Insight Discovery, adding that investors are

often better served by taking a direct approach to these markets

in partnership with a recognised company that is part of the local

establishment. “The more control an investor has over management

decisions, the better able he or she will be to limit or offset the

risks,” he explains. Greenwood also believes the direct approach is

important in frontier markets: “You can’t just say listed equities are

the only way to go in these countries,” he says, noting that his plan

holds small allocations to frontier markets’ infrastructure and private

equity. “You have to look at the whole opportunity set and find the

right manager,” which he admits can be a challenge.

These markets also face some formidable risks, including issues

with rule of law and political risk. These risks are fundamentally

different from the ones investors are used to dealing with in

developed markets where investor protection is more ingrained.

However, Sillitoe believes that a key opportunity in the frontier

space lies in the changing perceptions around the real risks of

some markets, where constant improvements are making them

more stable. As these countries change and evolve, they offer

opportunities for improved returns, especially in light of ongoing

poor economic growth prospects for many other countries.

As frontier markets continue to evolve, one thing is certain: you have to

be closely linked to them to succeed. “The only way you can really be in

a frontier market is to be there on the ground, buying the individual

companies,” says Bouroudjian. “You need to be living and breathing the

markets and know the customs. And the best way to do that is by being

there.” One good indicator of a market’s potential is who else is already

there. For Sillitoe, the presence of institutional banks and providers of

custody and securities services are good signs of a market’s ability to

handle investment. “Investors should ask up front who is there and

what they are doing,” he says. “The fact that major international banks

are operating in frontier markets should be a valuable source of

information. Market research firms with a local presence and strong

links to corporate decision-makers are also positive signs. Some of the

frontier markets are amazingly opaque: original and proprietary

research is the only way to find out what is really going on.”

Greenwood himself isn’t worried that more investors aren’t

flooding into frontier markets: he’d like to avoid a wall of cash that

could crowd out opportunities. Whether or not these markets will

be able to maintain their hidden gem status is up for debate –

especially as return-hungry investors continue to search the world

for new sources of growth.

perspectives: the future of finance | 15

“ The only way you can really be in a frontier market is to be there on the ground, buying the individual companies.”

the contribut ors

dan apfelExecutive DirectorResponsible Endowments CoalitionBrooklyn, NY

leo de beverPresidentAlberta Investment Management CorporationEdmonton

raul pomaresSenior Managing DirectorSonen Capital LLCSan Francisco

rob arnot tChairman and CEOResearch Affiliates LLCNewport Beach, CA

richard duncanAuthorThe New Depression: The Breakdown of the Paper Money EconomyBangkok

marc saluzziChairmanAssociation of the Luxembourg Fund IndustryLuxembourg

jagdeep singh bachherExecutive Vice-President, Venture and Innovation, Alberta Investment Management CorporationEdmonton

jim finkelsteinAuthorFuse: Making Sense of the New Cogenerational WorkplaceSan Rafael, CA

nigel sillit oeCEOInsight DiscoveryDubai

jack bouroudjianCEOIndex Futures GroupChicago

david normanFounderTCF InvestmentUK

ramon t olFund managerBlue Sky GroupNetherlands

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