December 20, 2017
The Family Office Alpha Report by Witherspoon Partners, Dec 2017
Fearless Predictions for 2018
By Keith Danko
The tumultuous times of 2017 are just about in the rearview mirror, but what surprises lie ahead? In no particular order, we share predictions for 2018 based upon what we see developing in markets, governments and the asset management business (spoiler alert: no Bitcoin projections here). In short, the news is mixed for investors and asset managers, but a U.S. political détente may emerge on the horizon, offering a hint of optimism.
- Passive investing will experience its fastest growth yet, and will be applied to asset classes which to date have resisted the movement to passive. Pressure on fees for active managers of all kinds will increase.
- Fewer new asset managers will launch in 2018 compared to recent years. A recognition that the odds of succeeding are not as good as most people assume, coupled with an acknowledgement that regulatory costs and the capital-raising challenges are substantial, will be the cause. With fewer managers launching, performance by new managers will be better than expected. By year end, investing in new managers as a smart play by institutions and family offices will be as accepted as it was back in the 2000-2004 peak of new manager outperformance.
- Following on the above, institutions will look to allocate more capital through new and emerging manager programs. Specialized funds of funds that cater to this sector of asset management will grow.
- The new managers who benefit the greatest will be those who spend the most time, attention, and resources on marketing. Reaching investors and breaking through distracted attention spans will be an increasing challenge. Those managers who understand that the asset management industry needs to prioritize marketing in the same way that other industries do will find disproportionate success.
- Artificial intelligence (AI) asset management will have a put-up-or-shut-up year. Too many managers are claiming special AI expertise. This will confuse the marketplace and bring about the driving out of good managers by bad managers. By year end 2018 there will be a much better understanding of exactly what AI can do, how best to access it, and what the true benefits of big data are. Investors will become much more discerning in allocating to such strategies.
- Credit-oriented strategies will be challenged. Issuers, operators, and managers in business, real estate and private equity will find equity capital more available as investors begin to realize the high IRRs achievable in illiquid equity investments that require a three- to seven-year holding period. This will pressure interest rates, arrangement fees and points, and equity-kickers attached to debt, resulting in lower returns from credit strategies. The credit managers who succeed best will be those who adjust most quickly to the more aggressive pricing levels.
- The tax reform bill will be very good for the US economy and the global economy, though its effect on individual families may be uneven. It will be the final driver of what will be viewed as a complete recovery from the financial crisis ten years ago. Three to five years from now there will likely be a price to pay in terms of deficit issues and higher interest rates, but for the next 12-18 months growth will accelerate.
- Inflation will return by the fourth quarter of 2018. Higher wages, higher energy prices, and higher housing costs (the shortage of single family homes will become severe in much of the country) will provoke a surprising surge in inflation; most investors will not be anticipating this.
- Fiscal issues will plague high-tax, slower growth states with large budgets and expanding deficits. Among those issues will be underfunded state pension plans. Puerto Rico will serve as the canary in the coal mine in two ways. First, the current lack of US political support to fund a Puerto Rico hurricane recovery given the territory’s $70 billion of debt and $50 billion in pension obligations will cause a re-examination of the federal government’s obligation to support individual states who experience fiscal distress. Second, the current exodus of Puerto Ricans to Florida and other US states exemplifies and highlights the easy mobility available to US citizens to relocate to other states and become instant residents there. States such as Illinois, New Jersey, New York and California, all who are now experiencing serious challenges, will find little sympathy from the other states (and those other states’ representatives in Congress), and will see their most productive workers and most mobile citizens (i.e. its youngest) continue to flee to more promising locales in the South, Midwest, and Southwest. Worth watching closely will be the actions of New Jersey under incoming Democratic governor Phil Murphy, an ex-Goldman banker who must avoid the results of the Corzine administration. The Illinois gubernatorial contest will also be interesting to watch, both at the Democratic primary level and the main election itself, given what is predicted to be the costliest such race in US history.
- Our fearless predictions conclude with a ray of hope: In 2018, a brand of practical politics will emerge as a growing force, appealing to the tens of millions of American voters weary of, and often disgusted by, the current hyper-partisan political climate. Political leaders espousing and seeking to execute solution-oriented initiatives will find that ignoring party dogma, and disregarding threats from the far right and far left, can become a winning strategy that will garner widespread support. Candidates who run in the midterm senate elections on such a basis will find surprising success.
Regardless of what news the crystal ball may hold, Witherspoon Partners wishes you Happy Holidays, and a healthy and prosperous 2018!
Photo: Garden of the Gods, Colorado Springs/Phoebe Outerbridge