A recent McKinsey study suggests that traditional fund managers should pay growing attention to the needs of their customers. Why start ...

A recent McKinsey study suggests that traditional fund managers should pay growing attention to the needs of their customers.

Why start now?

The traditional fund management industry is dying on its feet—or it certainly should be—because its core offering to both individual and institutional investors, namely index-relative performance, is wholly irrelevant to most of their needs. Traditional asset management is an answer desperately in search of a question.

The demerits of relative return investing should be clear to all in the aftermath of the bear market that savaged equity valuations beginning in late 1999 and early 2000. It was precisely this bear market that revealed just how overweight most investors were in equities as an asset class.

The danger now is that, on the advice of consultants, many institutions are making a whole new asset allocation mistake, by stampeding into bonds on the largely illusory presumption that bonds offer the “best” match against their liabilities.

Really? Do conventional bonds offer any prospect of capital growth? Are UK government bonds, none of which yields much more than 4.5 per cent to maturity, really a sound long-term investment? Let’s not even talk about the merits of the US Treasury market.

As traditional fund managers wrestle with this ongoing asset allocation debate between the relative attractiveness of equities and debt, another type of manager is quietly going about garnering client capital.

Absolute return investing is surely a more rational alternative to index-tracking, and aligning the interests of managers and clients in a common goal: capital preservation and cash-plus returns.

So it will not be much of a surprise if this year, as in 2004, hedge funds and funds of hedge funds continue to suck up substantial client assets. Not all of them will succeed, but then not every traditional fund manager is a Warren Buffett either.

The flood of money heading toward absolute return managers is going there for a reason. It seems like traditional fund managers are, as a rule, peddling tired old products rather than addressing the genuine and possibly complex needs of their clients. Nailing your fundamental product proposition to the continuation of a bull market is hardly an investment strategy.