Old Wine in New Bottles

2011 Consultant Search Forecast

April 2011

• Investment consultants servicing North American institutional investors will continue to favor asset
managers with the following five characteristics:
- A focus on non-correlated investments that add excess return to portfolios
- The ability to offer both traditional and alternative investments
- Innovative product development
- Fully globalized portfolios
- Competitive long-term incentive schemes
• These success factors reflect three core shifts in institutional portfolio construction:
- A greater emphasis on outcomes
- An increasingly central role for alternative investments
- A wider use of global benchmarks
• Managing inflation and longevity risk have become critical policy concerns, especially among corporate
defined benefit plans. More than one-half of consultants expect increased search activity for inflation-
hedging strategies; more than a one-third anticipate boosted mandates for liability-driven portfolios in 2011.
• Inflation fears are driving demand for illiquid investments, with consultants predicting significant
increases in private equity and real estate mandates.
• Appetite for hedge funds continues to rise. Consultants expect the most search activity to center on
hedge funds during 2011, although a growing number of large investors will turn to more direct
mandates, using funds of hedge funds for specialist portfolios instead of core hedge fund exposure.
• Institutional investors will continue to look outside the United States, with more than 80% of
consultants expecting their clients to increase their non-U.S. equity exposures in 2011.
• Demand for emerging markets equity and debt specialists will surge, with more than one-third of
consultants expecting EME to see the most search activity in 2011. Conversely, less interest will
manifest for EAFE mandates, the traditional international staple investment.
• Interest in U.S. core and core-plus fixed income strategies will drop off materially. Only 60% of
consultants expect moderate or strong search activity for U.S. bonds, which rank 9th overall among
expected mandates for tender.
• Traditional asset classes are expected to experience material manager replacement. More than 50%
of consultants expect more than half of U.S. equity, U.S. fixed income and EAFE equity search activity
to involve manager replacements.
Introduction

Casey Quirk and eVestment Alliance have worked together to produce their fifth annual survey of
investment consultants in the United States and Canada. Conducted in December 2010 and
January 2011, the survey asked investment consultants to forecast investment preferences and
buying behavior among North American institutional investors during 2011.

This year, 55 investment consultants, representing an aggregate $10.4 trillion of assets under
advisement—including 15 of the 20 largest North American consultants—expect slower growth in
the number of searches they will conduct. Nearly half of respondents predict search activity in
2011 will only match 2010 levels, and no one forecast more than a 25% rise in the number of
mandates. By contrast, nearly 90% of 2010 survey participants forecast a rise in search activity,
with 20% calling for a spike of 25% or more. Slowing growth in search activity makes sense, as
institutional investors emerge from the policy rebalancing many conducted during 2010, following
the global financial crisis.

The asset management firms successful in winning mandates during 2011 will continue to offer
product lines and servicing models that embrace three key trends continuing to reshape
institutional investment in North America:

1. A greater emphasis on outcome-oriented portfolios, which investors are using to address

their rising concern regarding inflation and longevity risks; this has led to further use of
commodities, property, and longer-dated investments.

2. The increasing role of heretofore “alternative” investments—hedge funds, private equity

and real estate—which are emerging as the centerpiece of active asset management
moving forward.

3. Ongoing portfolio globalization, and a wider belief that emerging markets require specialist
managers.

These trends reflect the new frameworks with which institutional investors and their consultants
are building portfolios, with exposure defined less by product packaging or home bias, and more
by the specific contributions investments make toward overall objectives.

April 2011 Old Wine in New Bottles 2

Exhibit 1

Emerging Institutional Investment Framework

Legacy Allocation Emerging Allocation

Paradigm* Paradigm*

Hedge Fund Illiquid • Private Equity • Portfolio objectives defined

Alternatives
Allocation Investments • Distressed around outcomes
Liquid Alpha • Global Macro
Private Equity
(Opportunistic) • Market Neutral • Alternatives become centerpiece
Real Estate • Real Estate of active asset management
Real Assets
• Commodites
• Long-Short Equity
• Long-only, long-short, credit
Equity Equity
• Long Only Equity managers compete head-on
for wider mandates
• Long-Short Credit
Credit Credit • Core Plus • Wider focus on real assets and
• High Yield
inflation protection
Cash Cash

Note: Not to scale. Source: Casey Quirk.

These new portfolio construction strategies continue to underscore longer-term implications for
fund managers servicing North American institutional investors:

• Managers offering non-correlated investments will realize the most success in winning
mandates.

• Firms offering both “traditional” and “alternative” investments will stand the best chance of
providing institutional clients with a total portfolio solution.

• Product development and innovation will remain critical competitive differentiators.

• Managers using global benchmarks and demonstrating international expertise will benefit most
from broader policy reallocations among larger institutional investors.

• Asset owners and their consultants will keep favoring investment managers with long-term
incentive alignment structures that motivate and retain talent.

April 2011 Old Wine in New Bottles 3

2011 Product Opportunities

Our product opportunity map compares expected search activity for the upcoming year relative to
forecast from the previous year. Consultants continue to believe that longer-term trends in search
activity favoring hedge funds, funds of hedge funds, and non-U.S. equities will keep driving
search activity in 2011. Respondents report that these asset classes remain net beneficiaries of
policy rebalancing, often at the expense of domestic equity, where search activity remains robust,
but fueled mostly by manager replacement rather than new allocations.

Exhibit 2

Most-Sought Asset Classes, North American Investment Consultants, 2008-2011

2008 2009 2010 2011

1 Hedge Funds/Funds of Hedge Funds International/Global Equity International/Global Equity Hedge Funds/Funds of Hedge Funds
2 International/Global Equity Domestic Equity Hedge Funds/Funds of Hedge Funds Emerging Market Equity
2
3 Domestic Equity Core/Core-Plus Fixed Income Emerging Market Equity1 ACWI ex-U.S. Diversified Equity
4 Real Estate Hedge Funds/Funds of Hedge Funds Core/Core-Plus Fixed Income Real Estate
5 Private Equity Real Estate Commodities U.S. Equity
6 Core/Core-Plus Fixed Income High-Yield Fixed Income Domestic Equity Global Equity2
7 LDI/Long Duration Fixed Income Private Equity Long Duration Private Equity
8 Commodities LDI/Long Duration Fixed Income Real Estate Commodities

Notes: 1Added beginning in 2010 2Combined prior to 2010.

Sources: Casey Quirk, eVestment Alliance.

Consultants, however, expect to see three noticeable shifts in search activity during 2011:

1. More demand for unlisted investments, driven by rising inflation and longevity fears among
North American institutional investors. Consultants believe private equity and real estate
search activity will increase substantially, particularly among corporate and public defined
benefit pension plans of all sizes, many of which are struggling to find ways to execute
liability-driven investment strategies.

2. Increasing specialist demand for emerging markets equity and debt. Admittedly, our survey
concluded before February 2011, when popular uprisings in several Arab nations and rising
inflation in Asia cast a pall over emerging markets. Nevertheless, consultants continue to argue
that their clients are underweight developing economies, and given capacity constraints in the
asset class, specialist managers may be best suited to manage EME and EMD mandates.

3. Reduced interest in core and core-plus fixed income mandates. As tactical de-risking runs its
course, and interest rates in the United States remain at a nadir, consultants believe searches
predicated on duration trades will wane. Instead, sophisticated institutional investors will
explore mandates that position credit as an alpha engine, particularly as sovereign default
concerns spread worldwide, from European governments to American municipalities.
Emerging market debt has been a key beneficiary of this trend.

April 2011 Old Wine in New Bottles 4

Exhibit 3

2011 Product Opportunity Map

High
Increasing Hedge Funds/
Search FoHF
2011 Expected Search Activity

Activity Emerging Markets

Equity International
Real Estate Equity
Domestic Equity
Private Equity
Core and Global Equity
Emerging Markets Core+ Commodities
Debt EAFE
Long Duration
HY
Fixed Income

Decreasing
Search
Low Activity

Low High
2010 Expected Search Activity

Note: International equity is ACWI ex-U.S. equity.

Sources: Casey Quirk, eVestment Alliance.

Catalysts for Change: Outcome-Oriented Drivers

Increasingly, investment consultants servicing institutions believe a new framework designed to

create outcomes, rather than built on simple asset allocations, will drive search activity. This means
risk budgeting and return attribution likely will play equal roles in future portfolio construction,
influencing policy reallocations.

Inflation appears to be the most influential factor driving institutional investors to separate portfolios
into return-seeking and risk-mitigation allocations, rather than simple splits between stocks and
bonds. As in 2010, more than 80% of surveyed consultants believe inflation protection will be either
a significant or moderate focus of search activity during 2011; more importantly, more than one-half
of consultants believe search activity related to inflation risk will increase over 2010 levels.

April 2011 Old Wine in New Bottles 5

Exhibit 4

Search Activity by Risk Focus, 2011

Inflation Risk

Emerging Market Risk

Interest Rate Risk (Duration)

Currency Risk

Credit/Spread Risk

Equity Risk

Illiquidity Risk

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Respondents
Significant Increase Moderate Increase Little/No Change
Moderate Decrease Significant Decrease

Sources: Casey Quirk, eVestment Alliance.

Inflation risk drove increased search activity for commodities managers in 2010, as investors sought
real assets. Consultants expect this trend will broaden in 2011 to embrace a wider array of illiquid,
longer-dated asset classes, such as property and private equity, which are more immune to inflating
currencies. Respondents expect search activity in private equity to focus on niche strategies rather
than large buy-out funds.

Such fears are particularly palpable among U.S. corporate defined benefit plans. Nearly all consultants
focused on corporate DB plans expect a significant focus on inflation-related search activity in 2011,
with more than 40% of consultants focused on the corporate sector predicting an increase in
mandates designed to protect portfolios from inflation. This dovetails with the growing interest in
liability-driven investing, in which more than half the consultants focused on corporate pensions
predict an increase during 2011. It also adds fuel to the trend of investment outsourcing: delegating
management of the entire pension plan to a third party able to provide total portfolio management that
anticipates and mitigates inflation and longevity risk. Nearly one-half of the consultants focused on
corporate pensions predict increased interest in investment outsourcing during 2011.

Search Activity Characteristics

Isolating search activity for new allocations, as opposed to searches for replacement managers
on existing mandates, shows the true extent to which “alternatives” are becoming mainstream.
Consultants report that a wide majority of searches for hedge funds, private equity, real estate,
and commodities—usually defined as “alternatives”—continue to represent new mandates,
reflecting a secular shift from benchmark-driven portfolios to less correlated instruments.

April 2011 Old Wine in New Bottles 6

 Exhibit 5

Expected Proportion of Search Activity from Manager Replacement by Asset Class, 2011

Commodities

Real Estate

Private Equity

Emerging Market Debt

Hedge Funds (including Funds of Hedge Funds)

Emerging Market Equity

U.S. High Yield Fixed Income

Global Equity

U.S. Long Duration Fixed Income

Other U.S. Fixed Income

ACWI ex-U.S. Diversified Equity

EAFE Equity

U.S. Core and Core-Plus Fixed Income

U.S. Equity

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Respondents

0-20% 20-40% 40-60% 60-80% 80-100%

Sources: Casey Quirk, eVestment Alliance.

Consultants believe globalization will be another driving force in 2011 search activity. More than
one-third of respondents indicated emerging markets equity would be a significant focus of 2011
mandates, the highest result reported for any asset class. More importantly, while consultants
predicted less search activity for global equity mandates than for ACWI ex-U.S. mandates, most
of the global equity searches reflected new mandates, while ACWI assignments focused more on
manager replacement. The biggest loser remains EAFE, where most of the flagging search
activity appears centered on turnover rather than increasing allocations.

Consultants’ focus on EME and EMD is likely partly cyclical, but also indicates a more secular
shift. Emerging markets currently face capacity constraints, creating fragmentation among
providers. This has encouraged several consultants, particularly those focused on large clients, to
seek out emerging markets specialists who can add value. Moreover, in the long term, most
investors believe emerging markets will represent the majority of equity market capitalization and
a sizable proportion of debt markets worldwide, spurring a shift to more globalized benchmarks
and portfolios.

April 2011 Old Wine in New Bottles 7

Exhibit 6

Expected Investor Preferences, 2011

Pension Consultants
Option A Option B

FoHF Direct HF

FoPE Direct PE

FoRe Direct RE

Fundamental Quantitative

Absolute Return Benchmark Return

Active Passive

-100% -50% 0% 50% 100%

Percentage of Respondents
Strong Preference Option A Strong Preference Option B
Moderate Preference Option A Moderate Preference Option B

E&F Consultants
Option A Option B

FoHF Direct HF

FoPE Direct PE

FoRe Direct RE

Fundamental Quantitative

Absolute Return Benchmark Return

Active Passive

-100% -50% 0% 50% 100%

Percentage of Respondents
Strong Preference Option A Strong Preference Option B
Moderate Preference Option A Moderate Preference Option B

Sources: Casey Quirk, eVestment Alliance.

April 2011 Old Wine in New Bottles 8

Other investor preferences remained largely unchanged from 2010 with two key exceptions:

1. Shifting demands for funds of hedge funds. Consultants focused on larger investors, as well
as those focused on non-profit funds, expect more searches for direct investments in hedge
funds than they did in 2010. This reflects three realities. First, most North American
institutional investors selected a core fund of hedge funds in recent years, and few are yet
convinced they need a change. Second, and more importantly, larger investors now seek
more specialized FOHF strategies in place of, or in addition to, a diversified FOHF mandate.
This challenges many FOHF vendors who do not offer a focused product. Finally, larger
institutional investors—particularly well-funded non-profit funds—still seek to avoid higher
fees and pooled vehicles offered by FOHFs. FOHFs remain core investment vehicles among
smaller pension plans who lack resources to select or access direct hedge fund investments.
Additionally, investors increasingly are using outsourcing firms to provide exposure to a
portfolio of hedge funds.

2. Tentative interest in quantitative investments. Underperformance of quantitative strategies in

recent years has discouraged consultants from recommending such portfolios. The robust
market performance of 2010 seems to have convinced some consultants that more structured
approaches to stockpicking will once again add value. Such responses, however, largely
remain linked to enhanced indexing strategies, and appear to have manifested mostly among
more specialized consultants, especially those focused on non-profit funds. Whether investor
interest in quantitative strategies with higher targeted tracking errors will truly manifest in the
short term remains to be seen, given the headline risk many quantitative strategies incurred
in recent years.

Defined Contribution

Consultants serving corporate clients—the cohort most involved with the shift to defined
contribution plan provision—increasingly have focused on target-date retirement funds, which
the Pension Protection Act of 2006 encourages as default investment options for participants.
Target-date and target-risk funds will attract more than 80% of the new inflows into defined
contribution plans between now and 2020. Consultants are emphasizing passive TDRF vehicles,
as mid-sized plan sponsors seek to rid themselves of manager-selection risk. Respondents expect
substantially less interest in packaged active target-date funds, where many believe the market
has started to consolidate among bundled offers and a few large investment-only providers.

Consultants also expect further search activity regarding customized target-date vehicles. Fears
regarding inflation have convinced a growing number of corporate DC plan sponsors, particularly
those with more than $1 billion under management, to explore creating tailor-made target-date
options that include a broader exposure to real assets than current off-the-shelf funds offer.

Nevertheless, consultants continue to expect significant turnover business from the large, if
shrinking, menu of stand-alone mutual funds within defined contribution plans.

April 2011 Old Wine in New Bottles 9

Exhibit 7

Expected Defined Contribution Search Activity, 2011

Stand-Alone Products

Packaged TDRFs - Passive

Customized TDRFs - Internal

Customized TDRFs - 3rd Party

Stable Value Replacement

New Stable Value Product

Retirement Income

Packaged TDRFs - Active

Target-Risk Funds

Managed Account Providers

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Respondents
High Focus Moderate Focus

Note: Sample only includes consultants focused on corporate pension plans.

Sources: Casey Quirk, eVestment Alliance.

Conclusion

Consultants indicate that asset management firms servicing North American institutional investors
face an increasingly competitive environment for 2011 and beyond. As traditional style boxes and
asset classes, outmoded by the rising emphasis on outcomes, fade away, investment managers
who fail to adapt to changing investment frameworks will suffer from slower growth. Consultants
continue to predict high turnover rates in core asset classes such as domestic equities, core fixed
income, and EAFE stocks, indicating a high level of dissatisfaction with incumbent providers,
most of whom are benchmark-tracking.

Managers able to provide non-correlated portfolios that improve an institutional investor’s excess
return in various and volatile market conditions will win business and improve their long-term
profitability. This means further changes in the league tables of leading institutional asset
managers during the next few years, as new players better positioned to take advantage of shifting
investment policies take business from less nimble firms still wedded to legacy approaches to
portfolio construction.

April 2011 Old Wine in New Bottles 10

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April 2011 Old Wine in New Bottles 11

Old Wine in New Bottles:
2011 Consultant Search Forecast
April 2011

John F. Casey, Chairman

Kevin P. Quirk, Partner
David J. Bauer, Partner
Daniel Celeghin, Partner
Grace L. Cicero, Partner
Jeb B. Doggett, Partner
Yariv Itah, Partner
Benjamin F. Phillips, Partner

Casey, Quirk & Associates provides management consulting services exclusively to

investment management firms. The firm specializes in developing business strategy,
enhancing investment practices, and crafting distribution plans. The firm draws on more
than 40 years of experience in delivering value to its clients and partners through a
unique combination of deep industry knowledge and experience, solutions-oriented
thought leadership, and a proven ability to influence change within organizations. Casey
Quirk publishes a series of thought-leadership papers on topics of interest generated by
ongoing industry research. To discuss these survey findings, please contact:

Yariv Itah Benjamin F. Phillips Philip Kim, CFA

Partner Partner Associate Director
y.itah@caseyquirk.com b.phillips@caseyquirk.com p.kim@caseyquirk.com
203-899-3010 917-476-2140 203-899-3012

Analyst team: Michael D. Chia, Jonathan L. Doolan, Jason D. Roche

Casey, Quirk & Associates

17 Old King’s Highway South
Darien, CT 06820
www.caseyquirk.com

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Built on the industry's most complete database, eVestment's flexible analytics and custom
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eVestment's diverse clients include leading investment consultants, asset managers, plan
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For more information, please visit www.evestment.com or contact us directly.