Asset Management Outlook 2018

Portfolio Construction and Concentration

• Rick Lakai (State Street) argues that long-term returns are driven by risk premiums and structural opportunities rather than daily trade signals.
• State Street advocates for a portfolio design that separates factor-based (smart beta) investing from concentrated active management to avoid "mixing and matching" strategies inappropriately.
• The Brown Endowment maintains a concentrated portfolio with approximately 33% in the top 10 positions and 54% in the top 20 positions to balance capital preservation with growth.
• Daniel Lopez Cruz (Invesco) notes that the fundamental law of active management dictates that deeper information sets justify higher portfolio concentration, whereas broad knowledge warrants wider diversification.
• State Street targets a return of approximately 300 basis points over public equities for private equity allocations, though rising capital inflows create concerns about future return delivery.

US Banking and Regulatory Arbitrage

• Neil Wilson (EJF) identifies a "jugular play" in small US regional banks driven by the May bipartisan Regulatory Relief Act, which recalibrates Dodd-Frank rules to encourage consolidation.
• The US banking landscape features 5,200 banks (down from 10,000 ten years prior), with 100 in the UK, creating a consolidation narrative where the Federal Reserve actively desires fewer, larger institutions.
• Small banks are critical to US infrastructure, representing over 40% of all construction and development lending.
• Valuation metrics for small banks (under $10 billion in assets) currently trade at 1.5x to 1.6x tangible equity, offering an equity entry point for consolidation plays.
• A debt-side opportunity exists in buying legacy LIBOR-floating debt at a discount while banks issue fixed-rate subordinated debt (5-6%) to retire floating obligations following the regulatory relief.
• Wilson asserts the banking system remains safe, citing tier one risk ratios of 15% and tangible common equity exceeding 10% for large banks, with smaller banks being even stronger.

Private Equity: Supply, Demand, and Returns

• Pension funds remain the largest provider of private equity capital but face a widening funding gap, increasing from $1.5 trillion (20% of liabilities) in 2007 to $3.8 trillion (30% of liabilities) in 2017.
• Invesco reports that approximately 30% of private equity fundraising is now captured by the top 20 funds, signaling significant market consolidation.
• Lopez Cruz warns that while top funds currently deploy $12–$14 billion, raising $20–$25 billion within a standard five-year investment period will likely make consistent alpha generation (3-4% over public markets) extremely difficult.
• Lopez Cruz maintains that private equity will continue to outperform public equities by 3–5 percentage points due to structural drivers: an illiquidity premium and higher leverage (4–6x vs. 2x in public markets).
• Rick Lakai highlights that the "implied fee" in private equity (management fees plus carried interest) is substantially higher than the negligible fees in index funds, requiring extraordinary operational improvements to justify returns.
• Lopez Cruz estimates that roughly 15–20% of LPs currently co-invest, though many express interest in doing so; this number is expected to grow as institutions seek fee reduction.
• A new trend involves "separate managed accounts" where large institutions negotiate tailored deals with lower fees (cutting the standard 2/20 model) in exchange for larger, direct capital commitments.
• State Street recommends maintaining a secondary strategy to provide liquidity options and tactical deployment flexibility for investors dealing with underperforming or closed funds.

Emerging Markets and Geopolitics

• Lopez Cruz recommends an institutional allocation of 5% to 10% in China within the emerging market portfolio, citing geopolitical risks and potential capital controls as limiting factors.
• Invesco deployed $150 million into a pre-IPO Chinese technology portfolio two months ago despite ongoing US-China trade tensions, betting on the country's long-term market size and economic rotation toward consumers.
• Lopez Cruz anticipates Southeast Asia (specifically Vietnam) and India as major beneficiaries if US trade wars force Chinese manufacturing to relocate their final production stages.
• Rick Lakai views emerging markets as a long-term value opportunity but remains underweight in the short term pending a resolution to US trade and tariff disputes.
• Neil Wilson identifies the US Opportunity Zone program (10-year capital gains deferral and exemption) as the most significant "social impact investing" vehicle, creating tax incentives for private capital deployment in underserved areas like Oakland and Savannah, Georgia.

ESG, Technology, and Cybersecurity

• State Street treats ESG factors as integral to risk control and return generation, noting a global divergence where Europe embraces mandates while the US relies on market-driven governance.
• Neil Wilson argues that mandatory diversity mandates (e.g., board quotas) could accelerate social impact outcomes, similar to the effect of Title IX on college sports funding.
• Daniel Lopez Cruz states that Invesco focuses on low-capital-intensity sectors (business services, technology) while avoiding cyclical industrials due to current high valuation multiples (10x EBITDA) and leverage.
• Neil Wilson highlights a systemic risk in the leveraged loan market, noting that 75% of loans in 2017 were "covenant-light" compared to 30% in 2007, exacerbated by quantitative tightening.
• Lopez Cruz notes that financial institutions are spending heavily on cybersecurity, with some managers investing up to $100 million annually in data and security infrastructure.
• Neil Wilson observes that technology consolidation is partly driven by the Federal Reserve's desire to reduce the number of banks from 5,000 to 2,000 to mitigate cybersecurity risks in smaller institutions.

ETFs and Liquidity Risks

• Rick Lakai states that regulators have been satisfied with the safety mechanisms of the ETF industry, which offer built-in liquidity valves unlike mutual funds, though ETFs can facilitate investor herding.
• State Street is cautious about launching transient thematic ETFs (such as cybersecurity) unless they represent a substantial, enduring return story for investors.
• Neil Wilson emphasizes that the ETF mechanism relies on a heterogeneous investor base to function correctly as a self-regulating system during market stress.