Since the summer of 2007, banks have suffered significant losses as a result of one of the biggest crises ever to hit the financial services sector, the so-called credit crisis. So far, banks have been the focus of attention as bearing the brunt of the credit crisis impact. But what of the fund management sector? This report asks how fund managers have been affected by the credit crisis – and what strategies they are adopting in response.
Some of the key findings withinthe report include:

• Investors do not have the same enthusiasm for complex instruments as fund managers. Increasing complexity defines the fund management industry today. This survey of fund management and investment professionals reveals that 57 percent of mainstream fund management firms use derivatives in their portfolios. The figure is even higher within large mainstream fund management firms: nearly one-third of those with assets of at least US$10billion use derivatives to a major extent. Even more fund managers (61 percent) now manage hedge fund strategies, which in many instances are complex. The survey also found that half of mainstream fund management firms manage private equity strategies, nearly half manage asset-backed securities and more than one-third manage collateralized debt obligations (CDOs). Fund managers still believe that with the exception of CDOs, all the above strategies and asset classes will rise over the next two years. On the other hand, 70 percent of the investors who answered the survey say that the credit crisis has reduced their appetite for complex products
• Trust in fund managers has fallen as a result of the credit crisis. Fund management firms have suffered a degree of fallout from the credit crisis, although nothing nearly as severe as the banking sector. Well over half of mainstream fund managers say investment returns have fallen and about the same proportion report falling subscriptions. But the damage potentially goes further than short-term losses in funds: six out of ten respondents believe trust in fund managers has been eroded due to the effects of the credit crisis.
• Lack of skills and experience isa key concern. There is evidence, in the light of the credit crisis, that some aspects of fund management require urgent attention. The skill sets of staff, for instance, have to some degree failed to keep up with growing sophistication. One in five fund managers that have invested in complex financial instruments, such as derivatives, CDOs or structured products, admit to having no in-house specialists with relevant experience. Investors are at greater risk still, with about one in three of the institutions investing in such instruments saying they have no in-house expertise of these. Rating agencies are seen as providing little support: one third of the respondents agree that rating agencies provide an accurate assessment of whether an instrument will default and just 1 percent of respondents think rating agencies are very accurate in predicting defaults.
• Risk management, valuation methods and governance structures are all being shaken up. There is a widespread feeling that fund management firms need to re-evaluate what kind of business they are conducting and the risks they are running. Four out of ten firms surveyed for this report say they have already formalized risk frameworks in the past two years as a result of managing more complex strategies, with a similar number planning to do so over the coming two years. Valuation methods have come under intense scrutiny during the credit crisis and a third of firms have reviewed this activity, while a further third will do so in the next two years. An even higher proportion, 38 percent of respondents, have reviewed governance arrangements – particularly relevant in the cases of funds that used risky instruments to enhance returns on supposedly low volatility funds – and a further quarter will do so in the next two years.
• Making fund management successful in the future requires a renewed focus on the client proposition. The credit crisis will sharpen the minds of fund managers: in a time of increasing uncertainty and investor conservatism, they need to demonstrate their added-value proposition. The concern is that investors will reject further innovation, particularly if it involves complex strategies and instruments. As mentioned previously, 70 percent of investors say the credit crisis has reduced their appetite for complex products. The fund management industry will need to prove the doubters wrong by developing products and services that perform well over the cycle and in changing economic environments. All-weather strategies, lifestyle funds, insightful asset allocation advice and sound risk management and governance practices are all likely to be at a premium in the coming months and years.