Elizabeth Corley (Allianz Global Investors), Charlie Porter (Thames River),
Jon Little (BNY Mellon Asset Management), Jean-François Boulier (Aviva Investors) Fiona Rintoul (Funds Europe, chair): The funds industry is going to see a lot of change in the coming year as major finance houses dispose of non-core assets and businesses. This is likely to lead to both consolidation and fragmentation within the industry. How do you see the landscape changing?
Richard Wohanka (Fortis Investments): There will be consolidation because most asset management companies let costs drift upwards in line with revenues. This means they will suffer the consequences of poorly managing their costs in relation to income over the last five years.
But I think consolidation will be less than people expect. The prices people will want to pay will not be those at which the banks will want to sell. Although there are many businesses on the block, actually none of them are getting transacted.
Todd Ruppert (T. Rowe Price): When a lot of people talk about consolidation, it’s all about size. I don’t think that size determines success. It comes down to business excellence. What is interesting is that there are those who have said balance sheet doesn’t really matter to an asset management company. Well, it doesn’t matter until it matters – and those firms that have a good balance sheet right now will be in a good position. I do agree with the idea that large financial services firms that have an asset management operation embedded within them might want to generate the higher multiple by selling, but there are not a lot of buyers right now.
Charlie Porter (Thames River): We talk about consolidation at the end of every cycle. It’s toughest for those businesses that are pure equity players, given that the market is down 35% and redemptions are at 35%. One of the big things to consider is the convergence between traditional managers and hedge funds. Over the last couple of years we’ve seen the traditional players trying to enter the hedge fund business because it has been a very lucrative business. But now the hedge funds that do actually survive want to enter the long-only space. The Ucits III vehicle will probably be the vehicle of choice.
The best targets
Funds Europe: Elizabeth, what do you think will define management firms as either acquirers or as targets for a takeover?
Elizabeth Corley (Allianz Global Investors): Market shares are changing more dramatically now than at any time in the last five years. You can see real winners and real losers, from those firms who are experiencing net inflows, to those seeing radical outflows. So consolidation isn’t just about acquisition. The whole question of how you run your asset management company is at the heart of this and knowing what you want to do with it. It’s not about trying to be everything to everyone; it’s about really focusing on where you’ll add value to your clients. You’ve got to be able to give your asset managers independence and really focus on delivering what clients want.
Jean-François Boulier, (Aviva Investors): Before the crisis we knew that there were too many firms in Europe. Consolidation in products, one way or another, will occur and this will probably bring cost advantages to the industry. The turmoil will be a trigger for that consolidation, but the turmoil is also a good way to see who are the real investors in this marketplace.
We will certainly see a big difference between the product sellers and the product managers. We feel this is an opportunity to show that being a long-term investor is beneficial and just because the markets are depressed, it is not the time to sell. So firms that are committed to their clients and face the current difficulties with them because they know there are better times ahead and because they are experienced enough to overcome these difficulties will probably be stronger after the crisis.
Funds Europe: You’re a newly launched entity and I know you will plan to acquire other businesses. Do you look at this as a good buying opportunity?
JFB: We think there will be opportunities, but it depends on price. First you need to make sure that the other firm is a close enough fit with your business so that it represents an addition to it and not a new venture, and then as an investor you have to think about the price.
Funds Europe: Jon, you’re part of a large firm with many facets. Do you see that as an advantage or a disadvantage in this environment?
Jon Little (BNY Mellon): We see it as an advantage. A slightly glib answer to the question about what will define the acquirers from the acquirees is that, in the short term, the issue is whether they have any money. It may sound silly but if you think about the deals done over the last two years, they were debt finance or private equity finance. A lot of that finance is disappearing from the market rapidly and there are people left trying to survive. There are a very small number of firms, and happily we are one of them, that can pay for any acquisitions with the cash they have in their balance sheet.
To reference Richard’s point, the prices that are paid are going to be a lot lower than the people that are selling them want and the deals that get done will get done, certainly in the next year and a half to two years, at very low prices.
Massimo Tosato (Schroders):
On a daily basis, there are companies being offered for sale. There are a very large number of commercial bank subsidiaries that at the moment may be looking for a new home. There are also quality boutiques looking for a new home. The reasons for both are totally different.
In the first case, the reasons are the necessity of liquidity in the balance sheet of the commercial bank organisation and the desire to break the close relationship between manufacturing and distribution because in many countries you are starting to have regulatory pressure.
For boutiques it’s more of a matter of survivor’s credibility. They are looking for institutions that will let them stay very independent but also that will give them an image of solidity and strength to be able to get through this crisis in case it continues for a long time.
We are also seeing a huge volume of activity in the alternatives sector. More than performance, what is relevant today is the capability to process liquidity, to undertake due diligence, and to be transparent. All this has managerial cost. A lot of the small entities that are unable to provide this will start to see huge consolidation – for example, the hedge fund industry. There is an estimate that as assets decline from €2 trillion to €1.2 trillion in the next six months, the number of players might decline as well by three to four thousand, down to six thousand players in total.
CP: I think Massimo is absolutely right. For a lot of the boutique shops there is a suspicion that they are going to need more regulatory capital over time. There is a belief that some of us are a little surprised at how little capital is required to run some substantial amounts of money. So there is the issue of access to ownership, a decent balance sheet, and kudos. Kudos is also very important now because brand is becoming so much more important for the boutique end of the market.
The other key thing is access to seed money. Seed money has all but dried up at the moment, so if you want to go out and seed ten new products with half a billion, it is so much more difficult than it was six to twelve months ago.
Benefiting the retail investor
Funds Europe: What are the key measures that need to be taken by the industry to ensure that European retail investors can benefit from greater transparency, competition between savings products, quality advice and access to investment education?
JFB: This is a very broad question and I would like to comment on three aspects. The first is the transparency of competing savings products. This is a necessity. We should have some common denominator on market valuation, for example. Maybe at least quarterly valuations – even for products that are on the balance sheet.
The other element in this question is about education. Education is really an effort we should pay attention to and probably invest more in. In Continental Europe finance knowledge must be improved to enable a sound buying of mutual funds, so I think we should bring more help to this. There have been many efforts in this area but certainly more has to be done.
This argument goes for us as well. As we say in France, it is always good to use the broom before the house. It’s necessary that we keep the level of expertise inside the industry at the appropriate level so that the sophistication in some products is well understood across the industry: by regulators, and inside the house between fund managers and marketers. This way we know the risks that we take and we also know the benefits of products without being too reliant on marketing material. Being trendy has probably been a benefit but I think this is really time to go back, not to school, but to getting the right knowledge level into the industry to fulfil our basic business.
MT: There are two aspects that might appear against our short-term interest as an industry but actually favour us in the long term. The first relates to product transparency in terms of pricing. We can collectively improve consistency in explaining total expense ratios and by including the cost of distribution and having a much more transparent way of representing that to a customer. For example, we know very well that at the current interest rates, fixed income and money markets are too expensive, and that the cost of distribution in Europe and in Asia compared to the US is too high.
The second aspect is the communication and marketing of product design. It’s obviously much easier for any manufacturer in any business to sell a story or a brand than to sell a benefit, but actually I think that in the clients’ interest we need to move towards selling a benefit rather than a story. This is a different approach to a sales model, which I think is extremely relevant.
Lastly, on the regulatory side, I feel there is not a level playing field in respect of all the vehicles or products that can be offered. Banking products, notes and bonds subject to the security regulations, insurance products and Ucits, they are all competing for the same space. Some of them are short-term, others are in long-term, but unless we achieve a completely level playing field from a tax and transparency point of view I don’t think that the customer will be fully protected.
Funds Europe: Elizabeth, do you think we are any closer to achieving a level playing field?
EC: I had hoped that MiFID would speed up the shift to equivalent regulation for equivalent products. There is little evidence of whether that’s really happening or not. The awareness among regulators and policy makers of the need for equivalence is definitely significantly better but this is more of an issue now than it was two years ago. We want to enable people and their advisors to make good quality decisions. If we have ideas, whether it’s on transparency, on fees, on risk, we in the asset management industry should be volunteering these ideas in anticipation of the fact that once supervisors and policy makers have addressed the major crisis issues they will return to how we make sure the retail investor gets the right deal.
It’s about advisor education as well. Ultimately, 90% of mutual funds and retail products are sold via an advisor of some sort and I think we can play a much bigger role in that, as we do in the US with our distribution partners there. We don’t do the same in Europe. That is a gap where we could be providing professional education and support to the advisors that clients rely on.
Funds Europe: Todd, from a US perspective, do you agree?
TR: Take a look at the profound change that occurred in the US market – that is the huge development of the independent financial advisor market back in the early 90s. A lot of the individuals that got into that business were coming out of the wire houses on the heels of the problems in the 1990-1991 recession. We’re at a point now, with many individuals in the wire houses losing their jobs, that has all the makings of what could be the development of a greater financial adviser market here in Europe, which is fee based.
The fee-based approach clearly enhances transparency and takes away some of the short-termism of products that might be sold by a large financial house. But it’s going to be difficult. In the US it took off because the banks were not the largest purveyors of products, but Europe is a very bank-dominated selling environment and whether they’ll permit or allow the independent advisors to get in, I don’t know.
RW: When it comes to education, what we tended to do with clients was to show them a graph that illustrates risk and return rather than focus on liquidity. This whole aspect is something that requires education. It is crucial today because in the past you got no value for illiquidity, while today you have phenomenal value for illiquidity.
We also never really focused on whether clients should hold a product or asset for three years or five. Consequently, in the panic that has occurred, there have been a lot of sales by retail investors of stuff that they are probably selling at the wrong time because they had not read the education material when it was published. So in our work going forward we will certainly tell our customer that if they buy a product, it genuinely is something that should be held for X years. In the meantime there may be volatility in it because it is a bit more risky, but don’t sell it in a moment of crisis.
JL: People still don’t really understand well enough the decisions they make. I wonder whether they make better decisions when they have more at stake. People care a lot about their mortgage, except maybe some in the sub-prime area. But most of them care about the rate and the conditions of their mortgage. People seem to make savings decisions from a position where they don’t really understand what they’re doing and don’t seem to spend a lot of time trying to. For example, there are a number of different reasons why the long-term investor would invest in equities, but many see it as a gambling decision. They see bonds as an income decision and they see cash as somewhere safe to stash their money. If we had more encouragement through the tax system, people would begin to see amounts of money build up that they cared about.
TR: I don’t want to presuppose that America is better but I do think the introduction of 401(K) 25 years ago and the requirement for education enabled us to build education tools. Some have worked and some haven’t, but I think it’s an important differentiator. In the US, over two-thirds, maybe three-quarters, of all long-term mutual fund assets are in some sort of retirement saving vehicle.
MT: In Europe there is a huge opportunity in the post-retirement market, potentially dominated by the insurance business, but this does not need to be the case. The mutual fund can have a fantastic role both as a component provider as well as a solution in itself.
JL: A worry is that the regulations around saving are actually more complex than those around taking out a credit card, and that must be more damaging to an individual. Taking on more debt is easier than it is to save.
Funds Europe: Rating agencies have in the past been used to benchmark and rate securities. However, the events of recent months show these ratings to be unreliable. This has raised many questions about whether the agencies are truly independent given that they are rating their own clients. How do you feel the rating agencies can deal with the issues of transparency and risk?
RW: I’m not trying to absolve the rating agencies of all blame. I do however think that you need to be careful not to tarnish them completely due to their failures in one area. They rate the ultimate ability of the borrower to repay the debt; they don’t rate the price stability of that instrument during the life of that instrument. So I think perhaps we should have a bit more balance towards them. How can we improve the situation? You need more transparency in the ratings process. This can be done by either having investors have more access to the models, or having some form of investor participation – not in the rating itself, more in some sort of committee participation that reviews rating agency processes.
MT: What would you think if we proposed that the agency service was paid for by the buy-side industry, rather than being paid by the issuing side?
RW: I think it’s a brilliant idea. If the industry could come up with some sort of sponsorship to that effect I think it would be brilliant.
CP: It’s a great idea. I think the costing of it would be quite interesting.
MT: It’s the model that you have to rethink. I was trying to think of a way in which you could cut any conflict of interest at the origin.
JFB: We are in charge of managing wealth for our clients so there’s no escaping the fact that we need the expertise and product knowledge. We also need to ensure that we will get the necessary information and we cannot delegate that to anybody else. It is our responsibility to construct portfolios that will be diversified enough, using assets we understand for which we balance the advantage with the risk in case of stress.
Certainly, a number of rating agencies will deliver some information to help take that decision, but it would be very dangerous to let rating agencies take the decision instead of portfolio managers. I think we should resist being obliged to buy some sort of credit product rated by somebody else that would lead us to forget to do our own work.
Funds Europe: To move on to a question about hedge funds. Hedge funds have seen a hard time over the last six months. What do you think the future will hold for the sector?
CP: I think that the hedge fund community is being used as something of a scapegoat for many of the world’s worries, which is not right. I think a lot of hedge funds have actually performed pretty well this year. The average hedge fund of funds is down 10% and compared to equity markets that’s not a bad result. There certainly has been an asset-liability timing mismatch within the hedge fund industry and that’s because these are violent and unprecedented times. The liquidity arrangements that were arranged ten or 15 years ago for some of these funds are just not appropriate within these markets. The level of redemptions has been extremely high over the past month. Morgan Stanley predicted that the industry will fall by 45% over the coming twelve months to a level of €1.3 trillion. Hedge funds are a part of the landscape going forward. There are a number of hedge funds skills that will be used by traditional fund managers to hopefully create better products for clients in the future.
TR: I don’t agree with you that they’ve been made a scapegoat. I do agree that hedge funds are here to stay. But a lot of the individuals and institutions that went into hedge funds over the last five years went in for uncorrelated returns or alpha, or both. That has not been delivered. It comes down to talent, but I think it was made so easy that the mere words ‘hedge fund’ had these connotations of grandeur making many people jump into the business. They weren’t sold or purchased properly.
MT: The attraction to the industry itself was based on the pricing model and that is now completely bust. I believe the institutional investor will have a much more influential role in the hedge industry going forward.
Under pressure from the institutional investor the pricing model is really going to change. It’s going to move towards being charged on the alpha production. Also, the time horizon in which it’s calculated and paid out will change. This will change the cost revenue structure of the hedge fund model and in a way it will become more similar to other parts of the industry and less attractive to any young guy with two years of experience wanting to make a hundred million dollars next month.
RW: What I think has happened to make the plight of hedge funds worse than it needs to be, is that most hedge funds operate on the concept of a mean reversion. Gradually, as more and more money came in there was increased pressure for them to increase their liquidity for their customers. So you got higher demands for liquidity until you ended up with monthly liquidity, sometimes even weekly. When you’ve got a dislocation, like we’ve had now, the mean reversion cannot work. In fact, it goes the other way. To meet the liquidity requirements, they had to sell the assets that were cheap and buy the stuff that was expensive. Therefore I think a lot of hedge funds will go bust. There will be tremendous consolidation but afterwards they will come back into
a world with opportunities to make money like we haven’t had since 2002.
EC: This is a shakeout that will be unnecessarily painful for some investors, but I think it is necessary for growing up – it is a proper maturing of an industry which could be very exciting within twelve to 18 months.
Funds Europe: Where do you think we’ll be five years from now?
RW: I am not as universally gloomy as everyone else is. We will have some consolidation, as we mentioned before and bonuses will be down etc. But the industry is here for the long run. We’ll learn our lessons, go through another cycle and five years from now we’ll probably be sitting round the table having lots of champagne and celebrating new assets under management!
TR: I’d say the future isn’t what it used to be. Let me liken it to a drug addict. For a drug addict, the problem is the addiction. In order to be cured, the drug addict has to go through withdrawal symptoms, but we all know that the addiction is the problem. What I think we’ve had as a global society is an addiction to debt and leverage. We’re now going through withdrawals but we’re treating them as the problem and not really attacking the debt issue.
RW: But you cannot take an addict off drugs just like that – you need to gradually wean him off and I think in that regard, the governmental response has been pretty accurate.
TR: I totally agree. My point is that we are never going to get the debt addiction down to zero. There will always be debt, but I think this weaning-off process is going to take a little bit longer.
JFB: I think we’re facing a lot of adversity right now, but I’d like to see that as opportunities. First we need to be close to our clients because their wealth is diminishing so we have to help them not to sell in such a depressed situation. But then we should look at the future with optimism. This is not the end of the world. So we need to build up our expertise in areas where there will be more need: for example, the liquidity aspect that has been at the heart of the crisis. It is something that will help design new products and new solutions for our clients based on long-term approaches. Participants:
- Fiona Rintoul, Funds Europe (chair)
- Jean-François Boulier, CIO, Aviva Investors (France)
- Elizabeth Corley, CEO, Allianz Global Investors Europe
- Jon Little, vice chairman, BNY Mellon Asset Management
- Charlie Porter, CEO, Thames River
- Todd Ruppert, president & CEO, T. Rowe Price Global Investment Services
- Massimo Tosato, vice chairman, Schroders
- Richard Wohanka, CEO, Fortis Investments