November 2010

CEOs: united we stand (extract 2)

roundtable_410In this second extract from FE's CEO roundtable discussion, panellists focus on risks that asset management CEOs must have uppermost in their minds       7_CEO_roundtable1  (Todd Ruppert, Eric Helderlé, Hendrik du Toit, Pierre Servant, Robert Parker, Elizabeth Corley, Jean-Baptiste de Franssu) Funds Europe: The Senate committee that grilled BP’s CEO was amazed to learn that he had not been aware of certain risks inherent in particular drilling operations. His defence was that a CEO could not know every single risk an organisation faces at every moment. What would the panel say are the three main risks – except performance – that asset management CEOs should have in the forefront of their minds, and how should they be controlled? Pierre Servant (Natixis): Reputation. Our business is about confidence and trust and if you have a serious reputational accident, you have an enormous problem from which it’s very often difficult to recover.

To try to prevent this you need compliance, risk management and client service. Client services remained important even during the crisis when we weren’t selling much.
The other element is talent retention. If you don’t attract and retain talent, you are dead in this business. And it’s not only a question of compensation; you need to create a good place to work in, which is not easy.

My other worry is bureaucracy that comes when you grow and become a large organisation. Our business is a people business; to make it work efficiently, you need a lean organisation, a quick decision process and an understandable strategy, specifically in a multi- boutique organisation, which is rather complex. We need to keep this at the forefront of our priorities. Elizabeth Corley (Allianz GI): Pierre has highlighted the long-term and permanent risks we all have to manage as CEOs, and I agree with all of them. We’ve also got some risks, which are derived from the situation we are in now as an industry, which are hopefully temporary but nevertheless sit alongside the ones Pierre spoke about.

There is a risk of overregulation and poor regulation. There is also a risk that the value of the Ucits brand is not preserved and not  respected as very precious by the industry. The active management of the Ucits brand is really important.

Furthermore, we are a markets business, our revenues are capital-market sensitive. The industry is also running revenue risks as a result of increased volatility and the interest rate outlook, particularly given how much of the asset base in continental Europe is in fixed income as opposed to equity. So the contagion of capital markets into our revenue model is something that is unique to where we are in the current market cycle. Robert Parker (Credit Suisse): If you look at who’s been successful and who’s had problems in the asset management industry, over recent years, there are some similar characteristics among firms that have problems. The first is poor balance sheet management. A classic example was the failure in London of New Star. Why did New Star fail? It failed because it put massive leverage onto its balance sheet. In the asset management industry, management of the balance sheet and how the debt is put on that balance sheet is critical. The answer is to put very little debt on your balance sheet.

Another thing to consider is where we are going to have accidents over the next two to three years. It’s going to be those private equity guys who over-leveraged in 2007 at the top of the market. The financial crisis is not over but it’s shifted. We are going to have pockets of problems, and the private equity industry is going to be one of them. Over at least the next three years when a lot of this refinancing comes up it isn’t going to get refinanced.

Another example, which is very relevant to certain firms in London at the moment, is where you have concentrated risk in your business on one or two individuals – a ‘key man’ risk. If those guys either leave or they have a performance accident or a regulatory problem, your business gets damaged and that comes back to the point about reputation. As Pierre said, it takes a long time to build reputation, but it takes a very short time to ruin one. Todd Ruppert (T Rowe Price): All of these points are extraordinarily valid, so let’s just keep piling them on; there are several other things that can put a business at risk. One is that there is some poorly conceived and executed M&A activity that takes place within the industry. Parker: The question is, does M&A add value in the asset management industry? Ruppert: No. If you look historically there are very few that did that. Parker: It’s tough to prove. Servant: In a merger, it’s the industrial project that brings value not the financial structure; since we know our business better than most intermediaries, it’s best to take care of it ourselves. Corley: If you’ve got an agreed merger you can get value. Parker: I would say there are only two models in our industry where acquisition activities work: AGI [Allianz Global Investors], and The Bank of New York Mellon. Funds Europe: Eric, for a boutique like Carmignac going through a period of dramatic growth, what are the risks for somebody in your situation? Eric Helderlé (Carmignac): I agree with the points that have been raised and I would add that we are all facing concentration risks in the future. Product concentration is a risk found in many asset management firms. We have seen it in the past and if you have a major concentration in one asset class and something happens, there is problem. Asset managers need diversified sales of their products.

Another issue is the concentration of clients. If you have a small number of clients who own most of your funds then you are at risk. Also concentration around one type of client could breed risk.

So all types of concentration are dangerous. Products and clients are the issues we will be looking at very closely, and which we want to address. Also, the market is telling us that human resources are key to attracting capacity and clients. This is why we shouldn’t go to excess in terms of regulation in Europe. On the other side of the Atlantic it’s not as strict as here. Parker: You made a very good point in asking that question, which nobody’s picked up on: The chairman of BP came from Ericsson and his experience was in the technology and telecommunications industry. He went before Congress to answer questions about the oil and energy industry, but actually he has very little knowledge of the energy industry. On the contrary, in asset management you have firms that are managed and run by long-term people who’ve grown up in the asset management business and this is a point I feel very strongly about. These are the firms that tend to thrive. Asset management firms that are taken over by investment bankers or people outside the industry don’t do so well, or sometimes fail. It’s the same with the banks. Hendrik du Toit (Investec): We understand our equivalent of oil wells a hell of a lot better than the BP chairman and this is for one simple reason: our businesses tend to be smaller, flatter and more simple than that particular example you mentioned. This is the complete opposite of the experience you had in the banking industry. The 50-somethings on the boards had no idea what the 30-somethings were doing. In our business one of our key risks going forward is that as we search for product relevance, we do not stray into areas of excessive complexity. I can see that risk on the horizon as clients demand more specialist tasks to be done by the asset manager. As they add more load onto the task of the fund manager, they’re taking away some of the simplicity and we will have to resist that if we want to run good, long-term businesses. Servant: Yes, I agree with Hendrik, complexity is rising; for example, investment managers are using more off-balance-sheet or structured products, which have risks
that can  be difficult to assess under severe stress scenarios. Ruppert: You have to find the intersection between what it is that you do really well, and client demand. There are client demands out there that you might not be good at fulfilling and you shouldn’t try to go after them. Trying to maximise short-term profits by growing assets under management, by doing certain things that are outside of your skill set, is a problem in the industry. Jean-Baptiste de Franssu (invesco): Product quality is the most important quest we have. This is not just about absolute performance or relative performance; product quality is many other things. If you are engaged to do something and you are not good at it or it's just the latest trend, it can lead to all sorts of issues.

One example relates to the number of share classes some funds have nowadays. Some funds can end up having 30 share classes. Can you imagine what an accounting error might mean? The complexity of managing something like this is incredible. I was told some of the major players in Europe today run in the thousands of share classes in their entire Ucits range. Parker: You’re killing your profitability and you’re significantly increasing your operational risk. Corley: Another longstanding risk to the industry is that the shared infrastructure is very poor. We have very few utility functions in Europe. We are looking at an outlook of reduced margins, reduced returns for our clients, but our cost infrastructure, whether it’s the distribution costs, operating costs, and regulatory costs on top of that, is not getting any simpler. We are not getting operational gearing and we’re not getting the simplicity of operations into our business.

Efama has tried to get standards accepted and we’ve tried to get Swift messaging and all these key things in place, but the industry singularly fails. The proportion of fax deals that still run through this industry is a scandal, and the people responsible for that are all of us and all our equivalents outside this room. But in a world of lower returns and higher mandatory costs ahead, we absolutely have to focus on the industry infrastructure. Servant: The number of funds is a key issue. We have to try to limit the number of funds to maintain our profitability. Every day a so-called new product comes along and you end up managing hundreds of funds with different share classes. Its costly to manage, the funds are not big enough, you have operational issues because of the funds proliferation, and so on. This is one of the problems in the industry. Corley: We’ve closed or merged 200 funds in the last twelve months and we’ve retained a huge proportion of the assets. Clients and advisers actually appreciate the simpler offer. Parker: Closing redundant, inefficient, unprofitable funds is actually an important aspect of product development. Du Toit: The challenge we have here is also with the regulator to create an environment where [closing and merging funds] is seen as something that happens in the normal course of business. If you look at the fundamental construction of a mutual fund, it is not really that easy to close funds because the owners are your distributed clients. To reference what Elizabeth said, industry infrastructure is a non-competitive part of our business. If we join forces, we can reduce costs significantly and we can still compete on the part where clients want us to compete, which is performance, service, and our ability to innovate. Corley: Regarding product proliferation, we all know that in July next year when Ucits IV goes live, merging and closing funds becomes more difficult because you have to get the vote of the fund receiving the merger, which is typically the larger fund, so we’ve got a window of opportunity until then. Parker: Yes, and that’s a very good example of where regulatory interference is bad for the customer and bad for us. Corley: Broadly, Ucits IV was a good piece of regulation. But that one article within the regulation is going to get in the way of industry simplification. It was unintentional and I don’t think anybody spotted it at the time, but now it’s getting closer and closer we’re all realising that this is actually a huge amount of work that we would have to do. ©2010 funds europe

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