CEO Roundtable Part 4
: in this final extract from FE's CEO roundtable, the panel considers the impact of ETFs, consolidation and boutiques on the competitive landscape
(Todd Ruppert, Eric Helderlé, Hendrik du Toit, Pierre Servant, Robert Parker, Elizabeth Corley, Jean-Baptiste de Franssu)
Funds Europe: should the growth of ETFs be of concern to the active fund management industry?
Hendrik du Toit:
The outlook for growth in our industry is very good and the fact that ETFs are growing hand over fist shouldn’t bother us at all.
It is not a problem. I see it as an advantage because before ETFs came into the picture, mutual funds were used for a huge amount of short-term trading which destroys investment funds for the long-term investor. Therefore, so long as ETFs take out the frothy, short-term trading from traditional funds, it’s actually really good for the long-term underlying investment return.
We were in a situation before where we were spotting trading patterns, not for money laundering reasons, but for performance impact reasons, and we were forced to hold cash against these trading patterns, which was just not appropriate. Now you can actually invest much better because a lot of that froth has been taken out by ETFs.
We can also use ETFs in our multi-asset product. But we are finding that ETFs are much more challenging than they appear and I would warn every retail investor to do a proper study before buying an ETF. It doesn’t necessarily do what it says on the tin and it’s not necessarily cheap.
Another financial accident waiting to happen is these increasingly obscure ETFs that have been introduced. There’s not going to be a problem with an ETF on the S&P 500, but some very obscure ETFs are being introduced, for example ETFs against a basket of private equity funds and these can be dangerous.
Private equity, to a degree, is totally illiquid for a five- to ten-year period, but ETFs are provided with minute-by-minute liquidity. How do you price that? Things like this are an accident waiting to happen. So that’s going to be the scandal of 2011.
: More and more active investors are becoming interested in ETFs but also investment managers who use ETFs as a wrapper, as a different way to sell their expertise, like a 40 act mutual fund or a Ucits fund.
The key thing with ETFs is to not do what hedge funds did and create a fundamental mismatch between assets and liabilities. As long as it’s a highly liquid ETF and it can be priced every five minutes, then it’s perfect. But do not try and bring complicated, highly sophisticated, long-term alpha products into a daily trader format.
One fundamental point in our industry is the matching of asset liquidity with the liquidity of the liability. It’s not surprising that one of the most stupid parts of our industry, which is the German real estate fund industry, has got itself into such a mess. There you had long-term illiquid assets that, in some cases, were provided to investors within liquid mutual funds. This was a complete mismatch, so it’s no surprise it got itself into a total mess.
Again, this is where we need to have a clear dialogue with regulators. If you look at the key investor information [required to be published in Ucits fund literature] and at the standardisation of risk warnings, the number-one risk on people’s minds is capital risk.
But there have been two other risks: the liquidity mismatch and the yield risk. Those are the more complicated risks to explain, but poorly managed they can also destroy value in the long run.
So telling the retail investor what the key risks are sounds simple, but it is much more complex than one would imagine. Nevertheless, the real danger of overpricing the capital risk and under-pricing the yield risk and the liquidity risk is still really huge at the moment, despite the lessons of the crisis.
Another issue around risk is to do with difficult-to-value securities. Commodities, large-cap equities, government bonds, investment grade corporate bonds – these are very easy to price. But let’s say portfolio managers got into not just CDOs, but also less opaque securities that are difficult to price, then there will be a problem with producing a portfolio valuation for the client.
If a client happens to be a mutual fund and the client sells, is the manager actually providing that client with the right redemption price if there are assets in the portfolio that can’t be priced properly?
Jean-Baptiste de Franssu:
Another issue we have is in our relationships with investors. Consider money market funds. It is just two years since US money market funds ‘broke the buck’ in September 2008, yet in Europe we already have enhanced money market funds coming back to market.
Yes, but they are not called money market funds anymore.
They are not called enhanced money market funds, so at least the label doesn't give the wrong impression about what they are trying to achieve. But they are still mostly used as cash vehicle. And there are still fundamental investment issues behind those types of products. I wonder what it will take for investors to understand they should not play with fire. Here again there are liquidity mismatches.
There is also an issue around risk management. In our industry we can supply a slightly superior yield on a short-term fixed income fund, which is entirely liquid and reasonable, but just of lower quality. We explain that it is of lower quality and explain the risk, that’s fine, but problems start when you allow the fund manager or the team to go into areas that are just that bit too dangerous. We haven’t learnt the lessons from 2008 – that our risk management functions have to be stronger.
Ruppert: It comes down to how it’s sold.
We are much more careful about the way those products are sold, I think everybody is now.
There’s a comedian in the United States by the name of Steven Wright who comes up with great one-liners and he said something that’s pertinent to this discussion. He said: “I think I’m having amnesia and déjà vu at the same time. I think I’ve forgotten this before.”
Funds Europe: Against the backdrop of consolidation and the formation of specialist boutiques, how do you see the competitive landscape changing?
Consultants are out there all the time pontificating about which model is better. A number of years ago the multi-asset boutique was great, but then there were situations where the weaker ones and even the stronger ones had difficulties. Then the argument became that the specialist boutique was better because it was more focused and very well aligned. Yet there have been a number of boutiques that have had difficulties because they could not sustain their business through the financial crisis.
Any structure in the industry can always be debated. The fundamental questions are whether you deliver what you say you’re going to deliver and do what is expected. Also you need to ask yourself whether you’re putting the clients’ interests first in the way you conduct your business. If you’re doing that, then no matter what your structure is, you’re going to do okay. Ours is an industry that you can get into with very little capital, and if you do what you say you’re going to do, and if you’re honest and you put the client’s interest first, you’re going to be okay.Servant:
There is a movement towards consolidation as polarisation takes place between specialists with targeted clients and products on one side, and the larger generalist type of actors on the other.
It is going to be difficult to remain a middle player offering a full range of products for all types of clients including institutional investors when the cost of doing business is increasing and fees are lower. Performance is key in our business but scale is also an issue, and we will see pressure to consolidate among the very small players, who have a hard life today on a standalone basis, and for large players because the cost of doing their business will go up.
Despite what I have just said, I recognise that boutiques with distinctive expertise can do very well and that consolidation projects can really be very destructive if poorly designed or executed.
But don’t you think it’s difficult to generalise? For example there are a whole series of interacting changes going on in our industry. Hedge funds are morphing into long-only managers, for example. I was working with a firm earlier this week that used to be a hedge fund and now their business is 90% long only!
Yes, and long only managers are becoming hedge funds.
Indeed, you’ve got long-only managers that are now becoming hedge funds. Another group that’s morphing are the boutiques. I was working with another firm earlier in the week that used to be a boutique. They’ve been a successful boutique and now have assets under management of £40bn [€44.7] so they’re not boutique anymore. You also have a problem with the boutiques that aren’t growing.
Due to regulatory cost, if you ran a business, which had £100m in assets under management ten years ago, then you were probably okay. You would be making a little bit of money. Now I get calls from firms saying they’re stalling at 200m to 300m and they’re not making money, so they’ve either got to close down or sell the business. So that barrier to entry is rising.
One important thing that is coming through as a result of concentration is that some global actors are choosing to focus solely on distribution and move away from manufacturing products. This opens the door to let more open architecture in, particularly in highly concentrated countries. If you have some major actors stepping out of the manufacturing industry, it will provide breathing space. The networks will, at some point, be forced to sell what’s best for the clients and, mostly, that product or solution will no longer be supplied by the parent company.Servant:
You may well be right Eric, but this will put pressure on fees. It will be difficult for asset managers that are not big enough, unless they are specialised and have unique skills that can make the difference. But for the more general type of actors providing a global range of expertise, there is still the scale issue if they want to maintain their development efforts.
I understand there’s a minimum fighting weight if you want to serve more than one market, but I just don’t buy the scale argument at all.
If I look at operating margins of some of the very largest players in the market, they’re below the 30% range. Obviously, one-product boutiques are going to go into the 70% range, but there are a whole lot of businesses operating with operating margins between 30% and 50% who have between $50bn [€35.6bn] and $150bn in assets. They are not huge businesses, but they’re very comfortable with what they do and they’ve actually succeeded in continuing to move ahead of the commoditisation curve, which is a real challenge. They have been able to find markets and if you can’t find markets today you won’t survive.
So rather than just looking at scale, a management firm should look at what business it wants to do, what scale it wants to be, and what it needs to achieve that. There isn’t a single answer that is relevant to the whole asset management industry.
I agree, but I do think that market shares are shifting fast, and they’re not shifting only through M&A activities. Rather, they’re shifting through product quality, service quality. It’s about being really good at what you do and the assets flow to it. That’s what’s really happening.
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