|Massimo Tosato, vice chairman, Schroders
From a fund management corporate perspective, is the crisis unfolding worse or better than expected? Are you more or less optimistic now about the business outlook until the end of 2009 than you were in December 2008, and why?
As far as the markets are concerned, the levels reached in early March are probably the lowest that we will see in the current crisis. However, the industrial and macro economic consequences of the crisis will probably last another couple of years and the recovery will be very gradual.
From a corporate perspective, last year, if we consider negative flows and market declines, the value of assets under management in Europe fell more than €1.3 trillion and this is the key driver of lower revenues for our industry in 2009. Excluding money market funds the European industry has lost €395 billion - that is more in absolute and relative value than anywhere else in the world. Within the EU though, the UK, which has a different investment culture and different distribution channels, remained steadier.
Our industry outlook is moderately positive. Pushed by the extremely low interest rate levels, we anticipate a ‘step by step’ increase in risk appetite over the next 24 months.
In the first four months of this year, we have seen a very strong shift in the first level of trade-off between risk and return with strong demand for investment grade corporate bond funds of which Schroders has been the major beneficiary across Europe.
Looking ahead, in the second half of 2009, we see a move towards hybrid products like convertibles or protected equities, before any return to equities as investor confidence slowly recovers.
How do you feel the reputation of fund managers has been affected in the eyes of institutional clients and retail investors?
The current crisis has created the most challenging market environment that the global asset management industry, but particularly in Continental Europe, has ever encountered.
Whilst we did not help trigger the crisis, the impact has been significant and has raised questions about the structure of the industry along the entire value chain and whether we can provide the best investment outcome for clients.
Investor confidence has been lost and reputations impacted as risks have not been properly understood, managed or controlled.
In addition, in the eyes of the general public and politicians, our industry has not been good at differentiating itself or explaining its positive role to society and the wider economy. We are bundled together with investment banks, hedge funds, private equity managers and all the other participants in the financial services industry as a single group to blame.
To rebuild this trust, there are several steps that the industry must take, including better communication, investment into proper investor education, and an overall improvement in the manufacturing and distribution of better and cheaper products.
Are product development and pricing reflecting changes in the financial and economic environment? How do you see this evolving?
The problems outlined above are structural in their nature. If the industry is to regain the trust of investors, getting product development right is crucial. For many years, the industry has sold thematic products.. It is so much easier to sell ‘fashion’ as opposed to solutions.
We want to meet the evolution of customers’ needs offering multi-asset solutions – a 360 degree approach to managing wealth throughout their lives. In particular, in the decumulation space, we could partner with the insurance industry to develop retirement products that benefit from our combined strength and investors’ need for guarantees.
In terms of pricing, we undoubtedly need to manufacture and distribute cheaper products. The average fund size in Europe is €117 million versus the average fund size in America of €855 million. UCITS IV will be very relevant in increasing the fund size and operational efficiency on a pan-European scale.
Reducing total expense ratios (TERs) by 30 to 50 basis points can have a major impact on net customer returns over 20 years. We also need to work towards establishing a code of conduct, involving all market participants. Within those, let us not forget about the role and remuneration of the credit rating agencies. Banking or Independent distributors have a key role in the game (the majority of the totoal costs in many cases), bringing further cost efficiencies to the end investors.
How do you view regulatory developments so far and how would you like to see regulations change? Will regulatory developments help create a more level ‘playing field’ between fund products and bank products?
It is quite easy to understand the political pressure that is leading to increased regulation for hedge funds and private equity in recent months - a ‘something must be done’ approach. Regulating the manager, as well as the products would be the right approach. We are in favour of proper, simple and well designed regulation. It’s critical in ensuring a level playing field in both manufacturing and distribution in the long only space as well.
There are many different products that achieve a similar result of managing long-term savings – mutual funds, life insurance, structural bonds and notes. Yet, their rules and controls are completely different and managed by different regulators. Think about the life insurance products or the structural bonds.
Given that they all have the same end objective; I am very much in favour of a draft, regulatory proposal that unifies control and monitoring.
How do you perceive risk management to be changing, if at all, in fund management? Are balance sheets and minimum regulatory capital requirements more important for fund managers now than they were before?
As a component of the investment management process, risk management is very much in demand. From a regulatory standpoint, however, currently there are differences in approach between EU Member States.
There will be change as regulators take a more harmonised view to risk management, which we generally welcome. As a result of the crisis, two risks – liquidity and counterparty risk - have focused the minds of investors and regulators alike, and both must be an integral part of any risk management framework.
On balance sheet strength, I cannot possible comment, as you know Schroders is in quite a unique position!
The Turner Review in the UK wishes to see risk officers occupying a more visible place at the forefront of investment firms. How do you feel about this? Will the CRO be a main board appointment in the future?
The Turner Review looks at risk management alongside good governance. We will need to reflect on the outcome of the government-commissioned review of governance by Sir David Walker later this year, in tandem with the issues the FSA raises in its discussion paper on risk management.
That said, we support the proposals so far. At Schroders, our organisational structure provides clear accountabilities for risk management. Our Chief Financial Officer, a main Board appointment, has responsibility for monitoring our overall risk framework.
Has remuneration of senior fund management executives been affected by the bonus controversy within the banks? How do you see executive and manager remuneration changing?
First of all, remuneration has been dramatically affected by the collapse on profitability.
This is one area where the incapability of the industry to differentiate itself from the other players could have a negative consequence. There is a very relevant difference between a pure asset management business which is an agency business, from an investment bank or commercial bank, where the manager commits the capital of the institution in principal risk. Having said that, in the UK, the initial guidance issued by the FSA in relation to compensation practices provides an indication of how remuneration will need to be structured in the future – long term performance will be the key driver.
As far as Schroders is concerned, a large component of remuneration has always been in deferred bonuses, locked-up for the longer-term, mainly in shares in the company or investments in our managed funds. So bonuses have always been linked to the long-term performance of the organisation and the money that it manages.
How do you see the players in the industry and the landscape changing in the future? Is there more scope for M&A going forward or will development be through organic growth?
The current crisis has led a number of banks and insurance companies to conduct a strategic review of their operations, to identify non-core operations for disposal. As a result, a number of companies are up for sale, and it is evident that there are more sellers than buyers in our industry these days.
An additional complication is that a significant number of the companies that are for sale are owned by commercial banking entities. As such, their evaluation is rather difficult. You don’t buy the client ownership; you only lease the clients which remain in the ownership of the branch network. To evaluate this revenue stream is not an easy exercise.
From the seller’s perspective, raising tier 1 ratios is going to be a main driver in the transaction market, but from the buyer’s viewpoint, now it’s all about asset consolidation strategies.
In the current M&A activity how will clients’ interests be balanced with shareholders’ interests?
The excess of manufacturing capacity and the production costs that are too high are affecting both company profitability and total expense ratios. An industry consolidation process is therefore beneficial to both customer and shareholders.
Do you anticipate any changes to distribution structures? Will banks still want to sell funds and will distributors be as supportive of mutual fund products in the future as they have been in past years?
I believe that the current Continental European distribution model is not really working. There is an intrinsic conflict of interest between manufacturing and distribution. The industry is also missing the dominant presence of long-term saving plans that are promoted or facilitated by a supportive taxation regime.
Changing or evolving the distribution channels is a long term challenge – it will take many years, it’s not a matter of months.
Firstly, we expect to see an increase in fee-based versus commission-based income. There needs to be a better economic alignment between manufacturing, distribution and the end client.
Secondly, there is a real need to encourage the urgent introduction of regular saving plans. This could include mandatory schemes or automatic enrolments, unless the employee states otherwise. Regular monthly savings, harmonised tax incentives, a minimum holding period and portability are crucial to its success.
Promoting the growth of independent distributors could be very beneficial.
Finally, we can also see a positive, with the continued development of electronic platforms. As their use increases, so does the level of information transparency available to the end saver.
©2009 funds europe
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