|Richard Wohanka, Fortis Investment Management
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?
The fund management industry did take a severe hit last year, one only has to look at the jump in cost income ratios to see that. But there have only been a handful of high profile casualties and no real scandals outside of Madoff, indicating that it's a pretty sound industry and especially when compared to other areas within financial services. Obviously any fall in the markets eats straight into the bottom line, so 2009 has been a little bit better for many firms, and we are also beginning to see a return of retail clients as banks stop offering very high deposit rates. Institutional buyers have been a bit slower to take on risk again but they too are coming back into the market. Really, asset managers should see this year as an opportunity: this is the time to go back to clients who had been working with investment banks and show them how we can help them achieve those same goals but in a more enduring relationship; as a number of banks pull out of the asset management business as a core activity there will be more "captive" networks opening up; alpha is back and talent is cheap. But our challenge is to persuade those investors who are staying on the sidelines to come back to the markets, by finding the right opportunities for them and marketing them effectively.
How do you feel the reputation of fund managers has been affected in the eyes of institutional clients and retail investors?
In my view, fund management has lost some credibility over the last 18 months. One has to differentiate between retail and institutional clients. We are experiencing different reactions from different client segments and geographies, however, so my remarks may be too general.
For institutional clients in general, active management has become a serious but disappointing topic. In difficult markets clients expect their asset managers to add value and outperform. This has not been the case for many asset managers who did not seem to anticipate the magnitude of the credit freeze and the market collapse in late 2008. Even hedge funds disappointed with negative returns (although clients seem to have forgotten that they did not promise to provide positive returns all the time).
Scandals such as Madoff have tarnished the industry. One of our team members in Canada teaches in a Trustee Development Program and he reports that a lack of trust was palpable as far back as last October. The trustees in the room were quite open, albeit polite, about their own feelings that they could no longer believe what investment managers told them.
Clients will be more cautious about our industry’s promises. They will look more carefully before appointing a new manager. The historical diversification approach will also be challenged.
So all in all, a mixed view with disappointment on one hand due to underperformance but there is also openness for solutions in the risk and strategic part of the investment management business.
Are product development and pricing reflecting changes in the financial and economic environment? How do you see this evolving?
The financial crisis enhanced the already-existing trend of clients demanding more transparency and simplicity. This applies both to product development (products should be understandable regarding their risk exposure) and pricing (products should be transparent in terms of the different types of fees that are applied). We think this demand is here to stay for the coming years as investors will focus on risk management. Price sensitivity, in combination with scepticism about the benefits of active management, is also reflected in the strong growth of index trackers and other passive products.
Fear and lack of direction have also created renewed demand for the development of guaranteed products.
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?
Lord Turner (the Chairman of the FSA) has said there will now be more intensive supervision of the banks and a more intrusive approach from the regulators. What is clear is that regulators will become more attuned to the concept of liquidity within retail funds balanced against the flexibility of the product.
On the other hand, UCITS IV introduces “master-feeder” structures allowing a UCITS (feeder) to be (fully) invested in another UCITS (master). This allows UCITS to have increased economies of scale and lower operational costs and makes the framework more attractive for the creation of funds for institutional investors.
So one can envisage a situation where there is more flexibility for the creation and marketing of the product yet a return to old-fashioned investment instruments within the product itself. Bank-structured products will be seen by regulators as more opaque and therefore more likely to be the subject of more intense regulatory oversight.
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?
Risk management will rely much less on models, although models remain useful. Qualitative and judgemental assessments will be necessary in each area of risk: market (investment), credit and operational risk, for example.
The issue of regulatory capital requirements is complex but at the same time has revealed itself to be too simplistic in some areas. Capital requirements and management should be seen as a useful and efficient tool to ensure the sustainability of the asset management industry. However, it must be efficiently aligned with the realities of business and the market environment.
By simplifying the process of calculating capital and at the same time using sensible computations the process will be useful and will therefore be used; otherwise it will remain a useless burden distracting risk managers from the real and important activities of risk management.
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?
In parts of the financial industry, risk management was already represented on companies’ boards. However, this did not prevent the crisis for a number of reasons: the lack of “true” independence, regular overruling on the basis of the growth and profitability argument, and last but not least company management being unwilling to wait for a thorough analysis of new products and businesses by risk management and operational departments.
Commercial considerations should not drive a financial institution without a real and effective input from empowered and independent risk management, operations and systems departments. So yes, risk management should be represented at a high level but it should also have a presence at other levels in the company - especially where decisions about new businesses and products are involved - and it should have power of veto if necessary. This will only be possible if the status of the so-called support functions, which have always been considered less important than the front office, improves.
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?
The remuneration of senior fund management executives has inevitably been affected by the bonus controversy within the banks, as scrutiny of compensation in financial services increases. At Fortis Investments, we have always delivered part of the compensation to our senior executives in long-term awards rather than cash. This year, we delivered a greater percentage of senior executive compensation in long-term awards.
In asset management, compensation is generally based on multi-year performance rather than short-term gains. Therefore, I do not think we will need major changes to our compensation arrangements. We are, however, providing our feedback to the FSA and other bodies on proposed regulatory changes to ensure that compensation structures reward our people for performance and do not encourage inappropriate risk-taking. I expect that investment banks will need to make more significant changes than fund managers will. However, we will all need to ensure that we can clearly demonstrate how considerations of risk are incorporated into our compensation decision-making and award processes.
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?
2008 was a very challenging year for the fund management industry, with revenues down sharply (by 20-40% according to Oliver Wyman) due to the combined effect of falling markets (meaning lower AUM for equity products) and clients shifting to lower-margin products or bank deposits.
The financial crisis will drive industry consolidation in asset management. We expect that a significant share of NOP growth in the coming years will come from consolidation and synergies.
Different kinds of asset manager are suffering from the crisis. As well as independent asset managers (both traditional and specialised), asset managers that form part of large financial groups are suffering from their clients moving their assets to bank deposits. Some of these are now making losses, pushing financial groups to consider selling or merging their asset management activities.
Given the turmoil in the industry, there will be opportunities to acquire asset managers at a distressed price. An alternative to acquisitions will be to establish joint ventures with other asset managers.
Consolidators will need to be well capitalised to make acquisitions. On top of this, asset managers with a global unified operating platform will have a big advantage in generating synergies and quickly integrating the acquired companies.
Acquisition targets during the consolidation process will typically have:
There have also been signs in recent weeks that organic growth could be making a comeback in the asset management industry:
Successful asset managers place clients at the heart of their organisation.
During the consolidation process, asset managers that do not put clients’ interests at the heart of their integration process will lose assets (especially those of the acquired entity).
The following elements need to be carefully managed during integrations in order to retain customers:
If carried out properly, a consolidation can generate benefits for both clients and shareholders. Clients benefit from better investment teams and a wider product range, while shareholders benefit from synergies.
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?
Changes in distribution have been relatively modest in recent years. Despite the huge number of people using the internet the proportion of mutual fund transactions taking place online is still surprisingly small. Apparently, most consumers still regard advisors as a vital part of the process of buying and selling mutual funds.
With interest rates coming down fast, banks' appetite to sell investment products will pick up. Mutual funds are well positioned to benefit from this due to their wide reach, relatively low cost and the wide range of risk-return profiles they offer.
On top of this the growing impact of regulatory institutions and regulations, such as MiFID, will be a stimulus for banks to sell funds instead of direct lines.
On the one hand, some banks could redirect their sales to the products of their in-house asset manager, as this can create a sense of "safety" that selling third-party products that might involve serious risks (e.g. Madoff) does not provide. On the other hand, banks might create more distance between themselves and their in-house asset manager, as this area of business, which used to be regarded as relatively risk-free, has suffered from the liabilities and reputational damage that have been caused over the past year.
As a consequence of the trend of increasing transparency and simplicity, banks will require their fund suppliers to intensify their support, including written material and training. Fortis Investments has a long tradition of supporting its distributors and is keen to increase co-operation with them in this respect further.
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