Our panel of asset management experts discuss a range of industry issues from a European perspective, including how to get the public saving more, and where funds sit in relation to cash savings.
Martyn Gilbey (head of business development – UK, Aberdeen Asset Management)
Richard Phillipson (director of institutional consulting, Investit)
Robin Stoakley (director of intermediary, Schroders)
Regis Martin (deputy CEO, Unigestion)
Funds Europe: With 0% savings rates in cash and money market funds, should the fund management industry be more successful at gaining inflows than it is?
Richard Phillipson, Investit: Savings as a proportion of GDP in Europe are holding up. In Germany, savings rates are over 20% and in Switzerland they are 26%, for example, though less strong in Spain and Greece.
The question is, though, why would anyone want to buy funds at the moment? With uncertainty about interest rates, I’m amazed at the continued enthusiasm for bond funds when the last published TER on European bond funds was over 1%. I’m not certain that it is still a good time to be buying them – or a good time for the industry to be selling them.
And equities? Well, if the equity risk premium is about 3%, say, yet your TER is 1.7%, then there is all the fun of equity volatility for the difference between 1.7% and 3%.
With an excess return of 1.3% and 15% long-term average volatility, I think people would prefer a cash fund – which is what Broadridge FundFlash tells us the French have been buying.
Martyn Gilbey, Aberdeen: In 2016, investors have withdrawn over $200 billion from active equities. Clearly confidence levels are shaky, volatility is higher, and geopolitical risk has a greater impact on investor confidence. Assuming a significant portion of this $200 billion has moved into cash, the figure puts into real perspective the challenge that the funds industry has to grow its business.
Robin Stoakley, Schroders: European cross-border market sales in October, net of e-business, showed six of the seven biggest-selling categories were bonds. The biggest-selling category was emerging markets equity, which I find interesting. If that isn’t a barbell approach, I don’t know what is! The mutual fund industry and the investment industry does very well when customers have a high tolerance of risk. At the moment, with Brexit, with economic uncertainty, with Donald Trump, there’s a very low tolerance and, therefore, people are going to keep investments in very safe assets, such as cash and bank accounts. Until people become more comfortable taking risk, that won’t change.
Regis Martin, Unigestion: There are megatrends in savings. With ageing populations and the rise of the middle classes in developing countries, the cake will become larger and larger with or without good performance. It’s simply a statement of fact that assets under management are growing on a yearly basis and the industry will have to face the challenge of how to invest all this money in order to pay the level of pensions that governments can’t afford to pay. People will realise as they look at their pension forecasts that they are not going to get the income they wished for and they will have to save in addition.
Stoakley: I don’t think this situation is going to evolve without compulsion, not when one in five 35-year-olds today are going to live to 100. The issue is that most people can’t afford to, or choose not to afford to.
Phillipson: Auto-enrolment has started in the UK, so we can begin to build towards the right numbers. Contributions are not high enough at the moment. In Australia, enrolment is compulsory, contribution rates are 9.5% now and will be up to 12% in 2025. But isn’t it a problem – with regards savings and investment rates in funds – that so much distribution is through banks, certainly in Europe? The banks have needed to strengthen balance sheets in recent years and it did not make sense to them to sell funds.
Gilbey: The moment the fund industry tries to compete with cash as a product, then that’s the next mis-selling scandal waiting to happen. The challenge for the fund industry is to position itself relative to cash in the context of long-term savings for people, irrespective of whether they’re going to buy retail products themselves, or whether they’re investing through a pension plan.
The industry needs to make itself far less daunting and more accessible than it currently is for most people and remember that this positioning needs to be promoting the benefits of investing alongside saving.
Martin: I can tell you from a continental Europe point of view that people do not get any more return for saving money rather than investing in funds – not when interest rates are permanently 0% or even negative.
I’m from Switzerland; we have minus 0.75% interest rates on cash accounts for most institutions, meaning people are paying to keep their cash at the bank. When people have to do that, their mindset changes and they realise they need to do something to compensate.
In France, people won’t buy money market funds any longer and banks themselves do not want to issue them – not with negative returns, which are bad for their reputation. Or some banks may try to add some kind of junk or illiquid underlying investments to their money market fund to boost return– but that will end in catastrophe in case of a liquidity mismatch.
So at the end of the day, it’s just not an option to buy a money market fund now, or to put cash on account. That’s what very low/negative rates are doing in continental Europe.
Phillipson: But there is still the question of whether people will pay the charges and commissions they have to pay on funds.
Gilbey: As long as they have a long-term horizon and believe that they’ll make returns that beat cash, they will. Also, at the product level in the UK, the government is starting to move in the right direction by making ISAs more flexible and I think these types of vehicles could become more attractive to millennials, compared to traditional pension products. Technology will be a critical enabler in this market.
Funds Europe: Is MiFID II – the updated Markets in Financial Instruments Directive – already impacting the distribution landscape in Europe, a year ahead of its introduction? How are distributors and asset managers changing?
Stoakley: The FCA interim market study of asset management had an awful lot of MiFID II running through it: product governance, know-your-market, distributors providing more management information on target market to product providers and product managers – which is woefully inadequate at the moment – and clear cost disclosures, absolutely. Clearly MiFID II is having a major impact and will continue to do so.
Gilbey: However, in the UK we’ve been there for some time. Asset managers started the conversation with distributors a while ago about target market information and how MiFID II is going to impact us. Distributors of all types are generally up to speed with the issues and we’re reasonably advanced. We’ve certainly got there with the inducements aspects of MiFID II.
Phillipson: I’m aware of a case where a Spanish distribution unit was begging an asset manager not to drop prices too far because it would make it entirely clear how much ‘fat’ there had been in the system previously. So that is difficult. I mean, from the point of view of the relationship between distributors and asset managers, how many distributors are asset managers going to cut from their lists in order to be able to understand their clients better?
Stoakley: The UK model is highly intermediated and very different to mainland Europe, where there is a rather small number of very large distributors, so I would say in Europe, lists will not be cut as much as in the UK. However, in the UK virtually all our small company client business is routed through platforms.
Gilbey: Across Europe, there will be fewer distributors that fund managers will want to do business with, based in part on operational efficiencies. As a result, consumer choice could become an issue for regulators, who presumably will want to see a reasonable spread of market participants.
Stoakley: The flipside is also true, that distributors may partner with fewer asset managers, and what does that mean for customer choice and good consumer outcomes?
Martin: What worries me is the pressure put on both the distributor and the asset manager to document everything related to the sale of a financial instrument – that is suitability and appropriateness. All of this will require some infrastructure, processes and systems in place and small distributors will not be able to afford such an upgrade. This will increase the cost of doing business, and end investors will have to pay for that, thus affecting their returns.
Phillipson: Regulators might be surprised if they looked at the scope inside businesses for firms to deal with these changes. Firms can have quite complicated businesses and still be fairly profitable. We are aware of firms with margins of 80%. I wouldn’t cry too hard for the industry!
Martin: Fair enough, but we may have to cry for the end investor. The industry does not want to reduce margins. There is not a lot of competition at this stage, especially among big distributors and large asset managers. The barriers to entry in this business are so high that there is no need for large players to jeopardise themselves.
Phillipson: Would you worry that a small Swiss quantitative investment manager would be able to create a product that was demonstrably better than average and find the backing?
Martin: The issue is the distribution; it’s about who is able to place the product to clients, and unfortunately it’s nothing to do with the talent of the asset manager. So a small to mid-size asset manager may hook some institutional clients – but accessing large distributors’ networks? This is a quite another challenge.
Funds Europe: Do you recognise an increased focus on alternative investments and how can regulated products adapt to meet this appetite?
Gilbey: Alternatives represent significant and growing allocations in most portfolios. An important question is one of access: many investors, including large institutional investors, prefer to access their alternative exposure via regulated products and jurisdictions.
The direction of travel for global regulation is that if you’re not in a highly regulated, internationally recognised jurisdiction, it’s very difficult for you to get distribution.
Martin: Institutions are recognising they will have no other choice, because large fixed income or balanced allocations may have been very successful in the past, but won’t be able to generate the returns necessary to match their liabilities. What is interesting with new liquid alternative investments is they are far cheaper than the illiquids were. So it’s not about the ‘two in 20’ hedge funds or private equity; it’s about 50-60 basis points for alternative premia funds, or for dynamic asset allocation funds which are not so expensive compared to what they can generate in returns.
Stoakley: Absolutely right. What it boils down to is different ways of managing existing types of assets. For example, in terms of smart beta, the underlying investments are largely still the same – equities and bonds. Also, many alternatives strategies are based on manager skill, as in the long-only world. If a long/short manager gets either the long or short side wrong, you have an issue rather like with a long-only manager underperforming and picking the wrong stock. But with alternatives, investors want genuine alternative investing, which might be aircraft leasing or infrastructure. A problem, though, is liquidity demand from distributors.
Gilbey: In a world where investment risk shifts from employers to individuals, the role of multi-asset providers becomes very important. With more demand for assets, there are capacity issues, and a role for multi-asset providers being able to genuinely provide access for retail investors, irrespective of savings vehicle, becomes really important.
Stoakley: There is definitely a focus on liquidity. What advisers need to do is make sure the customer understands exactly what the risks are. I spend a lot of time saying to people that if they can afford the time, then take more risk. It might be quite a bumpy ride, but you will get to where you want to be. A lot of people, particularly in the pension field, are probably not taking enough risk.
Gilbey: Demand for infrastructure seems to be outstripping supply, an issue exacerbated by how long it takes to get allocated money and invested. There is a lot more work to do in industry and in government to figure out how to speed up the life-cycle or the access point at which investors can get exposure. Supply should not be provided through daily priced, unitised funds. This is a highly illiquid asset class and one retail investors can access via multi-asset funds.
Phillipson: A real estate fund I’m aware of, and which takes you at least three months to get out of after you’ve given a month’s notice, barely wriggled in the recent property fund suspensions. Investors could be taught that investing in less liquid funds would be a much less bad journey than investing in funds with supposed daily liquidity.
Funds Europe: What impact do you expect Brexit to have on the development of the funds industry across Europe?
Phillipson: Brexit is, frankly, the least of the industry’s problems. Running businesses properly would be much more valuable than thinking too hard about what being a third country is going to look like in five years’ time. So, yes, firms have to think about it, but it’s probably not the item furthest up their lists. What they really need is the infrastructure and cost base to run funds at half the price they charge retail clients now. Most of our clients already have enough footprint in Luxembourg or Dublin so don’t need to be desperately excited about it.
Gilbey: There was an initial perceived risk of regulation arbitrage entailing firms having to deal with different regulatory regimes and directions of travel. But given the FCA’s role in shaping MiFID II and the globalisation of regulation, I suspect the impact of Brexit in the short term will be minimal for the development of the industry across Europe.
Martin: Brexit has been great news for Ireland and Luxembourg as it’s one competitor less. They will win new business without even asking. They will be pleased to front the management of UK fund managers, and delegate investment management to them.
But I doubt there will be a lot of investment managers moving to Luxembourg or to Ireland. Luxembourg and Ireland should retain their core services, which are risk management and fund company management. But that’s it. The key competencies of asset management I expect will remain in the UK.
Phillipson: We saw this with hedge funds. They all promised they were going to leave the UK and move to Zug.
Martin: I can say from experience in Switzerland that even a tough Brexit may well not cause much damage for the UK asset management industry. UK firms will only need some sort of footprint in the EU to comply with the Ucits and AIFMD cross-border regulations.
Funds Europe: Do you expect to see more consolidation in the industry?
Martin: There will be more consolidation in passive management because that business is about scale and distribution. In active management, it’s about people, which makes these firms very difficult to merge. Quite often, through mergers, there’s more destruction of value than creation of it, even if there are benefits through synergies.
Phillipson: There are huge swathes in the industry that are deeply mediocre and would not be missed. Whether that goes on to become passive, quant or skilful active, I don’t think it matters.
Gilbey: Acquiring and absorbing assets is often a simpler process than merging people and cultures. Distribution reach can make consolidation attractive. I recall trying to assist sub-$100 million hedge funds in Asia with distribution. Clever strategies run by clever people but lacking distribution. For them, one option is to access distribution by way of consolidation.
Stoakely: As costs increase, there’s no question we will see more mergers. They will be about synergies in the sense that putting together two $200 billion businesses to get a $400 billion business, and taking €300 million out of the cost base, will keep a business going another ten years.
Phillipson: We benchmark firms to help them understand where they are effective and where they aren’t profitable. So we can see opportunities. For instance, one firm could take over the fixed income business of another and both would be much better off without having lost either firm.
Stoakley: Our GAIA platform uses third-party hedge fund managers and we launch Ucits hedge funds for them. These are funds that haven’t necessarily got distribution already and it works fantastically well for both parties. I can foresee a world where firms with established distribution, like ours, could easily start doing more third-party distribution for managers who haven’t got that capability. And it probably suits the buyers, too, because they get access to firms they wouldn’t otherwise get, with the comfort that a well-known firm like Schroders is carrying out due diligence. And for us, we get to distribute products with a margin and without the cost of fund management.
Martin: It is a great strategy, as firms can diversify their clients and diversify revenue streams by asset classes. Combining manufacturers with distribution is a strong model – but as we are acknowledging, quite often this is fantastic on the paper, but at the implementation level, it proves to be difficult.
Gilbey: A challenge is that the parent companies of bank or insurance-owned asset managers are less inclined to sell them because asset managers provide a nice diversifier for their balance sheets and an annuitised income.
Funds Europe: What aspect of the industry would you most change if you could?
Martin: Discrepancies between jurisdictions and their consequences for market access. It cannot be explained why we have a different regulator for each jurisdiction and no level playing field on a worldwide basis. It would be better if there were one regulator, one set of rules, and full market access so that fund management firms could concentrate on the most important thing, which is generating returns for investors. Manco [management company] in one country, portfolio management in another, and differing tax treatments in the middle, these are all just distractions which come with a high cost to the investor.
Phillipson: I would elect for better business management, which will allow better pricing and better investment and savings outcomes for clients. The FCA asked firms that it was going to look at for its Asset Management Market Study for some fairly basic management information. Granted, some of what the FCA asked for was against the grain of how firms think, but the difficulty firms had in explaining their businesses was extraordinary. Few firms can say how profitable their products or clients are. But when the totality is so profitable, who cares about the detail?
Stoakley: In the UK and, I suspect, in Europe and other parts of the world, there is a major time bomb due to greater longevity and a lack of savings culture, coupled with states that can’t afford to look after individuals in retirement.
The industry has been woeful at getting its act together to provide some form of meaningful voice, to tell the world and their customers to save and why they should be saving. People should be saving more and saving earlier. I would like to see the industry become effective as a voice to promote the idea of saving or investing.
Gilbey: For me it’s the question of continuing to build confidence in the industry and trust in financial services more generally, with the result that our customers are happy to save and invest more. As a part of that, we need simplification of language, of product, and of regulation: improved transparency. The FCA market study is clearly taking us in that direction.
©2016 funds europe