As fund flows surge, our expert panel discusses the drivers for sales and how distribution is changing under regulatory pressure and consumer trends.
Richard Garland (head of global advisor, Investec asset management)
Gilly Green (director, head of wealth and distribution practice, Knadel)
Jon Beckett (fund buyer and UK director, Association of Professional Fund Investors)
Richard Withers (head of government relations, Europe, Vanguard Asset Management)
Funds Europe – European fund sales struggled last year but have bounced back in 2017. How would you describe demand in various channels and geographies?
Richard Garland, Investec – We did see a big rebound in fund sales in the first quarter, particularly driven by Italy. Money is starting to move back into equities. By one measure, flows were €210 billion for the first quarter and this could be a record year.
Globally, people have been sitting in cash or fixed income for quite a long time, but it seems they want to get back into the market.
To some extent people are now becoming more cautious on the US and so money is going into European equities. Meanwhile, people are talking an awful lot about emerging market equity, but we’re not really seeing the flows.
Nevertheless, I would say we’re moving into an equity phase of the market and it seems like the whole fund distribution industry is on fire, particularly in Europe.
Richard Withers, Vanguard – Last year, geopolitical elements meant people were standing on the sidelines unsure what to do and staying in fixed income. There is still geopolitical movement but people are a bit more ‘risk on’. In the UK, net retail sales for March were the highest they have been since June 2013.
Jon Beckett, APFI – Certainly this quarter looks fantastic from a flow point of view, but one quarter doesn’t make a trend and underneath some of the figures there are some inconsistencies.
Some groups have done exceptionally well but there are some inconsistencies between groups. Although we can see perhaps the beginning of a distribution pattern that would be familiar to the United States but now happening in Europe, a lot of flows have been going back into money market and bond funds and a rotation to bond passive might be a defining trend for this year.
Gilly Green, Knadel – Though if flows are increasing, then why is this?
Certainly, in the UK I think pensions reform is a significant factor, with advisers and some of the platforms offering ‘guided advice’ playing a relevant role in driving flows from smaller investors.
Seventy per cent of the assets coming in are driven by pensions, particularly from SIPPs [self-invested personal pensions] as we move away from DB [defined benefit] schemes. That’s a growing driver in the long term. So, while there may be some differences between inflows between quarters, the level of investment for individuals is rising.
Don’t forget, we’re also still implementing compulsory pension schemes for smaller firms in the UK at the moment, so that in itself is also going to drive further investment.
Withers – There are a lot of discussions about packaged solutions, including lifestyle default pension funds, but the discussions are very much focused on the accumulation phase. A lot of fund managers are now beginning to consider decumulation-phase solutions. That’s a future trend that could be disruptive.
Garland – A general trend globally is the desire for outcome-based products. People want some certainty, or at least an idea about what they’re going to get.
Green – Yes, but outcome-based investing has changed. For example, investments in equity can be for growth or purely for income and dividends when interest rates are low.
The trends suggest mixed messages. More data on clients might offer some explanation, such as transactions by age differences. With people working a lot longer, the whole drawdown phase might be much more drawn out than it ever used to be.
Beckett – You scratch an issue that is a moot point for asset managers. Large distributors, insurers, and big private banks effectively are holding omnibus accounts and the asset manager doesn’t get the look-through to understand the demographic of the investor below it. At the same time, managers are being challenged to come up with solutions to match a demographic need.
It will be difficult to work this out because distributors see themselves as gatekeepers and don’t necessarily want to share that market information.
Garland – Before the changes in the IFA market in the UK that led to IFAs outsourcing fund management to discretionary fund managers (DFMs), Investec’s Cautious Managed fund and other balanced or multi-asset funds had a clear role within portfolios. But now that DFMs are using building blocks to build portfolios, it is harder for multi-asset funds to find the right fit. You need to find a different place for them in a portfolio, such as the alternatives bucket
Beckett – Fee pressure may be the backdrop to that. When I started putting portfolios together, I started by taking a multi-asset manager as my core, and introducing some sort of tactical asset allocation element, to which I added satellite building block funds. I think that model would still exist today if not for the fact that fund selectors are very wary of the double-tap charging and general fee pressure.
Withers – It seems at the moment that there are increasing attempts by manufacturers and distributors to play in each other’s space, often trying to protect margins of existing businesses, which are being challenged. The reality is that this will shake out and people will return to focusing on where they can add value. So, people who are good asset managers will stick to asset management; people who are good distributors but lack experience in asset management may revert to only being a distributor.
In continental Europe, there are some integrated models beginning to separate out, such as Deutsche Bank and Commerzbank.
Green – Advisers who are more ‘investment-intelligent’ like to feel that they’re adding some value with their asset allocation by either using different specialist funds, or through asset allocation funds from particular managers.
But one thing that is often difficult is getting a true look-through into what a fund is doing. Perhaps if managers gave more access to the underlying investment breakdown, then advisers might not do so much of their own.
DFMs spend quite a lot of money to get their models on to platforms; once they’ve done that, there can be a significant difference between platforms, meaning if they rebalance weekly versus monthly it can create differences between their performance from one platform to another.
It’s not very clear what you get as an investor when you go to a particular platform, especially with managers of different quality moving into each other’s space.
Garland – RDR has created ‘orphan’ investors because IFAs cannot afford to look after smaller investors as the advisory fee will not cover their costs.
Withers – There are numerous findings about an advice gap in the UK. After the RDR, the government and the FCA are trying to stimulate guidance on one hand, as well as achieve low-cost advice.
Beckett – There is a lot of due diligence and hard work behind fund selection and, as Morningstar has said, there is a widening gulf between professional fund investors operating at the top levels, and those who sit more at the advice end of the spectrum. That’s why the APFI has been active on the due diligence front.
The Door Funds initiative is a massive step forward in due diligence, because one thing that’s been lacking is standardisation and it has created a monster of an industry in the RFP teams and process.
So I think improving standards in fund selection is also part of this issue when it comes to DFMs and creating multi-asset solutions.
Green – A large institutional investor has better access to do detailed due diligence on fund managers. A small adviser on a platform doesn’t.
I’m very reserved about anyone who is not a restricted adviser - how on earth can you do due diligence on the whole market?
Funds Europe – What impact do you expect for cross-border fund sales following the introduction of MiFID II, and will global fund distributors shorten their buy-lists?
Garland – All the major private banks are working with fewer managers. ‘Winner takes all’ is where the market is going, as the same fund groups are chosen. By definition the flows go to the same managers and the big firms will get bigger.
Yes, I think boutiques can probably survive. It is the firms in the middle that are going to find it gets tougher and tougher.
The other challenge is that global distributors who want to provide their own solutions and choose in-house funds. They want to do their own cooking, with their own ingredients, and on top of this many distributors in Europe have declared themselves to be non-independent.
It makes MiFID II look all ‘smoke and mirrors’. Declaring themselves non-independent means the distributors can keep receiving rebates. Was not the point of MiFID II to end rebates?
I had imagined originally that MiFID II would lead to a whole swathe of sub-advisory, multi-manager type of deals, which would be in the best interests of clients who would receive institutional pricing.
Withers – It is the case that buy-lists are becoming shorter. Distributors will have to reveal the total cost of investing to their clients. As well as giving rise to pricing pressure on asset managers, platforms will need to control their own costs. To manage this, they will work with fewer managers.
Beckett – I’m not a fan of asset concentration. The conventional thinking on bond funds was ‘big is best’.
This was because in the primary placing market, you had to be the biggest fund to be at the front of the bond syndication chain. But even in the bond space, we’re moving towards secondary markets with bond-liquidity trading platforms and the very largest funds are now starting to struggle to perform. There is a tipping point where success unfortunately breeds mediocrity, but whilst we still have an AMC [annual management charge] model that rewards and incentivises and encourages asset accrual, when does the fund manager put a cap on asset-gathering?
Garland – For an asset manager to get a fund on a platform, you first have to have a three-year track record. Yet, on top of this, selectors will tell you that the fund must have assets of 500 million to 1 billion dollars. Why? Because, as an investor, they don’t want to own more than 10% of a fund, and they won’t promote a fund unless they can place 50 to 100 million dollars in it. So by definition, they want a big fund.
But then, of course, the problem is that performance can suffer if the fund is too big.
Withers – But being large should lead to economies of scale and cost reductions that should be returned to investors.
Beckett – You’re right, growth should lead to net benefits for investors.
But there is also a second point: slippage costs. These are effectively the implicit costs that occur before the price is struck. I’ve seen some very good evidence that shows that slippage costs do rise quite significantly as funds start to reach supertanker proportions and this is a net drag for the end investor. Institutional syndication models would help smaller funds get to scale without being on the wrong side of cartel rules.
There are 100,000 funds in the world today and 90% of them reflect the industry before commissions were, or will be, banned in some countries. They are funds sold based on marketing strength and commission. Academics have actually identified that the funds that were most heavily marketed in the US to financial advisers were the funds that were most likely to underperform.
Effectively, as an industry, fund buyers have rewarded the wrong funds, based on marketing strength.
Garland – The Department of Labor law in the US is applying fiduciary standards to retirement accounts, but the approach is also being put across the whole industry and many distributors in the US are cutting up to a third of funds from their platforms, which means yet again there is a smaller amount of funds selected and more money going into them.
Green – The partnerships between distributors and platforms just aren’t there at the moment, but MiFID II, with the requirement for distributors and fund managers to exchange information, could improve that.
The regulator is trying to look at it from an investor’s point of view. MiFID II brings suitability requirements for investors to be sold funds that are suitable to their circumstances and needs into the realm of platforms and fund managers – this is an issue that has been at the very front of advisers’ and wealth managers’ minds for ages, but they’ve all struggled with it. Regulators are trying to make this more ‘end to end’ but the biggest issue with that is no one then has the sole responsibility for it.
The exchange of information about the client could be quite useful. Asset managers will need to partner with distributors, to make sure they get the right level of information. They may find benefits from knowing more about their customers.
Garland – But we’re still disintermediated. And there is also the question about if distributors have the means to give us the information. Costs are going through the roof. But I just don’t see the benefit of it because we don’t have any transparency beyond the omnibus account.
Green – The problem is that there are no common standards and unfortunately the timescales mean it is rushed. What’s going to be implemented is something hugely costly to everyone; that by itself is going to make distributors and wealth managers want to reduce the number of funds that they’ve got to track this information for.
Funds Europe – Apart from the route to market, what drives an asset management firm’s decision to work with a particular platform?
Garland – Asset managers have to be more selective. There’s a lot of cost for monitoring the large amount of distributors out there and making sure we’re getting the right data. So I think the industry will end up working with fewer distributors, and with fewer funds.
Withers – MiFID II’s target market rules require asset managers to look to align their products with the end customer. This implies fund management companies will have to ask themselves who is the intermediary that best gets them there? Who is the most culturally aligned distributor? And who has a remuneration model that is aligned with the product manufacturer’s own model? This will reduce the number of intermediaries that asset managers work with.
Our building-block approach at Vanguard, where we use large diversified funds, means we don’t want to be on a platform where they are constantly promoting niche and fad products.
Green – That in itself could drive people or advisers to go to particular platforms, if they like you. So choosing which platforms you deal with will affect the platform’s attractiveness for better or worse.
This could become even more of a vicious cycle if you are taking funds away from certain platforms. Investors might move from one platform to another to retain their access to particular funds - for manufacturers that’s going to appear like flow out from one platform and investment flows in from another - but actually it could be the same end person or end adviser. So there could be a lot of market disruption around all of these issues.
Withers – A big focus will be on sustainability of assets, especially with digitalisation.
Funds Europe – Can the reporting of costs and charges really be standardised?
Beckett – Standardisation is the red herring because we don’t have standardisation of value chains globally, let alone even just in a local market. It’s transparency that we’re trying to drive for, and establishing value for money. I think once we have that, my hope is it will expose those different value chains, it will identify potential solutions that occur within the ETF market relative to the traditional active market.
For example, one of the biggest banes for traditional active managers is their own supply chain, which usually charge them a fixed cost irrespective of the size of their asset book or fund. That is just a millstone that is weighing down smaller asset managers and I think that’s something that could be rectified.
Meanwhile, what I see is the technological innovation happening in the ETF side, taking some of that technology and applying it to the traditional asset manager to make it a much more scalable type of business, will then help drive down costs.
For me, if I was an investor I would like to know how much an asset manager has to pay away in custody fees and audit fees and administration. There’s a huge supply chain that the investors aren’t really getting to see. So for me it’s transparency.
Withers – We are ending up in a situation where we have got three well-meaning initiatives to improve cost transparency – MiFID II, Priips and Department of Work and Pensions requirements. Unfortunately, they look like they might be inconsistent in terms of the disclosure of transaction costs. If we are going to have disclosure of transaction costs, it would seem sensible to have one way to calculate them so that customers can easily compare them.
Green – Even performance figures are not standardised, so we can’t even compare like-for-like on performance, let alone anything else. I think if you’re going to be very transparent about your fees as a manufacturer, you need to also make sure that you’re getting a fair look around what you’re offering for those fees, and I just don’t think that’s going to happen yet.
Garland – The whole industry is seeing the institutionalisation of the retail space, so the end net result is we will end up being paid institutional rates for managing funds. There will be fee compression and so there should also be transparency.
Beckett – Certainly institutional fund buyers would agree with that, but there is a sense of paranoia that they aren’t getting a fund as cheap as the guy down the road. If we effectively graded standardised share classes at particular break points, I’d know I was not getting a better deal than the other institutional buyer with more assets under management, but I would know I was not getting a worse deal.
Standardised fees would mean that fund selectors wouldn’t have to spend some six months with an asset manager to try to negotiate a fee. If we had standardised charges then we would spend more time on investment due diligence.
Garland – In the US a firm cannot have a different AMC [annual management charge] for a fund. You can’t. There’s only one management fee.
You can have things like 12b-1, which is a shareholder servicing fee; you can have sub-TA costs, but at the end of the day there’s one management fee. This industry has completely lost the plot in the UK and Europe by allowing all these different management fees because then distributors end up wondering if they have the best fee deal. It makes it much simpler if there’s only one management fee,
No commission, no rebates, one management fee, completely transparent. This would change the whole industry and make it simpler for the end investor and for distributors. That’s a roadmap, but I don’t hear anybody talking about it.
Withers – I agree. We should be going down the route that the annual management charge advertised is the same as the ongoing charges figure that the investor experiences.
Beckett – Which was Daniel Godfrey’s proposal when he was head of the Investment Association.
Garland – You could actually make it simple: publish one single charge, you can’t have different management fees so that takes away complexities and negotiations, and then it’s all transparent and you’ve solved it.
Green – Why hasn’t the industry done it?
Funds Europe – How do you believe investors will be able to get investment advice in the future?
Green – If you get the financial planning wrong, you could miss out on 20% tax benefits. You can have any fund you like but it’s not going to outperform the wrong financial planning advice. When you have filled up your own and your partner’s pension and ISA, you’re actually starting to get out of the mass affluent market and you’re going to need something more than automated advice.
Garland – I think robo advice is not the solution for all types of clients; as soon as you have a lot of money you want proper advice.
Withers – Robo-advice in the UK is often not actually advice, it’s really discretionary wealth management. The US, however, has growing success with more technology-enabled advice, where real people still provide advice, behavioural coaching and empathy, all over Skype.
Pure black-box advice may serve a function for some people, but it won’t serve a function for all. There needs to be a sliding scale of advice and guidance options to meet different wants and needs.
Beckett – I think the reality is we sit around this table a bit like some of the handloom workers in the 1800s seeing the first steam-powered loom and going, ‘Well, that will never catch on.’
Industrial revolution defined our country for 140 years. Robotisation has already made a countless number of skilled blue-collar roles redundant in the last 30 years. I think you just have to look at ETF flows to see that people don’t actually value much of that human experience.
We have to obviously therefore embrace technology at a lower cost and to make ourselves better.
Funds Europe – How do you expect the fund distribution landscape to evolve in the next two to three years?
Beckett – More consolidation, more M&A, more cannibalisation for what is effectively a contracting asset pool.
Withers – Increased transparency, more digitalisation, and if people thought RDR was a game-changer, they’ve seen nothing yet.
Garland – It’s a growing asset pool because the buying power’s moving from the institutions to the individuals, but the challenge is that there will be consolidation of distributors and consolidation of asset managers, and it is a winner-takes-all market. If you are not one of those select few, you’re done.
Green – I agree to an extent, but I think there’s going to be more segmentation of propositions, and I think vertical integration is going to grow for the mass market. There will be slightly different models and propositions according to level of individual wealth. For example, the high-net-worth market will look more like institutional with segregated portfolios and tailored advice.
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