NORDICS ROUNDTABLE: Exploring the new Nordic landscape

We also hear that some institutions are asking to segregate their accounts to give them better risk control, especially within the hedge funds space. They are also asking to do their own compliance and consolidate their risk measures for their total portfolio.

Industry profitability suffered a lot in this crisis, because of the sharp contraction in the market and on top of that some fund managers saw quite significant redemptions. Although the industry has come some way since then, there are still wounds to be healed, which is triggering further change within the business.

Related to the issue of size is risk reporting. This is something, which in the Nordics, is still very dominated by my three co-panelists [the three big Nordic banks] although this is decreasing, thanks to international and local competition. The independent asset managers that I represent are typically not huge in the Nordics, a very few are mid-size but you have a large number of smaller managers. It is these smaller managers that are still licking their wounds, rather than the mid-sized players and the large ones, which have been favoured coming out of the crisis.

From our own perspective, we work internationally and have been subject to harsh due diligence processes in the past, but the focus on this has certainly increased a lot. Our experience is that the due diligence process has become a lot more rigorous on areas that were not core prior to the financial crisis and the Madoff scandal, such as operations, systems and procedures. The process of getting new institutional mandates is certainly more time consuming and more elaborate, even with Nordic institutions, which before [the crisis] were a bit more fast-moving and trusting.

Henrik Staffas, Swedbank: The funds industry was one of the first in the financial sector to emerge out of the crisis, especially in Sweden. We had a booming stock exchange last year and we had record inflows into the market. The inflows went to the medium-sized and large mutual funds, so the smaller funds still have a tough situation to deal with, and in fact we have seen some disappear from the market and we will probably see a few more leave the market. The focus now is regulation. What will happen with that? What will the authorities do?

Jopi Sairio, SEB: In Finland I have not seen any wave of M&A activity. During the crisis there were rumours about this but nothing dramatic happened. That is if we leave out the Icelandic organisations. Actually, it’s quite the opposite. Since coming out of the crisis, we’re seeing more start-up mutual fund companies, with new kinds of investment strategies. There are, of course, many mergers taking place in the industry. As a consequence of the crisis, asset values melted down and some mutual fund companies were forced to merge some of their funds to meet minimum requirements and also perhaps to maintain critical mass. Another trend, typically in Sweden and Finland, is that independent corporate pension funds are merging into the big pension insurance companies.

Moberg: We have seen some consolidation in the fund industry and I agree with Jopi that we will see some M&A activity going forward. However, I don’t think it will impact the markets as much as it would have done six or seven years ago since the market has become a lot more integrated.

Staffas: We won’t see any big M&A activity hit the Nordics. I think the fund industry will be more focused on merging funds – funds that never took off or funds that took a bashing during the crisis. Also we may see more focus on costs, with firms looking at what they can outsource and how they can reduce costs.

Rosengren: The market is getting more integrated but if you step into a Nordea office and ask to buy an SEB fund it’s not as simple as it sounds.

Staffas: But it can be done.

Rosengren: From the viewpoint of an independent asset manager, it’s different. I agree that the market is opening up and becoming more integrated. If you’re a foreigner looking at the Nordic industry structure you’ll see that the three of you [Swedbank, SEB, Nordea] control something like 65% of the fund management market. You have the foreign asset management companies that are quite successful on the institutional side and then you have the locals. To have any sort of meaningful M&A activity you need to have mid-size participants in the market that are struggling with profitability or are hitting the glass ceiling. In the Nordics this is not really something of which we have an abundance.

There are some cases where you can see that having certain managers merge would be good for the industry, or it could really revitalise the industry. But if you look at the firm-specific factors in each case, it is difficult to see those mergers actually taking place. Looking at the smaller managers, you have a lot of hedge funds and boutique managers struggling for critical mass. It’s very likely that we will see some of them teaming up.

But looking at it from a top-down perspective, those kind of mergers are not so revolutionary for the business or even that important. On the other side of M&A, it might very well be a good time for acquisitions where small managers are likely targets for managers with deep pockets who see scale and fit in acquiring assets. We’ll see also fund mergers. And of course next year Ucits IV is going to change the whole structure of the market.

Funds Europe: Since we’re on the topic of the competitive landscape, how has the increased focus on the Nordics on behalf of global players affected your business? And how has the competitive landscape changed? And do you think it will change more?

Moberg: Several global financial houses have been operating in the region for several years and they are very well established. These companies’ funds have been sold in Sweden for many years, so we have seen a gradual change in the landscape. It wasn’t just one wave of foreigners hitting the Nordic market.

Staffas: I agree with Stefan, we have seen the foreign presence here for a long time and it’s nothing new to us really. They have gradually taken a piece of the cake. We don’t see them as a big threat because we’re used to having them here.

Sairio: We have to keep in mind that there have also been global or European players who were an established part of this market and are now having some problems in their core markets and have shut down some of their activities in the Nordics. So it’s going both ways. From my understanding, visits from big international houses to Tier 1 clients in Finland have slowed down.

Furthermore, we can never enter into a discussion about foreign versus local without talking about the language issue. On the asset servicing and the custody sides, being on location and speaking the local language is something that is of essence for the vast majority of the market. The competition is tough and the language issue is maybe more vital on the asset servicing side than it is on the investment side of the industry.

Rosengren: There are certainly a number of international players that have been here for a long period of time and most of them are still focusing on our markets. But in the fund industry we typically have a lot of foreign entries when markets are at more of a peak than they are now, when those companies are generating excess returns and looking for growth overseas. They then usually pull back when times are tough. So I would agree with Jopi that the trend is more for the fund managers to pull out of the Nordics.

Then of course, in the wake of this crisis, but also in the natural progression of the markets, you have new instruments competing with fund investments. We have some very good service providers in the Nordics. Some of these international players are much bigger and are now putting enormous amounts of efforts into developing alternatives to market exposures through funds. The Nordic region is in no way immune to this development and the Swedish and Finnish markets are the most progressive on this front, with institutions increasingly using other ways of getting exposure. The Norwegian and Danish markets are slightly behind the curve on this development; it is something we’re going to have to live with and something that is also vitalising the market and forcing fund managers to rethink their value propositions and their role in the portfolio of the investors.

Funds Europe: How have Nordic asset managers and asset servicers developed their pan-European and global offerings?

Sairio: My perception is that the Nordics tend to stick to the Nordics. I actually don’t know many institutions that would be actively promoting their services outside their core or their home markets.

Funds Europe: Would you say this is the case in relation to asset servicing?

Sairio: To provide asset servicing it helps if you have a presence and a foothold in the market in order to, for example, participate in the local working groups and really know the infrastructure. On the asset servicing side, which is my expertise here, this is definitely more important than in the funds industry.

Moberg: At Nordea we have outsourced a large part of the portfolio management in certain markets to local portfolio managers, especially in the Sicavs.

Staffas: Yes I agree, on the asset service side that’s completely true. On the fund industry, I wouldn’t be surprised to see a trend among the larger fund companies, at least for new funds, to be launched in Luxembourg and use it as a hub to market the funds in all the available markets.

Rosengren: In terms of asset servicing, the Nordics have a number of players, which offer niche products or have specialised focuses and I think some of these have been successful in expanding. The process of launching Sicavs was maybe more intense a couple of years ago, when managers made more money. Now it is more of a waiting game, although this is going to be sorted out by Ucits IV and what that would allow.

International investors want the excess returns that the Nordic markets have been able to generate, but from a portfolio perspective most institutional investors don’t have room for a segregated exposure to Sweden or the Nordics. This means that if most Nordic managers are focusing on Nordic equities, it’s difficult for them to move internationally.

However, some of you around the table have been very successful with Sicav offerings in Europe. Some of the independent asset managers, East Capital included, have  also been successful in moving internationally. The key to success is that you have a niche that is interesting enough for institutions to want segregated exposure, or you have a broad product with a very good track record. Also, there are some really good global managers here in the Nordics that have been successful in finding investors both in the UK and in continental Europe. From an East Capital point of view, we are convinced that our future growth is not concentrated in the Nordics but rather in other places in Europe.

The Nordic players are more interested in growing organically abroad if we consider the mid-sized and small asset managers. The situation is different when it comes to the banks. They are already international, for example Nordea being very successful with Sicavs.

Funds Europe: Traditionally the Nordic markets have been strongly linked to the large institutional business in the region – how is this key market changing and what new demands are they likely to place on the asset managers and asset servicers?

Sairio: On the asset servicing side there are two different issues: one we always talk about, that is related to the core custody offering – price pressure, the level of automation, reporting capabilities and value-added products such as lending, OTC derivatives collateral management and so forth.

There is another thing which is very challenging for us, and that’s the ever-changing industry and the ever-changing infrastructure. It’s about keeping track of the industry and the numerous initiatives, both on the infrastructural side and also on the regulatory side, and to figure out where the industry is going. This is a major challenge and ties up lots of resources.

A typical example of the work we’re doing in this regard is to closely follow the MTF initiatives. We have to have the set-up ready with all the different CCPs if we want to offer clearing services to customers.

Staffas: For asset servicers, value-added products will become much more important; things like compliance tools, collateral management, working collateral for CCPs, etc. You can command higher margins on these services than on regular custody business.

My feeling is that investors still don’t want to take too many risks or invest in alternatives at the moment, but they are moving towards careful selection of their asset managers and looking at who should manage what. They are splitting up their assets instead of pooling them in-house, and some of those arrangement could include alternative investments.

Moberg: Yes, I agree with both Jopi and Henrik that there will be a lot more pressure to come up with new products. The transparency is very good and therefore I think we will see a lot of demand for our
new products.

Rosengren: The market has been through such turbulent times that investors’ portfolios are quickly changing into something that they had not planned them to be. This is not only triggering reweighting, but also making investors rethink the way they should build their portfolio and to review what they have left after those changes are made.

Another thing is that the performance of the markets has been very dramatic. During Q1 and up to mid-Q2, overall index-linked products were outperforming and then at the end of the year you had the contrary situation. In 2009 some investors said, ‘let’s focus on simplicity and go for passive management’. Many investors did not have a long-term view on allocations and just wanted to make quick beta allocations in a play on the rebound in oversold equity markets. And they did see outperformance of passive versus active strategies in the beginning of the year, especially within the emerging market space.

However, over the full year, active strategies outperformed. So as a consequence you have investors coming back to active management, but being much more critical on what should be active and what should be passive. Some institutions are focusing on alpha-beta separation, both from an alternative mindset, but also from the perspective of the whole portfolio. The drive for simplicity will remain. That doesn’t mean there can’t be a high interest in alternatives, but that investors just want portfolios of which they are more in control than before.

The crisis triggered questions on fund management fees, especially where managers didn’t perform and the institutions looked back and saw what they paid for. From what we read in media, this has been focused on index close or ‘index enhanced’ managers who have an active management fee structure. In reality, the fee pressure is always there and is part of our business so this situation is not so new. Our own experience shows us that as long as institutions believe in an active strategy and the manager they have found for that mandate executes on proprietary research and conviction, they are prepared to pay for it.

As a consequence of the market becoming more advanced, people are more sensitive about what they’re paying for and what they’re getting in return. The willingness to pay for alpha is very good – if you have good managers or good alternative structures. But when investors are paying for passive management, they’re very price sensitive. Some institutions will consider performance fees but since we’ve had a period of very good performance, perhaps they’re not as keen to have these structures in place.

Funds Europe: And now investors want to know exactly what they’re paying for.

Rosengren: Exactly. Coming out of this crisis there will be a focus on size. Small managers can be launched and can do well, but I think they will have difficulty attracting the Tier 1 institutions and trying to take in significant amounts of money. Before, you could be a manager with hundreds of millions of dollars or euros under management and be able to, at least theoretically, raise money from institutions. Today investors prefer managers with billions in assets under management and I think it will remain this way for a while.

Staffas: As Albin said, fee pressure has always been there, but maybe when markets turn down this pressure tends to get higher. We will probably see a continued fee pressure and when people start moving more to index-tracking products and ETFs the mutual funds will have to lower their fees as well.

Funds Europe: Consultants had said that there are interesting opportunities in the Nordic hedge fund sector. Have these opportunities been captured and has it led to further appetite for other alternative asset classes?

Moberg: The fund industry always has to strive to come up with new ideas and new kinds of investments. This is a job you cannot stop working on; you always have to be at the forefront of coming up with new ideas and new products, and we will definitely see that develop further.

Sairio: In Finland, during the last crisis in 2008, some pension insurance companies made a significant shift towards the alternative asset classes. The average allocation is probably somewhere around 5% of the total portfolio. But I went through the figures of some annual reports and alternative exposure even reached 15% in some cases. There has definitely been a trend towards increasing alternatives exposure and this was obviously triggered by the crisis, in an effort for investors to try and sweep in some extra returns.

The asset servicing for non-traditional assets is a different ball game to servicing more traditional asset classes. Being able to report competently and do everything that is required by the client is a tough job. This is a phenomenon that has built potential for some niche players. There are custody-type firms that specialise in alternatives all around the Nordics. Getting niche players in the business is a good thing for the whole industry and also for the end investor. It poses challenges to us custody banks, but that is not a bad thing – we have to be on our toes the whole time.

Funds Europe: Albin, from your point of view, have investors been asking for more alternative asset classes?

Rosengren: We don’t offer hedge funds but we do offer private equity and some special situation funds. What is clear is that investors are very focused on liquidity. This is related to past problems, but it is also related to an uncertain economic outlook and the desire to have the flexibility to quickly change positions. Commenting on private equity as an asset class, leverage possibilities are limited and many investors are still uncertain over the equity left in the funds they have. We’re still very early in the recovery and in the business cycle for institutions here in the Nordics to actively look at private equity. When you have a more philosophical discussion with them about the asset class then investors divide into two camps. Some would prefer other alternatives and liquid assets, while others believe the illiquidity premium is going to go up and are therefore looking to increase their private equity allocation. There is some private equity capital being raised but it is still very limited.

Funds Europe: At least it’s definitely better than what we’ve seen in recent times, which is good.

Rosengren: Yes, winter is slowly turning into spring.

Staffas: The thing we see in the retail segment is that structured products are still attractive and we’ve seen ever-growing sales in this segment. So, there’s still some appetite for the kind of product that can limit how much money you could lose.

Funds Europe: What does the panel see as the most important factors affecting them in 2010 and beyond, and what is their outlook going forward?

Moberg: Going forward we have to look at the emerging markets not only as investment in emerging markets, but also looking at the emerging consumer. These people are moving from rural areas into the cities and getting jobs. They are starting to be able to take on loans and begin consuming. Therefore, we do have to shift the focus a little bit to the emerging consumers, as they will play quite an important role going forward.

Sairio: Interesting point, I hadn’t thought of that. Going back to one of my previous points; the pace of change is really accelerating. Thinking back to the major changes in the custody world in the ‘90s, the biggest change was probably going from physical certificates to the book-entry world. Quite frankly, this is pretty much the only major change on the post-trading side that I can remember. But since a few years ago there have been a tremendous number of changes, new instruments, new infrastructure, etc. I read a study recently, which said that a Nordic institution that offers both front- and back-office products will have to face over ten new infrastructural or regulatory changes over the next four years. We’ve had some of those changes come through already with Mifid and then obviously the current buzzword is the Ucits IV directive, which can have a big influence on this business.

Staffas: During 2009 we have seen tremendous changes in the business infrastructure with the introduction of the CCP, with Burgundy being launched here in Sweden as an avenue MTF, then we have the Euroclear single platform coming up in a few years. We also have the new trading platform for the Swedish exchange. This infrastructure change will continue for the next few years and that is something to which we always have to adapt. For the representatives of big banks it is maybe a bit tougher; in some cases because we have our IT platforms and cannot adapt to change as quickly as smaller players. So that is a challenge for us. It is also something that we have to do to be competitive. Furthermore, we have to deal with the impact of upcoming regulation, both on a local level and on the EU level. It will be very interesting to see where we end up and what will be the effects on the business.

Rosengren: From a manager point of view, the interest in emerging markets is a trend which is enormously strong. If you talk to investors today about decoupling it’s a bit of a dirty word because they lost twice as much in emerging markets initially as they lost on the developed markets. But now emerging markets have been a much better play than developed markets. Looking back over the last ten years, you basically had no return in the Western world and the very high returns were in the emerging markets, irrespective of which emerging market you were looking at.

The search for growth on behalf of institutions is certainly there and the emerging market trend will be extremely important for any investor in the coming years.

If we take a slightly more short-term perspective on this and look at 2010, ultimately what is going to determine the future of our business is sustainable global recovery. Without that it’s going to be difficult to attract interest, even for emerging markets. If we have problems in the global economy then it’s going to affect everyone.

Talking about regulation from the point of view of an independent asset manager, there has been a lot of regulation introduced over the last ten years. The changes this brought with it have been good for investors and good for the business, but they’re also putting a lot of pressure on managers. In the Nordic market, you have some large players and you have quite a few very small players. It is these smaller players that have to bear the costs of all this regulation. And, if this is taken too far, there is a risk that competition is not as vibrant as it could be. I don’t think we’re there yet, but we’ll see what comes out as a consequence of this crisis.

Regarding Ucits IV, everyone can read the directive and find out the opportunities that it presents. I believe that some of you around the table will change your way of managing and servicing funds and smaller players will also do that. The industry is going to change, but it’s still early to have a perfect view of what all the consequences are going to be.