February 2011

US ASSET SERVICING: New York roundtable (part 2)

The New York Roundtable: in the second part of our New York panel discussion, Messrs Bowman, Masterson, Rudenstine, Salus and Wallace focus on US relationships with a variety of markets and drivers for development. AS_NewYork
Biff Bowman (Northern Trust), Phil Masterson (SEI), Bob Wallace (Citi)
Bill Salus (BNY Mellon), Nick Rudenstine (JP Morgan) Part 2: markets and drivers of development. Funds Europe: Latin America, led by Brazil, is a significant growth story at present. This is on your doorstep, so how is it impacting your clients’ business? Biff Bowmanm Northern Trust: I think asset managers must pay attention to Brazil in terms of strategy questions such as whether to have a physical presence or drive a business through alliances and partnerships. It’s too big and too important a market for our clients to ignore. Nick Rudenstine, JP Morgan: Yes, and clients are demanding that we work with them on a  strategy. Bill Salus, BNY Mellon: A typical challenge we are faced with is where a US manager wants to sell an Irish Ucits of its US strategy through a Canadian broker into Brazil. All through that chain, there is clearly a requirement for integrated technology and transparency.

Bob Wallace, Citi: Brazil is an original Brics country and is really coming into its own. If people haven’t heard about Brazil yet, they certainly will in the next twelve months. Rudenstine: For outbound investment, if a Brazilian manager needs a global custodian I think we would say our brand should be helpful to them. Salus: There are challenges around the transparency of sales information, of clearing information, and of all sorts of data that helps a fund manager understand how successful it could be in a market.

When we look at a market, we’re looking firstly at the infrastructure requirements for institutions and funds, and then we look at how products are sold in and out of that country. Bowman: What is clearly a challenge for US managers is that the US is just a single country, whereas going global entails a country-by-country process. You can set up a Ucits and obtain the passport, but every country is still different, and having a service provider who can help to pave the way to facilitate sales and facilitate distribution is the ticket. Salus: A few years ago distribution support in Asia was a case of having somebody that could translate the Taiwanese fax! Now it’s much more than that: it’s understanding what Morgan Stanley or UBS are doing within the transaction chain and linking that all together so that products can be rightly targeted into the appropriate groups of wealth managers.

Wallace: These days, China is one of the most interesting examples of that in terms of the dynamics of the local banks, distribution networks and selecting custodians. Large fund managers need to use local banks for distribution. Meanwhile, global banks are now trying to tie distribution with sub-custody contracts. This is causing challenges for everybody in the food chain. Funds Europe: Is the Irish Ucits fund seen as the standard way to enter Latin America for a US asset manager? What about US-domiciled funds? Wallace:  Historically, if you looked at the two major offshore fund centres of Dublin and Luxembourg, Dublin was the preferred domicile for US managers. Most non-US investors don’t want to be in a US-registered product because of the tax and the IRS, so it’s really a non-starter. So then you look at the offshore domiciles. Cayman is one and you have Dublin and Luxembourg. Investors are going into more regulated environments, so they will want a Ucits-type vehicle. Funds Europe: How have operational departments within US fund management businesses been impacted by crisis-related regulatory pressure, both domestically and internationally? Has this threatened business development and/or global expansion? How have asset service providers adapted to help clients with these issues? Phil Masterson, SEI: We recently had a CFO forum with our hedge clients, and I would say that they are definitely feeling the weight of regulatory changes, both due to the sheer volume of it, and to the breadth of the changes. We asked them what their greatest challenge was in the next twelve to 18 months. We gave them choices, and what they came back with was “addressing the new regulatory requirements”, which exceeded “economic and geopolitical concerns”. Frankly, I found this very surprising.

We also asked them, “What will be the impact of regulation on profitability?”  And nearly 50% of them felt that it would be significant.

Wallace: I feel that hedge fund managers in the US have felt the most impact. Most of them did their own administration and post Bernie Madoff, they never really rushed to outsource it. But then they took valuations to third-parties because institutional investors were telling them to.

And just as they had pretty much worked through that, they were then made to register as an adviser. In Europe, alternative managers outsourced already and many of them have already gone to the Ucits format. Bowman: The demands aren’t just from the regulatory environment.  Client demands are probably equal to, if not even greater than, from the regulatory framework.

That’s partly why asset managers have moved from self-administration to third-party providers like us. But they
probably needed to outsource anyway, simply for the transparency they are going to be required to deliver. Funds that self-administer don’t often have the scale to invest in technology or operations the same way we will. Wallace: We expected smaller managers to have problems, but in fact it’s the larger managers that have the biggest problems because they have institutional investors who are very demanding. They then have other parts of the firm that are in brokerage or distribution. Salus: I believe a recent Beacon Consulting study found nearly 74% of large managers are looking to outsource in the coming 12 months. Customers are looking across the spectrum, not wanting necessarily to have one fixed end-solution today, but rather the flexibility of a roadmap that provides options for alleviating pressures both today and as they emerge. Funds Europe: Are asset managers prepared to engage more in discussions about the price paid for investment-related services, particularly in light of greater complexity and arguably more risk to providers like yourselves? Rudenstine: There is more discussion about price and value but it’s not an easy discussion. With many asset managers underwater by 33% relative to where they were at the high-water mark – and us facing a similar set of issues – I think people are converging around the idea of outsourcing and finding ways to reduce cost. But there are no easy answers and our challenge is to continually demonstrate value. Salus: Once you add the industry-wide consolidation of managers and providers to all this, it becomes even more complex. Our services are more strategically entrenched within our customer’s operations platforms. Wallace: Asset managers are trying to get more efficiency from their product lines. They are closing more funds. Things don’t have as long to be successful, and this leads to more consolidation – they launch a new fund, they close a new fund.

You know, there are no net gains, it’s more consolidating, and that does help us – putting more assets in fewer vehicles helps everyone at the end of the day. Salus: If you’re the fifth best large-cap value product at a big fund house, you’re going nowhere fast. Our ability and willingness to demonstrate that to a customer, which we do at BNY Mellon all the time, is an interesting dialogue. It’s more meaningful for them to receive that data straight from us – just as meaningful as when we provide the data that illustrates why they are succeeding in the marketplace.

The economics of product management is something that we’re asked to help with all the time, from how to build a product to how to launch a product using the existing intellectual capital – likewise, gauging how successful a product is in particular markets. Distribution support keeps coming back to the table and is still king. Funds Europe: Arguably, we have seen the rise of the boutique over the past couple of years.  As they grow, are they looking to outsource, too? And are their relatively small asset bases attractive to you in terms of a source of revenue? Bowman: Boutiques can have international growth, but what they can’t have is a broad array that equals the product base of a diversified global asset manager. If they pick a niche, and perform in that niche, we could work with that firm on a distribution strategy.

If they can gather significant assets in a niche, or whatever their unique boutique element is, and if we could sit in a room and acknowledge the fact that they have a unique niche and a performance track record, then that will work, too. I think probably everyone in this room would be interested in that type of firm.

It’s a question of focus. If a manager wants to focus on just, say, emerging market debt, then there might be some interest. But we would advise a manager that they would have a hard time distributing 50 different funds globally if only one of those is really a unique and attractive fund. Funds Europe: As you take on new clients, how sensitive are you about the risk within those clients’ business? Do you turn away new clients because you’re not happy with their risk profile? Masterson: We’re very bullish for specialist managers. There are two sides to the coin. A question we think is important is, what’s going to define active management in future?

A lot of alternative managers are going to be the answer to that question, and I include managers of long-only concentrated portfolios in that as well.

The ETF market is a highly concentrated marketplace and I think there are significant opportunities there for alternative managers from either the portfolio construction process, or from a satellite type of role becoming more widely adopted. But even customised targeted funds are an opportunity, as target funds continue essentially to take market share in DC space.

To answer your question, we definitely are very focused on doing some evaluation and due diligence. Wallace: I think for the larger asset servicers, it’s going to be more selective, because our compliance people won’t allow us to do anything different. Funds Europe: They tried to come up with a common solution but, you had two different camps at least, and they couldn’t build the necessary bridges. Masterson: There are significant distribution benefits in the US clearing arrangement. The use of collective investment trusts is one example. They’re tradable through the NSCC [National Securities Clearing Corporation] and this has put them more on a par with mutual funds. So there are significant distribution benefits to having a streamlined system. Salus: The fragmentation provides distribution analysis issues. In the US, where omnibus accounts are prevalent, anyone who sits in the middle of that is able to understand that data to determine where things are being sold again. Trying to do that across the different European distribution channels is a difficult road.

We started to look at how we could open that through the ICI. The distribution data is out there, it’s just not easy to get and it’s not easily populated. As a result, the managers still have the same issues that managers had here years ago. Funds Europe: Does the European business model differ greatly from the US? Salus: European managers wanting to enter the US have shown a lot of interest in our turnkey fund products, as one example. Our service allows a manager to rapidly enter the market without having to wade through the red tape, as we handle all of that for them in an efficient manner. Wallace: The US is a sophisticated market with many different types of product sets.

I think most important for the non-US manager entering the US is to be clear about what market they are going after. For example, sub-advisory institutional mandates have a particular distribution model and how you set that up, and the service you need to support it, are totally different to other models.

This is probably the easiest way to enter on an institutional basis if you have a good track record, because institutional managers and consultants will give you the benefit of having developed a good track record some place else, such as in European equities. Bowman: I would say, at least in our experience, operating models are similar in Europe and the US. I completely agree managers would come in and look for a turnkey product.  But in our case, the platforms, the nature of the relationships and how that business is serviced are not dramatically different between the regions. The information managers need when coming from let’s say Europe into the US might entail a different dialogue, but once they’re on our global platform, I think it looks, smells and feels pretty similar regardless of where the manager is located. Masterson: I have been surprised by the amount of recent client additions and prospects that are Hong Kong-based or UK-based and who are looking at the US market from a mutual fund perspective.

This is surprising given the maturity of that market. It is the largest mutual fund marketplace in the world, and they think they’ve got institutional capabilities that they can repackage in this kind of format.

I think there has got to be a healthy dose of realism. When you go on the attack, I think the best way to instigate it is to target small institutional clients rather than the retail space. There are fund minimums, perhaps $50m in an equity strategy, and $200m to $500m in fixed-income strategies. Attacking the US marketplace isn’t easy, and there is much to be gained from having a partner.

In any case, I think from a servicing perspective, there’s not a fundamental difference in the service model. ©2011 funds europe

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