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INDUSTRY RECOVERY: Case of winners and losers

Heart_monitorWith increased assets under management in the European fund and asset management business, Fiona Rintoul asks if the industry has recovered from the financial meltdown

Assets under management (AuM) are on a broadly upwards trend in Europe. AuM fell slightly by 0.9% in the first quarter of 2011 to finish the quarter at €5.9trn, according to the European Fund and Asset Management Association (Efama), but were up 5.4% on the March 2010 figure of €5.6trn. Total inflows were strong in the first quarter at €30bn with inflows to long-term funds reaching €39bn, while money market funds shed €9bn.

This follows net inflows of €67bn to long-term funds in the fourth quarter of 2010, with substantial net outflows of €41bn from money market funds in the face (among other things) of stiff competition from term deposits.

So, with AuM picking up, can we say that the European fund management industry has recovered from the global financial crisis? The answer for many is: yes and no.

“It has partially recovered, but not fully,” says Laurent Ramsey, chief executive officer of Pictet, the private bank. “We have seen encouraging fund flows in the last two quarters, particularly in long-term Ucits. But with what’s happening in the Middle East, fund flows have slowed. There are a lot of uncertainties.”

These include: the end of quantitative easing in the United States; the “Japan factor” being felt; the sovereign debt crisis; and inflation fears. Quite a list. And so, while it is true that assets are rising again and institutional investors are active, they are not, as John Troiano, global head of institutional at Schroders, puts it “gung-ho”. Au contraire.

“Institutional investors are much more cautious and risk-averse,” says Troiano. “They are not inactive, so it is a recovery, but equity weightings are at historic lows.”

Now, says Toriano, institutional investors face a dilemma because bond yields are rising, and they have significant allocations to fixed assets, especially corporate bonds and high-yield.

“There have been some flows back into equities but not nearly to the extent you would normally expect at this point in the cycle,” he says. “Allocations to equities in Germany and Scandinavia, for example, are at historic lows.”

There have been similar trends on the retail side, with investors favouring high-yield bonds, but slowly creeping back into equities in the face of rising interest rates.

“We’ve seen strong interest in fixed income products, particularly high-yield bonds and emerging market local currency debt, as well as in multi-asset products,” says Ian Pascal, head of marketing and communications at Baring Asset Management. “As the pace of economic growth has started to recover, interest in emerging equities has started to grow again, particularly in countries where the economic cycle is a little more advanced and interest rates are closer to peaking than in the developed markets.”

There is considerable variation, however, from country to country, although overall flows have been stronger in Europe than in other parts of the world.

“There are certain countries where the retail business is not in good shape, such as Spain, where banks compete very hard on term deposits,” says Toriano. “It’s in net neutral mode, but if you contrast Europe with other parts of the world, it is more buoyant than Asia.”

But retail flows will come back in Asia. Investors in Europe, both retail and institutional, need to regain confidence, and it is not always immediately apparent how that will be achieved.

“A lot of investors suffered from the massive correction and missed the rally and today are in the difficult position of deciding where to redeploy cash which is yielding less than zero,” says Ramsey.

It is a tough environment, made tougher by the slew of regulation coming through, which will impact on costs and on systems and processes. It is clear that there are going to be winners and losers.

For Thomas de Saint-Seine, chief executive officer at Reyl Asset Management, the losers are those who were not able to provide liquidity to investors in the crisis and/or were not able to control risk – typically hedge funds of funds (HFoF). The winners are those with liquidity and transparency, who were more regulated, and were able to maintain their investment into the industry.

“A lot of big firms had significant restructuring at this time,” he says. “Even if they had the right product range, they were not able to maintain their level of service.”

That period of restructuring may be drawing to a close. “Looking at the larger investment houses, we have seen some M&A activity, such as the BlackRock and Amundi mega deals, or more recently, Henderson’s acquisition of Gartmore,” says James Barber, portfolio manager at Russell Investments. “However, more generally, activity within the industry has quietened down in the last few years.”

Activity at the boutique end of the market may be dampened too, by the increasing regulatory burden, which raises the barriers to entry, although for those that can get over those barriers Ucits IV will make it much easier to market funds across Europe.

But Saint-Seine sees the industry emerging very changed from the crisis, not just because of the new focus on transparency, but also because margins are lower overall, while margins may have improved since the dark days of the crisis. “Figures show the number of listed asset management companies that were not profitable in 2010 was 5%, down from a quarter in 2008,” says Barber. “Net margins have also expanded from 8.2% to 11.5%” – there can be little doubt that margins are under pressure among firms that don’t have something very special to offer.

“For big firms, margins are under pressure. For boutiques, the story is different. Sometimes they have limited capacity and can justify maintaining margins at a higher level.”

These two factors have effectively put the tin lid on HFoF – though Toriano notes that the segment has been able to come back via more transparent managed account and Ucits III structures – and the environment has been challenging for active fund managers, too.

“The ETF [exchange traded funds] industry has been successful during this period,” says Saint-Seine. “This sector is competing more and more with active managers, and the margins on ETFs are very thin.”

Of course, alpha generators will, in many cases, still be able to command high fees. “Some very large institutions are ready to pay more if there is real value added and a high level of service,” says Saint-Seine. Although he notes, that investors sometimes will not pay even if these factors are in place and that generating alpha and having excellent service are not in themselves enough to succeed; firms also need top-quality marketing of the kind that has propelled Carmignac Gestion into the top league of European fund managers.

And the reality is, of course, that most fund managers are not alpha generators. “Most active managers do not add value; they destroy alpha in Europe and the US,” says Saint-Seine.

This goes to the heart of the main challenge facing the industry: to provide value. Not only have a lot of actively managed funds failed to deliver outperformance, many observers will agree with the contention that the fund management industry has failed to provide good enough solutions for retirement saving, particularly the decumulation phase. Even in the accumulation phase, the industry has perhaps focussed too much on individual components at the expense of effective and efficient multi-asset solutions.

This needs to change if industry is to play the “central role in the global pensions and savings market” that Pictet’s Ramsey predicts it should. The two-pronged trend for big distributors to sell their asset management divisions and for distributors to work with fewer partners, but to demand more of them is perhaps the beginning of a greater focus on value for the end investor.

“There are early signs of asset managers and distributors working together to better educate end investors,” says Ramsey. “The spirit of partnership is more present.”

As part of this development, independence is becoming more prized even if it takes the form of management ownership of a parent that uses a long leash. As a result, many of the companies that top the European league table today are very different from the past with power shifting away from big bank and insurance company-owned players to independents, such as Pictet and Carmignac Gestion.

“There is still room for companies with parents, but people will scrutinise them for conflicts of interest,” say Ramsey.

Regulatory initiatives, such as the retail distribution review (RDR) in the UK, may also help to improve the service delivered to the end client. But there is work still to be done on reducing fund fees and bringing them down to US levels. Efama has already made considerable progress with this issue and the drive to introduce a European standard for fund classifications – sitting alongside the standardised Kiid (Key Investor Information Document) – should bring further improvements.

As to whether the European fund industry has recovered, with so many uncertainties on the horizon, it is too early to say. Few will disagree with Ramsey when he says that he is positive about the growth of the savings market in the long-term, but that the short outlook includes some potentially difficult challenges.

©2011 funds europe