INTERVIEW: Less patience with underperformance

Pascal Duval, Russell Investments’ Emea chief executive, is ringing the changes for performance fees, he tells Nick Fitzpatrick. The head of the multi-manager says fees are flawed, but good managers will understand.

A Funds Europe article has caught Pascal Duval’s eye. It’s one proposing the future of asset management will be defined by multi-asset investing, outcome-led solutions and should place a significant emphasis on passive strategies (FE, June 2013). Duval says he agrees with everything – except the emphasis on passive management.

For a London-based European chief executive who oversees a large indexation operation – which is one part of the broader Russell Investments business – and which has used its indices to create exchange-traded funds, Duval might be expected to fly the flag for passive investment; but this is not the case.

Duval, who is also chief executive of Middle East and Africa for Russell, a US firm, says: “The fundamental beta position is not paying enough. When fixed income beta is delivering negative real returns then going passive is the risky choice.”

But what about equities, where the debate about active versus passive largely resides?

“Passive equity is not enough to repair your deficit. It won’t deliver excess returns above the discount yield, so you need an alpha premium.”

In the UK, says Duval, if a pension scheme wants to be covered by the Pension Protection Fund (PPF) – which exists to protect defined benefit scheme members’ pensions when employers turn insolvent – the average pension fund would need returns from its growth assets of 3.1% per annum for ten years in excess of growth in liabilities to remove deficits and be fully funded on a PPF basis. They would need nearly double that for a full buy-out – that is, 3.9% for 20 years.

“No asset class will give you that today,” says Duval.

And that’s where Duval and Funds Europe agree: There is a need for an asset management industry that can deliver multi-asset investment to different types of client.

Multi-asset solutions make sense but have to be dynamically managed, he says, “because beta is moving up and down” all the time.

Investment management – including manager research and fiduciary management – indices, and strategic implementation services like currency overlay, commission recapture and transition management, largely sum up Russell Investments’ business, which was founded in 1936 and is now owned by Northwestern Mutual.

The indices have $4.1 trillion (€3 trillion) benchmarked against them globally and include the Russell 2000, the US small-cap market leader.

In the realm of transition management, Russell competes with the large investment banks on an agency basis, hoping to distinguish itself from the typical “principle” model employed by banks.

As for the investment management business at its core, the firm is a multi-manager. Russell’s flagship RIC Emerging Markets Equity fund, for example, uses 10 managers – including
one Russell fund – on a sub-advisory basis.

George Russell, grandson of founder Frank Russell, built on his knowledge about fund managers to take the one-time brokerage into strategic pension fund consulting in 1969 and then into multi-management.

Some four decades later, Russell Investments stands as gatekeeper to around $246.8 billion – or €179.2 billion – in assets under management, at September 30. This figure includes $69 billion of derivative overlay assets.

Specifically in EMEA, the firm has €31 billion of assets.

In its multi-manager business Russell Investments says fewer than 4% of researched money managers make it into its funds. Russell’s manager research team ranks a universe of more than 2,000 managers.

This factoid, which is from the company’s website, chimes with the picture Duval paints of Russell as a distribution gateway that has become tougher for external managers to pass through.

“We used to be quite long-term in our approach to hiring managers and we would hire them for the market cycle, such as three to five years. If they underperformed we would try to understand why.

Perhaps their style was out of favour or there were more fundamental problems.

“But 2008 changed a lot of things. It showed a major dislocation in markets and those dislocations meant the usual ways of achieving diversification didn’t work.”

A period of active manager underperformance saw Russell change its approach resulting in two parts to Russell’s manager assessment today.

“The three-to-five-year outlook remains, but we now also have a one-year outlook. We like to see where the manager is in comparison to the market cycle.”

Duval adds: “We started by saying it was impossible to predict styles. But things have changed. Our capability for analysing capital markets and the fact that asset managers themselves have evolved mean today we believe we can observe market cycles and take tactical decisions as a result.”

There is now less patience with underperforming managers.

“We fire a manager when we expect good things to come but they do not come.”

When Duval joined the firm in 1994 his brief was to set up Russell’s office in Paris.

He subsequently held various European leadership positions, such as head of institutional investor services, and head of partnerships and distributions alliances with financial institutions.

He got his current job in January 2012, and now that he is the Emea chief executive, Duval is ringing the changes about performance-related fees. He has strong views regarding these he and thinks many performance fees are structurally flawed.

It’s not enough to merely outperform the benchmark and get paid; the cost of delivering the beta return, such as through an exchange-traded fund, should also be factored in.

“We are strong believers in performance fees, but they have a bad reputation. Clients should pay at minimum the beta price to the fund manager. If at the end of the year the MSCI emerging markets has returned 10% and the fund returns 11%, the 70 bps cost of beta [which may be the cost of the ETF] should be subtracted [from the 1%] leaving 30 bps of real net added value. Of that, the client should get 80% and the manager 20%.”

He adds: “We have some products which are built on that concept, where we do have a performance fee above net-added value.”

Duval says the model has value when hiring high alpha managers, which tend to charge high fixed fees – often above the budget for pension funds. “A lot of the current performance fee structures are not structured that way, but we are proposing this to our managers. Often the good managers are OK with it.”

This is something for sub-advisers hoping to work with Russell to watch out for, but so are the opportunities that may come out of the emphasis on multi-asset investing.

At his appointment in 2012, Duval said investors were recognising the importance of seeing their portfolios as a whole rather than the individual parts.

Russell’s multi-asset team, which numbers 37 people, recently appointed Rob Hall, former head of manager selection at Schroders, as a client portfolio manager in London.

©2014 funds europe



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