London roundtable: “They want alternatives, but with the safety of Ucits”

Investors still struggle with asset allocation due to low real returns from bonds. Also discussed are diversity and model portfolios.

Robin Creswell (managing principal, Payden & Rygel)
Richard Haxe (managing director, Europe client group, Investec Asset Management)
Diana Mackay (managing director, global distribution solutons, Broadridge Analytical Solutions)
Gavin Ralston (head of official institutions, Schroders)
Matt Shafer (head of international distribiution, Natixis Investment Managers)

Funds Europe – What are some of the main risks investors and asset managers face in emerging markets now and where do you see upside?

Gavin Ralston, Schroders – Probably the premier risk is recession in the US in 2020. I think most economists do not have that as their central view and it is not priced into the market – certainly not into the equity market – although it may be reflected in the shape of the yield curve. Where do we see upside? A resolution of the trade dispute, and possibly significant fiscal stimulus – maybe starting in the UK.

Robin Creswell, Payden & Rygel – We look mainly at three areas of risk: currency, trade wars and rates.

Being a fixed income house, we think of everything from a fixed income perspective – yet I think a lot of these risks are for equities. We see some risk of one or two currency-devaluation wars over the next 12 months and we think trade wars generally will end up being a zero-sum game with risk to the downside, but likely to be resolved, with low rates being the underpinning for them. There is a lot of risk around potential recessions which are probably overestimated because of these factors and more likely it all feeds into equity risk, real estate and some risk in alternatives.

From a fixed income point of view, what we see is capitulation on the upside, meaning investors are going long duration, buying more risky assets and so on, and as long as the central banks generally are underwriting that, which they are emphatically doing, then we see opportunity in multi-asset credit, spread product, high yield, and emerging market debt, providing it is currency-managed.

Diana Mackay, Broadridge – A big issue in the retail investor market is risk aversion and front-running by sophisticated investors of central bank policies. So, the upside is huge flows into bond funds – but very little interest in any risk assets.

Another notable point is the scepticism we see in the mixed-asset arena. I’m not convinced that’s going to go away very quickly. All in all, it’s good news for the industry because flows will be better this year than they were last year, but it’s all into bonds.

Richard Haxe, Investec Asset Management – I do think there is an illusion of diversification with many end clients – the next ten years are very unlikely to look like the past ten years. We hear a lot of noise around Brexit, Trump, China, but (geo)political risk is always in the headlines. What is new is negative interest rates and in that environment, end clients are going into cash.

There is little idea what amount of risk one should take to get to a reasonable return. There are some studies in the US – and it will be similar in Europe – pointing out that you need to accept about four times as much volatility in a much more complex portfolio to achieve a similar return to 25 years ago.

Matt Shafer, Natixis Investment Managers – I look at it from a distribution perspective. One of the biggest challenges we’re going to have is uncertainty among private clients. If a client has three to five accounts at private banks, those banks have very inconsistent views about where to allocate assets, with one advocating US equity and another one negative on US equity. That leads to an awful lot of uncertainty for clients.

Funds Europe – In the past year, what investment areas and types of product have seen the most momentum in sales?

Mackay – Bonds. Only bonds – it’s just extraordinary. You had similar accommodative policies by central banks in 2017 and bonds led the way then, but people were also investing in riskier asset classes. This year, so far, it’s only bonds. I’ve pulled up the numbers: €193 billion of inflows into bonds between the start of January and the end of August in Europe, minus €30 billion in mixed assets, which is close to an all-time record. Meanwhile, there have been €91 billion of outflows in equities, which looks set to become the second-worst year on record.

Real estate is modest but OK, and money market funds are still pretty strong. What’s interesting is in the last couple of months, we’ve seen quite a shift out of global currency bonds and into government, safe-haven bonds, especially those denominated in the US dollar.

Creswell – So, there is an interesting division between US credit and global credit. Both of those are heavily searched.

We’re also seeing quite big demand from central banks as they are looking to reshape their balance sheets with global credit. Definitely there is demand for government bond mandates, which we haven’t seen for a long time, but there still is limited demand – at least typically – for global aggregated bonds.

Demand is very segmented and generally for high-quality bonds.

Ralston – In the fourth quarter of 2018, the very poor performance of every asset class had a big psychological impact on risk appetite. If you look at the year to date, there’s an irony in that extreme risk aversion has been witnessed this year, but it has been a reasonably good year for equity returns and other risky assets. I guess that’s a reflection of the lack of trust in risk assets as a consequence of what happened in late 2018.

Shafer – When we use the word ‘momentum’, we think immediately of flows, but if I look at where most of our discussions have been in the last year, they’ve been around ESG. We spend well over 50% or 60% of our distribution time with clients talking about the ESG category, whether that’s equity, fixed income or multi-asset. I’m not sure that most asset managers are seeing the fruits of those discussions, but those of us that are, we are confident that at some point, the fruits of all this labour will be there in terms of flows.

Haxe – We’ve seen a lot of interest in emerging market fixed income, such as corporate debt.

Funds Europe – Have you seen much interest in China?

Haxe – There has been, but in the scheme of things it doesn’t really pop up big time. There’s a handful of managers doing well in that space. I think the game is moving away from All China to China A-shares.

Ralston – So far, there has been more interest from institutional investors for China, because many are now separating China out from the rest of the emerging markets. From the retail customer… not much.

Creswell – What has helped is the mechanical changes in the market there, starting with the implementation of Bond Connect. The managers are ready now, but there is an evaluation process first.

Funds Europe – What we’ve heard about more than anything over the past year, apart from ESG, is private debt. Does this match your perception?

Creswell – In terms of fund distribution, private debt is difficult, and that tends to read across into the institutional space where there are particular liquidity needs. We see the demand growing but it’s less easy to participate.

Shafer – There’s been a big appetite for private equity in the global wholesale space in the last 18 months, but I don’t think private debt has moved as quick because there are a lot of other fixed income products available. For example, banks are leveraging up fixed maturity portfolios, which provides investors with yield, and yield is why clients probably want private credit in the first place.

Mackay – Distributors call for alternatives and products that are uncorrelated with the markets and yet they still only want to invest in Ucits-regulated funds. You see this also with institutions – a lot just want the regulation that surrounds Ucits – and even though you have more or less equivalent regulation with AIFs [alternative investment funds], you’ll hear distributors say they’d buy it if it was a Ucits. That huge comfort factor prevents big take-up of anything that’s in the more alternative space.

Funds Europe – Fund distribution is changing across the board. How do you anticipate this will change and what role will technology play?

Mackay – The biggest disruptor we’ve seen in distribution is MiFID II, which is encouraging a strong shift away from advisory and into discretionary portfolio management. Distributors in most European markets can no longer afford to spend time advising clients on accessing single funds. It is simpler from a regulatory point of view to bundle their clients into model portfolios. In America, this has resulted in a dramatic reduction of appetite for mixed-asset funds because most investments are now being managed through the model portfolios offered by distributors.

The same dynamic has occurred in the UK, where asset allocation decisions are now predominately made by discretionary portfolio managers or gatekeepers, and this trend will increasingly be evident in Europe. Where technology feeds in is how these model portfolios are going to be managed – that is, on an individualised basis. You can see a lot of quite interesting developments using technology at the robo-advice level, but also at the higher end of the value chain. It has the potential to democratise investment.

Ralston – I would agree with the growth in model portfolios. Wherever there’s an adviser-led industry – the UK is the best example – it’s gradually giving way to discretionary fund managers, and part of that will be the provision of model portfolios. The next stage is mass customisation. The technology now exists to deliver the sort of service to smaller investors.

Mackay – The danger in this mass shift towards discretionary is that sales volumes become much more volatile. We have seen that in the UK, very much. The UK was always the most stable market in Europe and now it’s the most volatile.

Creswell – Our data sits on a whole lot of platforms and we’re beginning to see our data being evaluated on a like-for-like basis with everybody else. What’s happening is that the data is getting better because it is being better supervised. Better data means better evaluation, which means that the tools you’re talking about can point customers to the more robust funds and therefore you’ll get better outcomes in terms of further allocation. I think we’re at the starting point of that. Some organisations’ distribution costs will go down and their distribution reach will get much bigger, so efficiencies of scale will increase. There are lots of potentially healthy outcomes.

Shafer – This conversation is interesting to think about from a larger group’s perspective, because pivoting to all of these regulatory changes puts everyone on a level playing field. But to get there if you’re big takes longer and costs more money. If you don’t fulfil the requirements for the big banks, then there’s no opportunity to distribute your funds any more. From my perspective, the requirements around data are challenging. There are a lot of data providers playing an intermediary role – for example, data housing of RFP and marketing support for fund managers. They all want a piece of business from you, telling you their solution will make your life easier. But just when you think you have it figured out, a new requirement comes in.

Haxe – I would agree with that point. What data does to the industry as well is that it takes away the mystique of the ‘know-all’ asset manager. Data and technology levels the playing field. As recently as ten or 15 years ago, we knew a lot more than our clients, but today our clients know as much as we do.

But I don’t yet see technology driving distribution. It’s easy to see [this in China] where you have a new generation of investors growing up, [who are] maybe much more familiar or comfortable with technology. Maybe they as private investors are going to jump on this, but in Europe I’m not really seeing that happening. The money is in the hands of the 50-plus age group and they are not going to suddenly move to technology en masse.

Funds Europe – Looking at the European market, do you anticipate any changes in the dynamics of the markets and investor needs?

Mackay – The focus on sustainable investing has to grow because the regulation is going to force it to. It will become very difficult for groups to differentiate by merely integrating ESG processes or launching ESG products, so asset managers have to think carefully about how they will approach the issue in a way that proves their commitment and helps them to stand out in the crowd. It’s also going to be a big change for distributors because it’s another layer of rules that they’ve got to grapple with in terms of disclosure. They’re going to be looking for asset managers to help them do that.

Haxe – We tend to hear that private banks’ management requests from their analysts that they rate funds on ESG or sustainability. But these analysts will confirm to you that the end client is not really asking for it.

Mackay – And yet distributors will say their own clients are asking for these products – but whether they will actually invest in them is another question.

Shafer – There are two reasons why there has been success in the model-based world. One is because a lot of asset management companies spent years trying to add ESG funds to their platforms with limited success in terms of flow. At the same time there was this huge shift to sub-advisory in Europe in the private banking space. So, now that fund sales have pivoted toward a sub-advisory or investment mandate that sits in a model that’s been delivered to the discretionary teams around the world. That’s where I think most of the success is coming today. The advisory sale of ESG in a fund framework continues for most banks.

Ralston – The other dynamic in the demand for ESG will be that it goes from being a specialist area to a necessary requirement for any fund to pass the screens. You’ll still get some very differentiated ESG products, but in the main, it will be hard to distinguish a sustainable fund from a regular fund because the two will converge.

Funds Europe – Do people trust the funds industry and what needs to be done to improve this?

Mackay – I feel we’ve talked about this for two or three decades – and yet assets continue to grow. There are accidents from time to time, but Ucits is a trusted vehicle and we need to really guard this brand. The more regulators allow us to stretch the brand, the more likely that potential problems will arise. We can always better communicate with investors and, as products increase in complexity, the need for greater transparency becomes more critical.

Ralston – This year’s Edelman Trust Barometer raised two interesting points. One was that asset managers are now less trusted than banks and credit card companies, who have made quite a significant improvement in their levels of trust in the last five years.

The second was that if you look at asset managers and fund companies by geography, Europe is at the bottom of the table. China is the area where there is the most trust in fund companies, the rest of Asia and the US are somewhere in the middle, but the European countries are towards the bottom.

Mackay – How much of this is because we have become so disintermediated and that investors know their advisers but not necessarily their asset managers? They’re seen to be ‘the people who don’t really understand what they’re talking about’ in the background?

Ralston – Yes, and the complexity and size of the value chain means that only gets worse.

Creswell – Do we know in that survey who the distrustful people are? I’m curious to know who’s been asked that question, because people who own Ucits funds trust Ucits.

What’s interesting about the fund industry is it did not blow up in 2007; it was the banks, so there haven’t been disastrous performance results. There’s some noise around fee transparency and the value of active management, but I suspect that’s mostly us talking to ourselves. That argument doesn’t seem to have permeated. The press talk about it, but the people buying the funds seem to have a very high level of trust and we want to do all we can to preserve that.

Ralston – That dichotomy arises because those people who invest in funds have generally had a good experience and trust the platform, but the proportion of savers who invest in funds is tiny. So, the survey is picking up a large body of savers who trust the banks and have got deposits in banks, and don’t worry about the safety of their money, but who lack the courage to go into investment funds.

Funds Europe – Generally, the funds industry is seen as male-dominated. Is this your view and do you see this changing?

Creswell – As a matter of fact, there are a lot more men engaged in the higher echelons of the fund industry, but that is changing.

Mackay – As in most industries, let’s face it.

Creswell – As in most. There are a lot more men than women engaged in the industry, it’s just that the ones being paid more occupy the higher levels. Payden & Rygel, of course, is an exemplar of gender diversity: we have a female majority-owned board, we’ve got a balanced executive committee, and we’re all in favour of that.

Fiona Woolf, who was Lord Mayor five years ago, started a diversity programme. We were a founder sponsor of that. We had one of our regular industry breakfasts last week, and the industry is heavily engaged in doing research and beginning to unpick what are the barriers to better diversity.

My children are entering working life now. My daughter could easily have come into the City and got paid a six-figure sum because of her skills, but she’s chosen to go to a technology company. We’re searching for key people now, we hired a headhunter and I had to say to her – not that we’re going to be gender-biased in favour of female candidates – “We want you to go and find more female candidates.” Maybe as we’ve begun to focus on holistic components of our industry, that might make it less male-dominated.

Ralston – The industry has made strides at the entry level. Looking at some statistics the other day, 20% of CFA charter holders are women, but of the UK candidates for Level 1 in 2019, 50% were women. The initiatives with entry-level graduates are starting to have an impact on women applying for and going through the development process in the industry. Where a lot of work is going on is in persuading women who are already successful to stay, and a lot of that’s down to culture. The regulator and the FCA is very hot on looking at the culture of firms, and I think a large part of that is making investment firms more attractive places for women to work, like making sure that it’s easy to work part-time or work in a job share.

Creswell – Men have won the evolutionary race in our industry and so they determine remuneration, so you could have equal maternity/paternity leave, but if you’re the main breadwinner, you’ll still be the one going to work. We escalated remuneration for a number of female staff in our office, and guess what: a number are paid more than their husbands, so now husbands are doing more school-runs than they were before.

Shafer – Asset managers invest in companies in a lot of other industries, which means we can influence how they evolve and change. Again, this goes back to the people on the street: are we seen as helping influence other industries on gender equality and the topic of diversity beyond gender? Or are we just trying to figure ourselves out at this point?

Funds Europe – Over the next three years, how do you see demand changing and what new developments do you expect?

Haxe – We are spending a lot of time talking to clients about China. We don’t yet see as much demand, but we see a lot of interest. I’m sceptical about three years necessarily as a timeframe, but I’m sure people are going to get more comfortable with China. The Chinese bond market will be bigger than the US Treasury market.

Shafer – I would highlight technology and passives as points to watch.

Creswell – Today the ten-year German Bund is minus 0.6, Japanese minus 0.263, and the 2068 UK Inflationary Bond has a real yield of minus 0.206%. What I think we’re already seeing signs of in the strategy world is a number of people going, “What do I do just to maintain my assets in real terms?” Over the next three years, a lot of people are quite asset-rich, a lot of people have repaired their deficits to some extent, or they’ve sold out their pension funds, so there’s a sense of burying your hazelnuts and trying to make sure that the hazelnuts are still there in three years’ time.

Ralston – A similar point is that if demand doesn’t change, there’ll be a lot of savers struggling. If their retirement objectives are based typically on an inflation-plus-three type of return, and they’re investing now for liquidity and safety in government bonds yielding inflation minus one or two, then there’s going to be a big issue for the industry.

Funds Europe – If there is one thing you would like to change about the fund management industry, what is it?

Haxe – I think the best thing we can do for our clients is to extend their investment horizon.

Mackay – I would like to see much more industry-wide communication on the benefit of long-term investing.

Ralston – An end to performance-chasing. A lot of money tends to go into the best-performing funds, often the best-performing asset class. We as an industry are guilty of that, and there’s a national behavioural bias among savers. It can end up with outcomes where, as the Dalbar study in the US shows, the average saver gets a lot less than the S&P 500.

Creswell – I’d like to see a level playing field across regulators supervising our industry. When they don’t act in a uniform manner, certain funds like those we’ve seen having problems appear to perform well and we fail to attract assets because they’re doing great. The corollary is when they’ve folded, we receive a lot of that money, so there’s a clear disadvantage to any fund manager where regulatory supervision is not properly enforced and is not equally enforced.

Shafer – I would echo the point that this industry does care about all the key global topics that are happening around the world, that we are here to help clients achieve their financial goals first and foremost – but also that the industry continues to be seen by the next generation as an attractive place to work in.

Mackay – Yes, but I have to say, table football in an office doesn’t encourage diversity.

©2019 funds europe



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