Massimo Tosato talks to Nick Fitzpatrick about Schroders' brand-building in fixed income, how to confront declining margins, and why the purchase of a small Swiss asset manager will definitely not be a catastrophe.
Massimo Tosato recites a list of grapes that he and his wife produce at their vineyard in Capalbio, South Maremma, Italy. At the end, he says: “There’s also some vermentino, a light, crispy grape that young people like to drink.”
It is a pet project at present, but the vineyard may one day make money.
Away from this pastoral tranquility, though, Venice-born Tosato envisages a world where asset managers become factories, achieving industrial efficiencies on a par with Unilever. This is how they will cope with tighter margins caused by fund distributors, who are themselves coping with extra margin pressure.
As executive vice chairman at Schroders, the London-based asset manager and private bank, Tosato is a board member and global head of distribution.
Schroders is also a FTSE 100 firm and has been a leader of share price growth among its asset management peers for the past two years – and this despite having little brand name in fixed income, the fund sector that has dominated asset flows.
Outpacing the FTSE 100 by a mile and flushed with cash, Schroders has been on the acquisition path recently, partly to address this fixed income gap.
Cazenove Capital was, at least in the UK, Schroders’ most notable and most recent purchase – but that deal was more about bolstering wealth management than fixed income.
The deals that mattered to the 209-year-old firm’s bond business started with the outright purchase of California’s STW Fixed Income, a US investment-grade bond manager, announced in December 2012.
Then, in April this year, Schroders announced it had bought 30% of Secquareo Advisors, a Swiss firm. Through the deal, Schroders is able to add insurance-linked securities – very significantly, catastrophe bonds – to its institutional offering for the first time.
Secquareo is small. Created in 2007, it has ten employees and $350 million (€262 million) of assets.
By comparison, STW was founded in 1985 and has $11.9 billion of assets.
But the small Secquareo holds a lot of potential, says Tosato, due to an expertise in catastrophe bonds.
“We foresee a major increase in the size of the ‘cat bond’ market because of regulatory requirements that are pushing insurers to utilise capital markets to grow business rather than their balance sheets. We estimate the catastrophe bond market to be about $50 billion, but this will grow to $80 billion to $100 billion over the next five years. Schroders is looking to raise between $8-10 billion of these securities.”
Schroders has £255.8 billion (€298.5 billion) of total assets under management. Building the fixed income division, which is co-headed by Philippe Lespinard and Karl Dasher, is a key strategy that Tosato says the company has been investing in for five years.
He says: “We missed the trend in fixed income in 2009, 2010 and 2011, when the market was heavily concentrated in global fixed income demand.”
Tosato claims investing in the fixed income business over the last five years means Schroders now has one of the best strongest capabilities in the market.
As well as the potential of catastrophe bonds within Secquareo (Tosato says these bonds will be a good diversifier for institutions and family offices), STW brings intermediate and long duration bonds to the institutional offering, too.
Asset managers making acquisitions would have been unthinkable only a few years ago, with the exception of distressed sales, such as the UK’s New Star and Gartmore.
In its half-year results in August, Michael Dobson, chief executive, said Schroders was committed to organic growth over the long term and described the acquisitions of STW and Cazenove as “unusual opportunities to expand in areas of strategic importance”.
Last year, UBS downgraded Schroders from neutral to sell. As well as citing headwinds for asset management fees, the broker reportedly highlighted the low likelihood of Schroders making any deals.
Axing 30% off the value of Schroders’ £1.1 billion of surplus capital, UBS said: “Accretive deals or capital returns would, in our view, release part of the discount, however, management recently indicated that they took a long term-view on capital management and sensibly indicated that they remained focused on return on invested capital when doing deals; making these less likely.”
At the time, Schroders’ share price fell 35p to £15.08, but at the close of business on Wednesday, September 11, this year, Schroders share price was £24.80.
Possibly undervalued a year ago, Schroders has seen good share price performance since. Tosato says there are multiple factors to this, including investing in talent across the organisation – even in the crisis – and revenue diversity.
The Cazenove deal was a different scheme to the other two deals. Originally, the idea was to consolidate and build economies of scale in Schroders’ private banking arm. Following the Retail Distribution Review (RDR) in the UK, and low bond yields and interest rates, Schroders expects the private bank sector to go through an age of declining margins and consolidation.
Cazenove is a good fit, says Tosato, and explains why. “Our business was concentrated on ultra-high-net- worth customers – a part of the market that tends to have income and capital protection at its core rather than additional capital growth. This includes business owners selling up and retiring or inheriting money.
“But a major component of Cazenove Capital’s client base is in the £3 million to £10 million sector of people who are still actively accumulating wealth. Therefore the acquisition comes with embedded growth.”
Tosato adds: “We also soon realised Cazenove Capital had one of the best rosters of UK and European fund managers plus a successful multi-manager business. This is an exciting opportunity as multi-manager in the UK has consistently delivered up to 25% of gross advisory segment income in the last two to three years.”
Cazenove added nearly £19 billion of assets to the Schroders pot.
A major factor in Schroders’ share price growth is the diversity of its revenues. Two-thirds of revenues are international, says Tosato, and he claims “exceptional” business results out of Asia Pacific in the first half.
In 1999, two-thirds of revenues were from the UK. Since joining Schroders in 1995, a major task for Tosato was to build European intermediary distribution.
“Business was almost all from the UK in the 1990s and my job was to build in Europe.”
Consequently, and since about 10 years ago, he says, the majority of revenues have been from intermediary channels despite the majority of assets under management still being institutional.
Yet having engineered this outcome, it is now intermediary channels in the UK and Europe that are forcing asset management margins to shrink owing to regulatory changes putting pressure on the intermediaries’ own margins.
The RDR is expected to cause consolidation of financial advice firms as they focus on smaller groups of more profitable clients, or exit if they can’t. Similarly, the second Markets in Financial Instruments Directive (Mifid II) is expected to be a driver of change across Europe.
“Consolidation in the distribution channel and more transparency in the post-RDR and Mifid world means distributors will put pressure on fund managers. Over the next five years we expect industry margins to remain stable in the institutional channel and to decline by 15% in the intermediary channel. We are building our business models around it.”
To confront shrinking margins Tosato says asset managers will have to apply the industrial efficiencies of multinationals like Unilever, the household goods manufacturer.
“I think in an industry where margins are declining, we will have to focus on quality, costs and efficiency of processes, which implies a significant increase in technology investment. [Asset managers] need to achieve industrial efficiency on a scale similar to the manufacturing sector, which under went this process 20 years ago.”
This industrialisation will have to take place across firms, from front to back offices.
A key starting area, Tosato says, is in client relationships and the technology support for this area. Tosato laments that the asset management industry is antiquated in how it handles information about its customers.
“CRM [client relationship management] systems and data management around customers are primitive in asset management compared to industrial companies,” he says.
“Other industries know so much more about their customers’ behaviour and attitudes,” Tosato says.
Winemakers know younger palates prefer vermentino, but the suggestion must be that asset managers know less about their customers’ tastes.
Hopefully for Schroders, the catastrophe bonds it now offers to its clients will slip down quite nicely.
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