BGI Boffin gets unwired from high-tech

Yuri Bender looks for patterns in the track record of BGI’s Lee Kranefus and finds him combining creative products with a traditional approach.

Lee Kranefus, chief executive of exchange-traded and individual investor business at Barclays Global Investors (BGI), may be an electrical engineer by trade, yet he has twice turned his back on the technology industry. First, when he went into investment management, and second when he told wealth management clients to diversify away from high-tech stocks. “During the 1990s, I was advising asset managers to be aware of what was driving their performance and cash flows. You need good products, distribution and a replicable investment process,” believes Mr Kranefus. “It takes a long time to build up a track record, but only a short time after a negative surprise for customers to leave you.” Few took heed then. “I have met so many investors with portfolios down 75 per cent over three years because they had everything in technology,” recalls Mr Kranefus. “Over the same period, a basket of eurozone stocks or S&P500 shares was only down 10–20 per cent.” He cites these numbers as proof that diversification and asset allocation are the most important disciplines in product construction. “The long-term trend has changed since people fell out of bed after the tech bubble,” says Mr Kranefus. “They wanted to believe you could ride the wealth boom escalator by owning five hot stocks.” As head of US mutual fund business for $730bn (E657bn) investment house BGI, he is happy that all his products are based on these core principles. The funds being sold in Europe by John Demaine’s team have been developed along similiar lines. Intensive use of quant tools “Our goal is not to compete directly with traditional mutual funds,” says Mr Kranefus. “Most flows go to very large producers with a traditional approach. BGI’s active funds, on the other hand, are based purely on quantitative, multinational asset allocation models.” BGI has several ranges of open-ended quantitative funds sold through distributors and used for white-labelled products for banks and fund houses. The European funds, valued at E8.5bn, are based in Luxembourg, Jersey and the UK. While the processes were previously the domain of institutional investors, the funds are now being pushed through intermediaries and fund supermarkets, including Cofunds, Fidelity’s FundsNetwork, TD Waterhouse and Transact. “Direct sales to pension plans and endowments were our historical speciality at BGI,” says Mr Kranefus. “But we are increasingly creating financial services products such as hedge funds and unit trusts to sell on to others. There will be fewer pure institutional managers over time and more intermediary managers.” He does his best to scotch reports of an imminent change of ownership. He describes BGI as “a strategic part of the global business” for Barclays, which recently brought in Bob Diamond as chairman of the funds house. When BGI was formed through a merger with the San Francisco-based Wells Fargo Asset Management in 1994, it was clear from the personalities involved that the Californian quantitative tradition would be upheld. At the time of the merger, product designers favouring a more traditional, “creative” approach were overruled. “Sometimes the human mind can find patterns when there are none there,” warns Mr Kranefus. “The traditional active approach leaves too much opportunity for errors to get magnified. Investors need to know there is a disciplined, yet imaginative process, applying quant tools such as information ratios, risk measures and Sharpe ratios.” Distributors such as banks and insurance companies are increasingly examining these processes prior to adding external managers or products to their buy-lists, believes Mr Kranefus. Higher visibility Yet correct branding can be just important. “In the US, people didn’t know Barclays Bank, while in Europe, BGI – the fund management arm – had zero visibility,” he reveals. “We had a full push in the US and now we are moving ahead in Europe, so you could say we have consolidated our marketing efforts.” BGI’s cleverly packaged iShares brand of exchange-traded funds (ETFs) has taken off in continental Europe, following listings on the Deutsche Bourse. Earlier this year, the iboxx Euro Liquid Corporates fund, investing in a basket of 40 investment grade corporate bonds, was launched by BGI with initial subscriptions of E750m, making it the world’s second largest ETF product. “Even a $100m fund would be considered a grand slam home run in the US,” reflects Mr Kranefus. But Europe’s investors still have little knowledge of these products and need to be educated about how and when to use them. “Bond index funds may sound boring, but investors need credit exposure with current low interest rates,” he says. “Five years ago, people held five bonds and thought they were diversified and that investment grade would never go bad. There have been plenty of surprises since then.” Instant exposure These iShares products have grown from zero to $40bn over the past three years, offering investors diversification and instant exposure to markets and sectors through a single trade. “We provide a tool set for wealth advisers who deal with retail clients. We also give them an asset allocation mindset to achieve their goals,” says Mr Kranefus. “We can help them shift around their portfolio, design their allocations and use iShares to implement them.” ETFs will eventually provide the ultimate open architecture solution, he believes, because an investor or intermediary can approach a broker and immediately buy from a choice of quoted funds. “Among financial professionals 100 per cent know about ETFs – and can describe the features. But only 1 per cent of investors are using them,” says Mr Kranefus. Outside the US, this number is much lower. That’s why his team of 50 sales people are explaining the business model to distributors. “It’s a consultative approach, aimed at identifying obstacles,” he says. “Some distributors don’t have the right structure in their client accounts and can only trade stocks and bonds. They don’t know how to do the paperwork for ETFs. But we can help them with this. It is often nothing to do with the investment product. It means working with each individual distributor, answering technical questions about settlement. How does this work better than what you are doing? This has been the problem.” According to Mr Kranefus, ETFs allow a true democratisation of financial services. “Retail investors have traditionally paid high fees for mutual funds, while institutions are treated more favourably, paying fees based on their large balances,” he says. “But with ETFs, exactly the same product is available for retail investors as for institutions. Our institutional discipline drills down our process and allows us to create a really good quality investment fund. Every individual can now access BGI. Previously this was only available to a few institutions worldwide.”

Discipline’s the watchword Lee Kranefus joined BGI in 1997, after spending six years with the Boston Consulting Group in San Francisco, focusing on retail and institutional financial services clients. Prior to consultancy, Mr Kranefus worked in technology. “Coming out of electrical engineering, my background is in the disciplined search for patterns,” he says. “Finance is extremely quantitative these days. Keynesianism has largely been replaced by the structured approach. The old ways may not have gone completely, but people are much more disciplined in deciding how much of their performance is value added and applying a much more disciplined mindset to get it.”

Kranefus: ‘People wanted to believe you could ride the wealth boom escalator by owning five hot stocks’