Banking on guided architecture

PWM: The mutual fund industry in Germany has been traditionally dominated by the banks. Have you seen any changes in the way these distribution channels operate?

Tim Blackwell: The main distributors are clearly still the banks, which control around 75 per cent of the mutual fund market. It is expected that IFAs [independent financial advisers] will continue to grow in importance over time, but it will be a slow process. At this moment in time, where there has been certain volatility and uncertainty in the capital markets, end clients are looking for safety and stability. Banks have been able to regain their reputation of being trusted advisers.

Marianne Loner: In general, all across Europe, business lines within financial institutions have changed their use of third-party funds. For instance, originally third-party funds where used in funds of funds as the starting point for OA [open architecture], and that has moved to the advisory and, for some firms, to the discretionary channels. So now, OA is represented in everything from institutional to retail. This is a very important change that we have seen over the last few years.

PWM: Are there any aspects that make the German approach to OA different from what is happening in other countries?

ML: The starting point is different. Historically the UK has been the most advanced country in terms of OA, and today it is a pretty established practice, called polarisation, among most institutions. The rest of the continent followed a few years later. In Germany, OA has only been around for a couple of years.

There are also differences in terms of practice. While most of Europe is still involved in full OA looking at the entire funds universe, the advisory channels Germany has mostly, but not exclusively, embraced guided open architecture [GOA]. There are two key reasons for this: first, the costs of educating the client advisers of financial institutions about the entire universe of fund providers are prohibitive; and, second, it is not feasible to expect that client advisers can discuss with their end clients details about the universe of fund providers and their funds. For these two reasons, financial institutions seeking to open up in their advisory business are looking towards GOA.

Another important difference is that Germany is allowing OA down to the retail branch level, whereas the rest of Europe is concentrating on the private banking and funds of funds channels.

Blackwell: ‘demand for OA from clients’	Loner: ‘OA at retail branch level’

PWM: GOA is all about choosing the right partner to enhance your firm’s capabilities. Which are the main criteria that distributors take into account when selecting a partner?

ML: Firms look at qualitative and quantitative reasons for making the partner selection. Qualitative reasons typically have to do with the financial strength and stability of the possible partner, the brand, the ability of that partner to provide a broad range of general and specialised products, and the ability to provide local and global support for marketing campaigns. And then, of course, they want a good deal in terms of financial conditions especially when they are a large size player.

In terms of quantitative criteria, each firm has research teams that look at the specifics of different funds across the asset classes. For instance, they will look at the risk/return relationship of any particular fund, the strength of the investment process (replicability), and relative performance. Distributors may also consider other strategic criteria in picking third-party providers as partners to end up with even better diversification and value added capabilities across their fund ranges.

TB: In addition third-party providers must often offer a comprehensive servicing approach to the distributors seeking to sell products through the advisory channel. They have to be able to enter into a very deep dialogue in terms of marketing support and product development. This is something which requires a large degree of attention and ultimately much of the selection from both parties’ sides is driven by whether this level of attention can be given or not.

PWM: The idea of working in partnership with a global investment powerhouse is always attractive for distributors. How can firms benefit from this?

ML: Some firms use funds in a satellite approach or to achieve tactical asset allocation shifts. Others use them for specific investment campaigns or as building blocks for their portfolios. Being such a large firm, with almost every asset class represented, we are able to offer our partners a full range of products which can be used in multiple ways so partners can develop the right solutions for their business.

However, fund selection is only part of the process. We find that many of our most important partners are very strongly committed to product development, so OA is moving beyond GOA into joint product development and in some cases co-branding. Intellectual capital counts!

TB: I think that the status we have both as a global fund house and as a local organisation in Germany means we may often be regarded as a ‘natural’ candidate for these type of intimate and resource-intensive strategic partnerships.

Germany is the third largest mutual fund market in Europe, and this strategically makes it a very important market in terms of the potential for growth. We clearly see the opportunity for a house like ours to remain a recognised preferred provider in the marketplace. Also the fact that UBS, as an organisation, doesn’t have a retail strategy in Germany makes us a natural and less threatening partner.

PWM: How is your experience in Germany, and in particular your partnerships with Deutsche Bank and Commerzbank, impacting on your presence in other European countries?

ML: Clearly leaders in the industry across Europe are looking at these partnerships and want to know where the success has been and why. Names such as Deutsche Bank and Commerzbank clearly enhance our credibility as a preferred provider to other potential clients in Europe. We are seeing that very successful, high profile partnerships like these are having the impact that banks in other markets are taking a look at the pros and cons of moving from OA to GOA, especially in the advisory business.

Furthermore, because we serve many of the world’s largest wealth managers, including our own in-house wealth management organisation, private banks recognise that we understand their business and therefore can bring a high level of insight and investment capabilities into their firms.

Across Europe we have only a handful of pan-European, or even global, partnerships. This is a very deliberate strategy of ours: we concentrate on large global firms to which we can bring a significant amount of value-added, beyond just product sales. This strategy requires considerable dedication resources and asset growth to achieve the needed scale for profitability, which is why we limit ourselves to a handful of partners.

PWM: What are the main trends in the marketplace in terms of the products and solutions distributors are looking for?

TB: In terms of business growth, this has been a difficult year. Looking at the overall industry figures the outflows from equity funds and the focus on fixed income and money market funds have been quite challenging for the German marketplace. Also you have the trend towards the use of structured products and certificates. However, in the medium to longer term the trend towards savings for pension provision and individual savings will support the growth in mutual fund solutions.

Further, even if there are outflows in equity funds, a provider like us can still be successful if it offers a targeted solution fitting a specific theme or need in the equity products space, which is not to forget absolute return products are becoming more and more important. And in response to the trend on structured products we can provide innovative structured solutions using funds.

ML: In addition, most of the world’s private banks have made a strategic commitment to increase their exposure to alternative investments. Until recently most of the shelf space in alternatives has been occupied by in-house products, but in the last year firms not only have increased the percentage dedicated to alternatives, but have also started looking for third-party providers. As a consequence, we are seeing several of our relationships, originally launched around long-only funds, expanding into the alternatives’ area.

TB: Following the new treatment of hedge funds in Germany under the new investment regulations we have been working on a project to put in place a fund of funds solution based on German law. The global expertise that we have in alternatives is the basis for this locally-developed wrap solution which we expect to launch in the first quarter of 2005. This will leverage the investment expertise of our existent alternative and quantitative platforms and meet a strong market demand.

PWM: Talking about the near future, are we going to see further developments in OA in the months to come?

ML: We see relationships intensifying and deepening beyond just providing products. Innovation is a major driver as this creates investment solutions for the end client. OA will continue being a continuous source of growth for us and our partners.

TB: Fund distributors sometimes look at sub-advisory arrangements as a way to achieve OA in terms of labelling and branding. We might see a trend where in-house managers will change their infrastructure and production capabilities and look for a sub-advisory type of agreement.