European distribution takes a step back in time

This year European distributors will move away from an open architecture back to guided architecture, taking the industry back to where it was five or six years ago , according to Cristobal Mendez de Vigo, group head of distribution and business development of F&C Investments. Speaking about the challenges that 2009 presents to Europe’s beleaguered asset management industry, Mr Mendez de Vigo said banks - which in continental Europe remain the main distribution channels for investment products - will favour in-house solutions, including funds or saving deposits linked to funds, to try “to shore up their customer base”. There was evidence of this trend already in 2008, he said. “This means much more competition for us asset managers and much more focus to be able to gain a share of a much smaller pie,” he said. “Banks will be much more difficult to penetrate”. In the UK, where industry regulators are pushing for independent financial advisers to provide transparency and best of breed solutions, fund managers can still compete on a more level playing field than the rest of Europe, believes Mr Mendez de Vigo. Fund managers houses will then have to revisit their business models and their core strengths. “We expect fund management houses to really go back to focus on what they have got, on retaining their existing customers,” he explained. Compared to last year, product development will decrease by more than 40 per cent in the fist half of 2009, making fund managers much more selective in their product launches, he predicted. It is vital therefore, to identify the market trends. Investors will be looking for sustainable protected capital and income generation, said Mr Mendez de Vigo. Lifestyle opportunities will also be popular. “There will always be pockets of investors who will be requiring high alpha seeking products that command a higher fee. But those are the niches that will be added to what is primarily a conservative, derisked, much simpler portfolio of income, capital protection and absolute returns,” he said. The niche offerings will include themes like emerging market debt, global convertibles, climate opportunities and Asia, which can allow investors to participate in returns, when markets recover. Time to focus For F&C this year is going to be the year of “focus”. Having created investment expertise and built up new distribution channels and entered new markets, like Italy and Spain, “this year will be about spending time and focus on that work to see it develop.” F&C has positioned itself as a player on niche offerings. “It wouldn’t be wise to try and immediately start distribution strategies playing the main stream offerings in countries we just entered, like Spain and Italy,” he said, “because there are too many competitors.” Strategically, Mr Mendez de Vigo said F&C will be spending time talking to many small or mid-size banks in Europe about outsourcing options. “Many banks will come to recognise that they are very good in distribution and client relationships, and that’s where they should focus.” Michael Jones, head of European financial institutions at Janus Capital Group, believes “banks and insurance companies and the big distributors are going to seek to protect their revenue by keeping as much as of their revenues in-house rather than favouring open architecture, which allows revenues to creep out of the doors.” But he believes this is a short term reaction and when markets return to a more normal environment, open architecture will revive. Perhaps the asset managers who will more impacted by this retrenchment in the use of external providers will be those that have their funds available on open distribution platforms. Players, like Janus, who distribute cross-border mainly through wholesale distributors, where the decision on which funds to employ in clients portfolios is made by investment professionals, - such as funds of funds, manager of managers or portfolio managed services, - will be less impacted, claimed Mr Jones. Gavin Ralston, chairman of Emea at Schroders identified two distinct conflicting trends in the market. One is that many banks have put their asset management businesses up for sale so that “they will permanently get out of offering proprietary products.” And secondly, that a higher demand for fixed income products always tends to be associated with a lower use of external providers. “It is a cyclical reduction in the use of third-party funds. We saw that in 2002-2003 and we are seeing it now,” he said. “Most commercial banks tend to have particularly strong capability in fixed income, so naturally when the fixed income weight goes up, the use of internal products goes up with it.” Demand for alpha Mr Ralston believes there will still be a search for products delivering strong and consistent alpha and when managers start allocating more to equities, they will continue to seek high alpha. Andreas Feller, head of private banking wealth management solutions at Vontobel Group wants to dispel the myth that open architecture is not profitable for a distributor, because third-party providers pay a commission to the bank distributing their products. Although he admitted that “from a group perspective using own funds would be more profitable since the share of wallet is 100 per cent with the same group,” clients do expect independent and transparent product selection from private banking boutiques like Vontobel, said Mr Feller. “Hence a large part of our value proposition would be eliminated and we couldn’t cope with such a fact. Our stance towards open architecture has not changed.” Moreover, the risk of ‘in-sourcing’ back in-house is that in-house production may be of insufficient scale and profitability and that would be very short-lived, believes Mr Feller. The consensus is there will be a significant consolidation in the asset management industry in the next 12 to 18 months. This may be for cost efficiency issues or because financial organisations realise asset management is not part of the core businesses. Big distribution firms will probably merge, sell off or close down functions in their asset management firms. Indeed the recent announcement from Société Générale and Crédit Agricole that they will combine asset management operations is a clear indication of this trend. Mr Feller at Vontobel Group, which manages SFr113bn (E76bn), has a contrarian view. “I don’t think that banks (unless perhaps the very small ones) will exit asset management. You still have to provide a proper investment strategy and process and portfolio management to the clients. And bottom-up views from fund managers are part of such investment process.” Also the jury is out on which asset management model might be the emerging winner from this crisis. Mr Feller says that while active investment boutiques investing in a couple of sectors will survive and benefit, boutiques with only a “one pillar strategy” might suffer, because of the decline in assets under management. “Ultimately active asset management companies with sustainable alpha will benefit,” he said. Specialised sub-advisers, typically in the area of real estate, private equity, infrastructure, or some dedicated emerging markets will be the winners, according to Mr Feller. “Large companies tend to follow the benchmark. From an investor’s point of view, I’d rather go for cheap replication via ETFs than buying funds with little tracking error.” Tough for boutiques Mr Mendez de Vigo at F&C believes large managers will be favoured. “While the period 2005-2007 was the big moment for boutiques, for very specialised concentrated fund managers, they will now be in a tough position versus large managers, who have specialist teams across the firm and they can offer a variety of product ranges to clients,” he believes. According to a study from management consulting firm Oliver Wyman, the satellite model embraced by active niche players will not disappear but will evolve towards a multi-satellite version, in which a number of players will combine their expertise to acquire scale, thus reducing risk and earnings volatility. In addition to pure “core” players, like ETF managers, those who will emerge stronger will also be “industry consolidators”, who are those firms, both domestic or international, able to aggregate the best abilities available on the market and gain access to distribution - which is often the main asset of small captive asset managers - gaining size, scale and brand recognition.