Picking and choosing to maintain principles

Most big, cross-border investment groups pride themselves on being able to deliver whichever strategy their clients desire. They want to react to changing market circumstances, and quickly put the right funds on their distributors’ shelves.

Not so T. Rowe Price, the conservative Baltimore-based funds house managing $245bn (e200bn), which is increasingly making a name for itself in selected European markets.

“There are many funds in Europe with assets under $50m, which cannot earn the full management fee,” says Todd Ruppert, CEO of T. Rowe Price Global Investment Services, in an interview during one of his regular trips to inspect his Queen Victoria Street offices at the heart of London’s Square Mile. “Six organisations over here have more than 300 funds for which they are paying out administration expenses. Many of these must be unprofitable. If one of our investors wants a standalone Russia fund, and we add that to our Luxembourg Sicav range, how will that benefit the shareholders? At the end of the day, it doesn’t.”

Mr Ruppert believes in strict management of these expenses to maintain lean and profitable product lines at T. Rowe Price, which announced profits for the first half of 2005 nudging $200m, on the back of a $9.6bn increase in assets under management since the beginning of the year.

“Among our distributors, there is currently a clamouring interest for a natural resources fund to add to our European Sicav,” says Mr Ruppert, referring to an area in which his group has been involved Stateside since 1969. “We have a great story to sell, with a phenomenal track record. And there is great interest from Europe, but not from strategic investors, but tactical players who want to catch some juice while they can. We know that money will just race in, and then race back out again. We would be left with a smaller fund, adding huge operating expenses.”

Keep costs low

Mr Ruppert is clearly proud that his European operation has gone against the product proliferation trend followed by many competitors. “We only have 13 funds in Europe, and the O&A [operations and administration] expenses are generally between 10 and 20 basis points, 25 at the high end, so we have managed to keep costs pretty low.”

T. Rowe Price has decided against launching new products, which could severely damage profitability. Those who think he is turning away good money may be even more surprised to learn that Mr Ruppert only wants to deal with those sales outlets who can provide the right sort of business.

It is common currency in the long-only world that distributors and their clients choose their funds and manufacturers. In the hedge funds arena, where there is a capacity shortage, it is supposed to happen the other way round. However, Mr Ruppert believes that traditional fund managers should increasingly make a smart choice of which distributors they do business with, rather than the other way round, if they want to protect their reputation, smooth their inflows and efficiently manage their business model. He has recently closed his US small cap and US high yield finds in Europe, where his staff are now focused on selling their large-cap US equity, emerging markets and high alpha global equity capacity.

“As an organisation, we will now close a product if we believe the velocity of cash flow will be disruptive to existing shareholders; in fact we close products very often,” reveals Mr Ruppert.

“Most fund managers, if they have capacity to take on international assets, they will be taken on. But after the mutual fund scares and scandals, we have been applying greater scrutiny in working with partners that match up to the values we have here as an organisation,” says Mr Ruppert.

“We have an excessive trading policy at T. Rowe Price. We don’t want individuals or institutions moving in and out of funds rapidly. If they do, we ask them to leave.”

When BNP Paribas’ fund selection unit recently said it had replaced T. Rowe Price as manager of its high yield assets, the French house led observers to believe that this was due to a mismatch of expectations in terms of preferred fund management styles.

Mis-used by investors

While Mr Ruppert is far too diplomatic to comment specifically on this incident, he questions the assumption that relations are dissolved or created on the distributor’s terms. He says that white-labelled, single fund products can typically be mis-used by investors, and it is much safer for manufacturers to be involved in asset allocation driven products, with a multi-manager approach.

“If you offer high yield bonds in a low interest rate environment, institutions will utilise the fund as a trading vehicle. But it is an illiquid asset, and excessive trading will make it very difficult for existing retail clients if institutions are going in and out. Trading costs go up, there is aggravation for our trading desk and it hurts existing investors.”

Fund groups active internationally are particularly at risk from such irregular trading practices, says Mr Ruppert. “In India, sophisticated investors of corporate cash make massive savings by taking advantage of daily changes in the interest rate environment. For buy-and-hold, long-only investors, it is extremely disruptive, and not good business to have on your books.”

Certain asset classes such as emerging market debt have been particularly vulnerable, he says. “In the high yield area, we are trying to find mis-priced bonds, identifying a double B security being revised to triple B. But if all of a sudden, the fund experiences massive redemptions, you can lose an arbitrage which has been smashed out.”

Although T. Rowe Price has depended on third-party distributors for attracting more than a quarter of its global assets, Mr Ruppert is clearly not happy with their behaviour. In fact, many of the accusations of malpractice, which observers throw at manufacturers, he believes really should be directed to the intermediaries.

“If we look at some of the practices of distributors today, many are more concerned with short-term profitability than their clients,” he maintains. “They are fiduciarily obliged to look after their clients’ best interests. Their services are not a cash cow to grease their own pockets. Assets need to be secure in the care of a distributor.”

Mr Ruppert describes a downward spiral, which is far from over, starting in the late 1990s, when local banks offered “high octane stuff” which eventually scared investors away when the market crashed.

“Now these disillusioned, shell-shocked investors have foregone capital appreciation in favour of capital protection, leading to an explosion in structured and capital guaranteed products. Many distributors are selling them responsibly, but others are force-feeding investors, who have no idea what they are buying or the egregious fees they are paying. This is a big problem today.”

And although manufacturers must choose their distribution partners responsibly, it is almost impossible to influence their choice of product. “It is very difficult to dissuade distributors from offering x, y or z,” says Mr Ruppert. “We could have told German banks that it was a great mistake to sell high octane technology funds in 1999. But they would have kicked us out of the door, as that that’s what was selling.”