Selecting the right product

Guided architecture, which involves teaming up with a limited number of product providers, is fast becoming the favoured option for European distributors wanting to offer third-party products. This model, which promises to give investors access to best of breed solutions, enables distributors to retain client loyalty and at the same time maintain a comfortable business, says Diana Mackay, CEO at Lipper Feri. Distributors can claim to add value and justify their retrocessions and charges.

A strong implication deriving from this has been the need for setting up professional fund manager research teams and engineering sophisticated selection processes, often including a quantitative screening followed by a more in-depth analysis.

But what are the criteria adopted to differentiate the best of the best in this continuously expanding ocean of new products and managers?

Performance, identified as the top selection criterion by an overwhelming majority of distributors in recent PWM fund buyer research, is certainly a necessary but not sufficient condition. “If you don’t have performance, nobody is going to look at you, but if you do have performance, you’ve still got to have more,” believes Ms McKay.

A TOTAL DISTRIBUTION RELATIONSHIP

And more and more big bank platforms are taking a very holistic view of asset managers. They want a total distribution relationship, not just a product push, but actually proactively being involved in helping them build their business, says Ms Mackay. “They are interested probably more in a broad-based robust investment process across all funds than in terms of specific performance on individual funds.”

Indeed, a solid investment process across the breadth of product range is an important differentiating factor for a company to be selected but also to remain as the privileged partner.

At DekaBank, the ten partners (Franklin Templeton, Gartmore, Goldman Sachs, JPMorgan, Lombard Odier Darier Hentsch, BlackRock Merrill Lynch, Schroders, Swisscanto, Threadneedle, UBS) that contribute to the German bank’s funds of funds were selected ten years ago and have never been replaced. “We selected those partners, regardless of their brand name, as they completed DekaBank’s range of products,” says Steffen Selbach, head of fund of fund business at the German bank.

The reason the manager list has never been changed or expanded is because the combination of their product range is such to cover any sector or segment necessary to build Deka’s main fund of fund business, composed of 1000 different products.

“Those ten partners are sufficient to cover everything that the capital markets could provide you with. I could not point out any single incident where we wanted to invest in a certain field of capital market and we did not have a fund for it. If this had been the case, we would have thought of getting other partners on board,” says Mr Selbach.

Having the possibility to access managers is definitely an important differentiating criterion at Popular Banca Privada in Spain, the joint venture between Dexia and Banco

Popular, where third-party funds represent 50 per cent of the total fund assets.

“Two, three years ago clients used to think that open architecture was the solution to their investments, and we used to have more external funds because of client demand,” says Javier Gefaell, CEO at the Spanish Bank. But today, especially with volatile markets, clients have a neutral opinion with regards to open architecture. What they are interested in is performance, he adds.

It is therefore important to have a close relationship with a limited number of well established providers, with which a bank can sign distribution agreements, to offer direct access to the fund management organisation or the managers themselves. “For example in this recent turmoil one of our big houses, well established, with great reputation, has been extremely opaque and we have cut exposure to them immediately,” says Mr Gefaell.

“Transparency is key, it is not only performance that matters to us. Also, if one of our big clients need to see the manager, if something is not working, we need the fund manager to see him and explain what has happened and why he has made those decisions. For us this is very important,” he says.

Past performance no guarantee

Georges Wolff, head of fund manager selection at ING Private Capital Management in Luxembourg - responsible for the selection of the best funds and sub-advisors to be used in ING private bank discretionary managed portfolios, its funds of funds structure as well as its advisory business - explains that past performance, which is the focus of quantitative analysis, is certainly not the guarantee for future performance.

“Nevertheless it enables distributors to screen the best performing managers. Analysis on performance enables us to understand how it was generated in the past, whether it was consistent, and assess the behaviour of the fund manager in different market environments,” he says. Three managers short-listed in any asset class from the quantitative process, are taken through the qualitative analysis, which gives insights whether performance is repeatable in the future. A best manager is selected, but the other two are kept on a substitute list.

‘The sense of qualitative research is to accept that there are different styles and different methods and then you go pick up what you believe is the best’ - Werner Wiedenbrig, Erste Bank

“Unfortunately there is today a lot of market pressure to look at 12 month performance,” says Mr Wolff, “although that is not in line with the investment horizon of most of the fund managers, which would be typically between three and five years or a full market cycle.”

The main reason for changing managers would be performance, but also changes in the organisation or key people leaving, which can jeopardise performance, he says.

Rushed decisions

Qualitative factors are also taken into account. “I think you can make a lot of mistakes when you take a very fast decision that is only based on performance, especially when you look at very active managers,” says Mr Wolff, explaining that short-term underperformance can be due to active bets not being rewarded by the market.

“What is very important is knowing the manager, how he takes his decisions, in order to be able to assess, when the performance is lagging, whether there is something abnormal that should bring us to the decision to cut it or it is something that we have seen in the past and it is in line with the manager style.

“On the fund side, we have very strict rules, where we have a tolerance of underperformance and after that, if we still see the performance deteriorating, we will cut the position,” says Mr Wolff.

For a sub-adviser, for which one of the important selection criteria is his experience in running segregated mandates and from which in addition to full transparency, they expect to be able to produce a even more tailored personalised reporting, they are a bit more generous, he says.

One factor that can affect the manager selection process is whether the fund company is centred around star managers, relies on a team management approach, or even employs a quantitative model.

Mr Wolff says that all models have a risk. “For the star manager organisation, it is obvious that there is a strong key personal risk, but for the pure quant manager you have the model risk, and last year there were some important problems that occurred with quant managers that had huge impact on performance too.” The team approach, on the other hand, could mean that there is no clear ownership of the decision-making process which could lead to average performance at best.

“I think it is important for us to really understand the process and clearly identify the risks and how they are managed. But as a fund selector, it would be a bad idea to prefer systematically one type of organisation to another because it could bring you to have a very biased approach,” says Mr Wolff.

Neverthless fund selectors do have their preference. “I prefer the team approach because it gives me a better feeling that the fund will continue to perform well in the future,” says Werner Wiedenbrig, chief product officer at Erste Bank, making reference to the possibility of a star manager leaving the company. In addition star managers can make mistakes, he says.

Mr Wiedenbrig, responsible for selecting funds, which are sold both off the shelves and in the fund of fund business of its Sparkassen network, starts his fund selection process from a universe of about 1500 long-only equity third-party funds. These are all the funds registered in Austria fitting in one of their 40 predefined investment vehicles, defined in terms of region, style and so on. If private banking clients ask for a particular product, they will do separate analysis on that as well.

Similarly to Mr Wolff, the quantitative analysis is just a filter, which allows Mr Wiedenbrig to do a ranking of the top 10 for each vehicle, for which they recommend a maximum of 3 funds as well as the best every quarter. Mr Wiedenbrig says that from a quarter to another, 20 per cent of funds are replaced in their recommendations for the advisory segment.

Luck or judgement

If a fund ranks top according to the quantitative model but we don’t understand why the fund is better than the rest, we do not recommend it, he says. Understanding why a manager has performed well in fact means understanding whether “this is a function of good luck or function of good work.”

“That’s the sense of qualitative research, to accept that there are different styles and different methods and then you go pick up what you believe is the best. You can’t compare one with another, you have to research into it and understand whether that is a sales story or a true story.”

So transparency, good communication and being able to respond with quick and deep information when it is needed is paramount, according to Mr Wiedenbrig.

Overall financial stability of the manager, performance and flexibility are the top three selection criteria for Banco Poste Fondi (BPF), the fund management firm part of the Poste

Italiane group, explains Massimo Sarmi, CEO, Poste Italiane.

Flexibility means that the manager selected - and large fund companies offering a wide range of products are favoured - has to guarantee a constant flow of information to the specialists of Banco Poste Fondi .

“When we select a manager we reserve the right to intervene and often we exercise it, when it is necessary to take important decisions on operations to do on the market. Therefore the manager has to inform us in real time of the initiatives they take, which is what enable us to take some essential decisions together,” says Mr Sarmi.

The firm employs Pioneer Investments and CAAM to run, with different degree of delegation powers, the totality of its E3.27bn in mutual funds, which are offered to clients through only a few thousands of the 14,000 Italian postal offices. The plan is to extend technology support and progressively train personnel to make it possible to offer these types of advice based products to all offices, explains Mr Sarmi.

Trust in the brand

These funds are created exclusively for BPF and the brand of the external manager is not important. What counts is Poste Italiane brand, says Mr Sarmi. “Italian savers trust Poste

Italiane brand, they know they can expect security and simplicity from us when investing in our products.”

The great majority of Poste Italiane clients invested in funds go for bond or balanced funds, says Mr Sarmi, but unlike some other Italian banks that claim to be looking to implement strategies to migrate the very risk averse Italian investors versus a riskier or more efficient allocation, Mr Sarmi says that that is not the case at Poste Italiane.

‘When we select a manager we reserve the right to intervene and often we exercise it, when it is necessary to take important decisions on operations to do on the market’ - Massimo Sarmi, Poste Italiane

“We are more prudent, we are considered as a safe form for savings. If our client loses money, he thinks that is due to bad management, and not to the equity market going badly,” he explains.

At Poste Italiane, assets in managed savings, including mutual funds and some form of insurance products are over E21.7bn - and insurance products take the lion share with almost E18bn. This total figure represent less than 10 per cent of the total savings and investment products offered by Poste Italiane, including structured bonds, postal savings certificates and postal savings books.

“Today, we still have E75bn in traditional postal saving books,” says Mr Sarmi.