Size matters and matters of size

There are almost 30,000 mutual funds on offer in Europe – three times as many as in the US, yet total European mutual fund assets are only half of the US amount.

In any discussion on the reasons behind this, local cultures and practices will always surface. There are also questions about the difficulty of trying to attract the savings euros and the profitability of trying to do so.

A current reality, right across the European fund industry, is that despite various warm words of support for increased pan-European product integration, the vast majority of fund houses are hidebound by local market dictates. Be they local tax aspects, territorial xenophobia, protective domestic marketing or the never-ending fashion parade pressure to launch new products (despite complaints about product proliferation).

To be able to feel comfortable on various of these fronts, and perhaps be able to take a more objective pan-European view, groups must have domestic critical mass. But how much mass is needed, how should it be structured and how might it compare with peers either at home or abroad?

The following study focuses on the five key headline profiles of five of Europe’s key markets: France, Italy, Germany, UK and Spain, also taking into account the Luxembourg or Dublin funds whose parentage is from these countries.

Comparing the type and number of funds in issue (Table 1) gives an immediate indication of local market preferences and practices, or does it? France seems stronger than the UK with regard to equity funds, for example.

But analysis of assets under management tells the real story about local market appetite (Table 2). Money market fund usage in France has long been a noticeable prime feature, currently taking a 41 per cent industry share, as have the property fund followings in Germany (18 per cent) and the UK’s predominant leaning towards equity funds (74 per cent). But newer dynamics are also visible.

Cultural differences

German investors’ swing towards equities may surprise greyer-haired readers who remember Germany as the bond fund fortress. Funds of funds, using third-party funds are preferred by French investors, whereas Germans choose the proprietary variety. In Spain guaranteed funds have 24 per cent market share.

These observations highlight pan-European cultural differences, but how can they be translated into fund sales and added value for investors?

Average fund size might be a starting point (Table 3). The analysis of Table 3’s results seem to suggest that in each country, and in each sector, the size of average assets provides sufficient scale for an investment group to gather enough assets to at least be able to survive as a mid-stream player. The challenge seems not too daunting and although money market and property fund sectors would need careful examination, in most other sectors, if given a little time, it would appear a fund asset size of between €50m and €100m would be a credible play.

The recent introduction of hedge funds of funds, as well as straight hedge funds into the retail arena is easily spotted in the table by their lack of critical mass, but they are beginning to gain recognition.

However, average numbers can deceive if skewed by large individual funds or a plethora of smaller funds. An analysis of the percentage of funds below average size in each sector creates a sharper, slightly worrying, reflection of market dynamics (Table 4).

The percentages of funds in each sector with below-average assets are themselves averaging around 70 per cent. Even in the money market sector – the easiest management style to undertake – the below average analysis ranging from 58 to 83 per cent is surprising.

What these numbers mean is that at the lower ranking end of each sector, efficient business modelling is tough for the fund managers involved, and looking beyond them, the delivery of reasonable portfolio management costs to investors.

The immediate conclusion is that too many funds are on offer to retail investors and the never-ending endeavour by fund groups to compete domestically, on as wide a front as possible, is delivering neither scale nor internal value.

There has long been a hypothesis that it is not profitable or efficient for a manager to run a retail fund with under €50m. Deeper study of percentage of funds below this benchmark (Table 5) makes for stark reading, and ought to make product development, marketing, sales and finance directors think twice before launching new products.

If overall asset size analysis (Table 2) indicates sufficient investor appetite to support the industry as a whole, then underlying statistics on sub-€50m funds plainly show pulling power is concentrated in very few hands in each sector.

In Spain, for example, high percentage figures for sub-€50m funds look particularly frightening to anybody wanting to create domestic business. The two leading banks, Santander Central Hispano and BBVA together control nearly 50 per cent of Spain’s mutual fund assets. They took in 54 per cent (€11bn) of all new fund launch sales in 2003, almost €5bn of which went into just three guaranteed funds.

Plainly, no single group has leading expertise in every sector and larger groups can afford to harbour a certain number of small, unprofitable funds in the hope they can grow the asset base or maintain the status quo as a loss-leading market positioning statement.

Changing patterns

Without further analysis a general assumption might be that numbers of sub-€50m funds carried by any particular group at the top end of the fund community would be relatively small. To test this hypothesis, each country’s fund ranges were analysed by attribution at ultimate parent group level and numbers of funds in the total fund range that are sub-€50m calculated as a percentage of the whole range (Table 6).

The “relatively small” hypothesis is blown apart. The top quartile of the biggest fund groups in each country shows surprisingly large sub-€50m percentages: France 60, Germany 53, Italy 42, Spain 59 and the UK 29 per cent. Examine the second quartile and percentages obviously increase as overall size of assets in fund ranges declines, 69, 61, 54, 84 and 38 per cent for each country respectively. Don’t even ask about the third and fourth quartiles.

Differences between industry styles in each country become apparent. Europe has very strong tradition of banks as dominant financial product manufacturers and providers, except for the UK, where the industry grew independently and, until recently, banks did not compete in this space.

Due to various mergers and acquisitions, this pattern is changing but the legacy is that in terms of fund sizes, the UK is more robust than its European neighbours. France, with over 5300 funds, is the most fragmented and even in its first quartile ranking by assets, there are groups whose percentage of funds sub-€50m are in the 80 to 90 per cent bracket.

The above research takes no account of any group’s corporate structures, regional bias, weightings of other investment management business or cross-fertilisation with other entities. It is an analysis drawn from publicly available information.

Nevertheless, European groups are not tackling the problem of excessive numbers of very small, unprofitable funds currently on offer. Ordinary investors need to be schooled into understanding the importance of long term saving in good scale mainstream products and having them available. They should not be constantly seduced with messages about the latest fund fashion offering, which has its day then fizzles out into an on-running and costly small fund.