The benefits of getting the experts in

From Archive 01 October 2005

‘ Firms look for performance, risk, style, consistency criterion, but also looks in detail at the teams themselves. You need team stability. You need to make sure that all the managers are committed to developing the business.’ - Vincent Lecomte, BNP Paribas

By PWM Editor

At last, distributors are beginning to realise that they do not have the in-house expertise to make the most of the range of products they are expected to deal with and are looking towards outsourcing non-core investments. However, one potential pitfall is ensuring you pick the right manager for the job, writes Elizabeth Cripps

Once upon a time, the purveyors of fund management products were like British men tackling DIY: no matter how bad a job they made of something, it was considered a sign of weakness to hire an expert to do it for them.

Fortunately for everyone concerned, this attitude has changed. Distributors, such as insurance companies and banks, have learned that the way to get something done may not be to do it oneself. Instead, they are delegating those tasks for which they lack in-house expertise to the highly trained carpenters and cabinet-makers of the fund management world.

Distributors in the US have long been handing out sub-advisory briefs, led, says David Schofield, European business head at Janus International, by insurance companies.

On this side of the Atlantic, the UK has been the frontrunner, also driven by insurers. But delegation is by no means only a UK trend. Switzerland, Scandinavia and the Netherlands are characteristically advanced in the sub-advisory arena; it is a growing theme in Germany, and Italy “has been doing it for some years”, according to Mr Schofield.

Goldman Sachs Asset Management (GSAM), a giant in the market for delegated business, sources 25 per cent of its $13.6bn (?11bn) of sub-advisory mandates in Europe from outside the UK.

Why delegate?

Nick Phillips, head of northern Europe distribution at GSAM, picks out three key factors behind the trend. “One is economic,” he says. “Fee pressure on asset managers to sell products, pressure on being able to pay portfolio managers to manage assets, and distribution costs. So distributors are looking at their core competencies. They are saying: we are trying to compete with global asset managers, we should focus on what we do best and, from an economic point of view, put resources into distribution.”

Mr Schofield at Janus concurs. Insurance companies with in-house asset managers have realised, he says, as equity markets and solvency ratios plummet, that they should “focus on core competencies and look to hire outside experts who know what they are doing”.

‘Distributors are looking at their core competencies. They are saying: we are trying to compete with global asset managers, we should focus on what we do best and, from an economic point of view, put resources into distribution’

Nick Phillips, Goldman Sachs

The second factor is comparatively poor performance. Mr Phillips explains: “Asset managers or life insurance companies have to compete with a larger range of managers as the world becomes smaller from an asset management point of view.”

Thirdly, client demand, or “range completion”. Individual investors, who are increasingly investment savvy, are demanding hitherto obscure products, such as emerging market equities or debt, Japanese equities, or funds of hedge funds.

This leaves the distributor with a choice. If it doesn’t have the expertise in-house, it can hire a team and develop a track record, “which can be expensive and take a long time,” or hire a manager who has the expertise already.

Vincent Lecomte, chief operating officer at BNP Paribas Asset Management agrees that customers demand a greater range than one house can provide internally. Of the ?18bn in its flagship Parvest Luxembourg-based umbrella fund, ?2.4bn is handed over to external providers.

London-based St James Place, which runs around £10.5bn (?15.4bn), has always used only external managers. David Lamb, head of group business development, puts it bluntly: “We reckoned we needed expert asset managers and we weren’t expert asset managers. We needed to seek the best investment talent we could rather than grow it in-house when we were starting a new business.”

Customers, he says, “know that if they want higher returns they have to invest in equities, but they appreciate the risk involved, that how long you are prepared to do it for makes a difference, and that not all investment managers are the same. Because of all the publicity, they understand that there are good and not so good managers, and it is difficult for them as they don’t know how to choose.”

Why sub-advise?

GSAM has done well from the sub-advisory boom, recently scooping mandates from retail houses retail houses Co-operative Insurance Company, Foreign and Colonial Investment Trust, Skandia UK and Lansforsakringer in Sweden. US equity specialist Janus International has six sub-advisory deals in Europe, including two from the UK, where it runs funds for the private banking arm of Barclays and for mass-market insurer Norwich Union.

Both Mr Schofield and Mr Phillips see this as an opportunity to access high-net-worth and retail markets that would otherwise be tough, or impossible, to break. Mr Phillips points to the “massive client bases” of retail banks across Europe, while Mr Schofield adds that insurance companies “have very big retail distributions and large sales forces. This is a market that Janus, say in the UK, would never be able to target directly,” he says.

Then there is the question of fees. Mr Schofield describes them as “comparable” for sub-advisory and institutional mandates, sometimes even lower for sub-advisory briefs in the US market. But Mr Phillips acknowledges that sub-advisory fees are “slightly more expensive”.

However, this is not money for nothing, he stresses. A sub-adviser can educate a distributor’s sales force about the products, and may even present to clients. “It’s a partnership,” he says, “and if it’s a partnership it has to work for both parties. They are happy to pay more.”

Undoubtedly, delegation is big business. So does this mean that fund managers will abandon their institutional heartlands for the new sub-advisory arena? Not according to Mr Schofield.

“Certainly not from an economic point of view,” he says. “And from an administration point of view these mandates tend to be more complicated. We as the portfolio manager are dealing with a number of entities – the sponsor of the fund, their custodian, in some cases a consultant as well, and there may well be a fund administrator on top of that.”

Why worry?

There are other potential pitfalls meaning delegation is not always the win-win situation sometimes described. If you are going to hire an expert to do a job for you, you want to be certain that he really is an expert. And he needs to be sure that it is the right job. “We view our Intech product as a high quality premium product and we would like to choose our partners carefully,” says Mr Schofield at Janus. “We wouldn’t want to spread ourselves too thinly. There are reputational risks as well, on both sides. Our brand is being associated with another one.”

St James’s Place goes through a lengthy selection process, then checks what the manager actually buys and sells against the stated investment approach. It also puts the individual running the money at centre stage, on occasion dropping a house because a key manager has left.

But it would be far too simple just to consider each manager in isolation. Rather, as all the delegators acknowledge, they have to be viewed as a group. Robert Swan, head of offshore marketing at Skandia Investment Management Limited, offers a football analogy: “It’s not worth having ten left or right wingers; you need a completely balanced team. We try to select managers that offer a complementary blend of all styles.”

Preparing for the worst

Of course, no matter how careful the vetting process, things can still go wrong. Vincent Lecomte, chief operating officer at BNP Paribas Asset Management, explains. “First of all if the basic criteria such as performance or risk are not met any more, this becomes an issue.”

This does not necessarily result in instant termination: “There are various steps in the process, and the firm is put under watch.” However, a “major breach”, for example, compliance problems or a change in management teams that could affect portfolio management, could cost a manager his mandate, instantly.

St James’s Place delegates to nine asset managers, but has appointed (and subsequently rejected) at least three more since its inception in 1992. For example, Scottish Amicable was dropped in May 1997 because of concerns over its decision making process.

Too close for comfort

Another potential hot potato is liaison with end clients. Do distributors feel that managers are treading on their toes if they try to get too close to customers? Once again, there is no straightforward answer.

For St James’s Place, for example, the boundaries are very clear. “It is all done through us,” says Mr Lamb. “If you talk to fund managers, what they are good at is managing money. What they are not good at is holding clients’ hands and doing marketing presenting.”

But according to Mssrs Phillips and Schofield, not all distributors feel this way. “There will be some arrangements where we are hired on an arm’s length basis,” says Mr Schofield, “and have no input into training the sales force, and so on. It looks and feels and smells and walks like a separate account for a pension fund. The other extreme is where we are intimately involved in co-branding and jointly marketing.”

The key, then, is to make sure both parties know where they stand beforehand. If you hire someone to put up shelves, you don’t necessarily want him to hand out DIY advice to your friends. If you do, you will probably have to pay him more. Either way, it saves a great deal of trouble to have the ground rules established from the start.