The channel tells the story

There are many methods which can be used to define or describe a national market for funds. One useful way is to consider who are the ultimate buyers of funds and which channels distributors use to reach those buyers.

In general terms, funds distributors have two decisions to make. The first relates to the type of fund they offer. If they have an in-house asset management capability, they may choose to offer their own – in-house – funds. Alternatively, they may elect to offer other suppliers’ funds – or third party funds.

The second decision is whether or not to assume responsibility for making investment decisions. Most of the time, ultimate clients will be discretionary, in that they pass the decision of which fund to buy to the distributor. Often, though, clients will be non-discretionary, in that they make most of the investment decisions for themselves. In this situation, the distributor is merely an agent that executes the clients’ orders.

The year 2002–3 was a particularly difficult one for the fund industry and its investors. As we have explained in previous issues of PWM, many distributors chose to focus more on in-house funds in response to challenging conditions.

Clearer insights about the industry therefore come from the changes that took place in the distribution of third party funds. Over 2002–3, we estimate that total demand for third party funds fell from about $1200bn (E1100bn)to $981bn.

Who were the clients?

Chart 1 shows who were the ultimate buyers of third party funds in four of the largest national markets in Europe. What this chart highlights is that virtually all third party funds used are distributed to clients. In early 2002, we found that only 5 per cent of third party funds were used by distributors for their own purposes, which did not involve clients. By early 2003, this figure had fallen to 2 per cent.

The chart also shows that non-discretionary clients became fewer in relative terms, while discretionary clients became more important. In 2002, 42 per cent of third party funds were ultimately bought by non-discretionary clients, across Europe as a whole. A year later, the equivalent figure was 29 per cent. This trend was also apparent in Spain, Italy, Germany and France.

As we explain below, these four markets are quite different from Switzerland, the UK and the Netherlands in terms of the channels through which third party funds are distributed to clients.

Nevertheless, as Chart 2 shows, non-discretionary clients also became less important in Switzerland and the UK in 2002–3. The Netherlands stands out as an exceptional market. The main change was a sharp fall in the importance of discretionary clients.

Meanwhile the quantity of third party funds that were used by the distributors, and not passed onto ultimate clients at all, soared from 13 per cent in 2002 to 35 per cent in 2003.

The key message from all this is that the retreat from open architecture during 2002–3 was driven in part by the ultimate clients. Previously, distributors had been doing good business supplying third party funds to non-discretionary investors who felt that funds per se were attractive, but considered that they preferred funds from third party suppliers.

In the very difficult conditions prevailing in the financial markets through the 12 months to March 2003, the non-discretionary clients moved away from equity funds and bond funds towards cash, money market funds and real estate.

In a previous edition of PWM, we explained how a number of distributors had moved from using third party funds (ie, what we called the Pay Someone Else business model) to selling their own proprietary products (or what we called the Do It Yourself model) in order to boost their own profitability.

You might suspect that this would have caused the quantity of third party funds distributed to discretionary clients to fall. In fact, Charts 1 and 2 imply that, in relative terms, the quantity of third party funds distributed to discretionary clients actually rose. This is probably because some distributors saw third party hedge funds and third party money market funds as being attractive investments for those clients that had entrusted the distributors with responsibility for decision-making. Had this not happened, overall demand for third party funds would have fallen by far more than it actually did.

Reaching the clients

Other insights become apparent if you look at the channels through which third party funds were distributed. Chart 3 shows that, in 2003, an estimated 44 per cent of all third party funds distributed in Europe passed through local branches. Relationship managers accounted for another 29 per cent, field sales forces for 13 per cent. In addition, 2 per cent of third party funds passed through the distributors’ own fund supermarkets, while 23 per cent went through “all other” channels.

In three of the larger national markets for funds – Spain, Italy and Germany, local branch networks and relationship managers accounted for well over 50 per cent of all third party funds that were distributed in 2003. We estimated that these two channels accounted for 46 per cent of the third party funds that were distributed in France. However, this figure may have been reduced by the information we received from one or two very large organisations. In early 2002, we had found that branch networks and relationship managers together handled no less than 87 per cent of all third party funds distributed in France.

Except, perhaps, in France, branch networks and relationship managers became more important during 2002–3 in these four markets. This is partly because universal banks – which tend to emphasise these two channels – have traditionally dominated the distribution of funds in these countries. It is also because investors needed greater reassurance and support from the distributors in difficult times. “Other” channels, where investors do not necessarily deal face-to-face with the distributors’ staff, diminished in importance.

The ‘other’ factor

It was a different story in the UK, the Netherlands and Switzerland. Chart 4 shows that, in these three markets, field sales forces and “other” channels accounted for the majority of third party funds distributed. In all three countries, branch networks are relatively unimportant.

The UK was unusual in that the relative importance of the different distribution channels hardly changed during 2002–3. In the Netherlands, distributors increasingly focused on “other” channels, while relationship managers became more important in Switzerland.

This begs the question of what are the “other” channels. Chart 5 shows that, in most countries, the distributors’ own fund supermarkets are relatively insignificant, and account for 2 per cent, or less of third party funds that are distributed. In all three countries, pension plans and asset consultants are more prominent features of the landscape than they are elsewhere in Europe. Fund distribution is often handled by executives based at the distributors’ head offices.

As was the case elsewhere, the ultimate clients needed more “hand holding” by the distributors in 2002–3. In the Netherlands, this was carried out mainly by head office executives; in Switzerland, by relationship managers (typically at the private banks).

Our conclusion is clear. You can tell a lot about a funds market from the channels which the distributors use to reach their ultimate clients.

Andrew Hutchings, research editor, Sector Analysis

^{Source: Sector Analysis}