Time to split up

There is a clear trend to separation of manufacturing and distribution of investments in those new, emerging markets for long-term savings, which most global fund managers are trying to target.

Take Israel, for instance, where the two main banks, Hapoalim and Leumi, have controlled 80 per cent of the country’s financial transactions. One of the final reforms that Benjamin Netanyahu drove through, before his resignation from the post of finance minister last year, was a requirement for the banks to dispose of their fund management divisions by 2008.

“The banks sell only their own funds to customers, so people don’t get any semblance of objective advice,” said Mr Netanyahu at the time, stating that the banks have always controlled captive markets in both fund management and distribution. “In future, banks will be able to sell funds, but no longer own them.”

Fred Jolly, chief executive for European and Middle Eastern business at multi-manager house Russell, believes the same trend towards separation of functions exists everywhere, although a small country such as Israel can move to change legislation overnight. His group is also preparing to sign distribution agreements with banks in Central and Eastern Europe, where there is no established, indigenous fund management industry. In the same way as these markets have gone straight to mobile telephones in the communications industry, skipping out landlines altogether, he believes they will move straight to open architecture. In effect, there is no need for their banks to buy fund management facilities, when they have access to the best external groups.

But are the highly developed markets of Western Europe ready for such a radical shift? Is it not the case that investors here would also be better served if they can buy savings products, which their bank has no real financial interest in selling?

The European market where the link between group manufacture and in-house distributor has always been most solid, Germany, is also one of Europe’s largest. But even in Frankfurt, cracks are appearing, and specialist predators from other countries are ready to exploit them.

“The key change, as compared to the late-1990s, is that foreign asset managers now have access to bank distribution networks, which are extremely powerful,” says Rainer Schroder, head of Germany for Threadneedle, the UK group which has built up a huge respect for its products among Teutonic banks. “Unit linked life insurance is also an important and growing market. Some insurers use group products, but more and more are using external funds.”

Not so open architecture

However, while small changes can mean big revenue growth for outsiders, there has been no reversal in philosophy, believes Mr Schroder. “There is still a very close alliance between distribution and product creation within these players. When they talk about open or guided architecture, it means there is a prominent place for their own products and limited space for all the others.

“I don’t see why, in the next 10 years, integration between production and distribution in German universal banks will subside. There are one or two exceptions, but the majority will stick to integration of their activities, producing their own products, plus a selection of other people’s,” concludes Mr Schroder.

“Things are changing, but slowly,” says Ingo Ahrens, head of Goldman Sachs Asset Management (GSAM) for Germany, the European market in which the American sub-advisory specialist has invested a substantial allocation of its resources.

Unlike European banking or insurance groups such as Crédit Agricole and Allianz, it has long been in Goldman’s interest to stimulate and talk up any Europe-wide trend to decoupling between distribution and manufacturing. This is because the US house does not have any captive distribution machine, and relies on European retail banks and insurance companies to sell its funds.

But everybody at the group, from the distribution foot soldiers, up to the chief executive, understands that the battle to establish a long-term trend in the German market will be a particularly gruelling one.

Ahrens: increasing demand for niche products

“Deka is a very good example here, as they have outsourced part of their asset management,” says Mr Ahrens, referring to the pioneering German bank, which has partnered with foreign manufacturers including GSAM, Merrill and Schroders.

Driven by clients

Rather than coming from regulatory requirements, or any philosophical position, the slow German trend appears to be driven by clients’ demand for new products. “It’s not that distributors don’t have the ability to manage portfolios on a top-performing basis,” believes Mr Ahrens. “But with new asset classes, in terms of time to market, how long will it take to build the products? In Germany there is demand for niche asset classes in specialised products. Would it make sense to manage Japanese small caps in Frankfurt?

“This situation is very different from Austria, where sub-advisory is a standard thing, and has a lot of benefits,” continues Mr Ahrens. “Austrian banks have a very pragmatic view: ‘I have a client here who wants Japanese equity. I don’t have the manufacturing expertise, but I do have the distribution capacity. So let’s get the deal done’.”

German banks will inevitably move down the same road, due to client pressure, believes Mr Ahrens. “It may be painful to go in this direction, but the client is more or less demanding that. It is very hard for asset managers to be first in every asset class that they manage. Also, from an economic standpoint, it might be more efficient not to produce everything yourself, so you are looking more honest in front of your distribution network.”

It is this economic question, which often controls the decision, with some of Europe’s banking overlords extremely reluctant to allow rival manufacturers into their networks.

“What we can see is that when a bank such as Commerzbank or SEB goes to open or guided architecture, this leads to immense dips in inflows and AUMs at their asset management division,” confirms Rudolf Siebel, spokesman for the BVI, Germany’s powerful mutual funds association. “In the profit and loss account of a universal bank, the asset management division is expected to provide revenues on top of those generated by the bank’s distribution division.”

Dexia Bank, one of Belgium’s premium brand retail banking networks, is still not keen to give retail or private clients access to any external fund groups, therefore requiring Dexia Asset Management to keep a high maintenance product range of 400 funds, including structured products, on its books.

“The bulk of our business is sold through retail banking networks of Dexia Bank in Belgium or Luxembourg, and also through our private banking,” admits Michel Vanderselst, the group’s Brussels-based global head of institutional sales.

“We are first an in-house manager, and our main task is to manage products for the group. But my task is to build on that.”

Customer service

It is a task Mr Vanderelst and his staff in France, Belgium, Italy, Switzerland, Austria and the Nordic countries have managed quite successfully. Nearly 45 per cent of the group’s e91bn in assets (up from e72bn in 2004) are from external clients and this for a group whose prime task is to service its bank’s captive customers.

His modus operandi is to take products already selling well internally, and then leverage them for sales outside the group, by creating partnerships with external distributors. The irony is that while Dexia expects its manufacturing to work hand in glove with its distribution network, the growth plan for its asset management business is based on this link being loosened elsewhere in the European market.

“Some very large groups will say: ‘Why do we need an asset manager’?” reflects Mr Vanderelst. “The question is ‘to buy or to build.’ After all, they can always buy in external funds when they need them. Others will build funds for very good reasons. That’s what Dexia is doing – we want to keep our asset manager. Then there is open architecture, and some points in between.

“But there is a lot more talking about open architecture than there is actually investing in funds. Banks talk about it because it’s what their clients want to hear. When you look at the percentage of external funds sold by their networks, then it is much less than the talk, although the volumes are still significant, even with a small percentage.”

Yet why should bank clients be directed elsewhere, if their proprietary manager can deliver the goods,” argues Mr Vanderelst. “If the performance of bank clients’ assets is good, as in Dexia, you don’t need to go elsewhere. Open architecture sounds good, but it’s not easy to manage for a distributor. You can pick out the best funds, but when you switch a partner, you have to switch your clients’ funds too. This is easy to do in a portfolio, on a multi-manager basis, but very difficult to do with retail clients.”

Fortis, which manages e105bn, is Dexia’s main rival in the Benelux market, has a slightly different approach. While 95 per cent of the group’s assets in Belgium comes from bank clients, 75 per cent of new distribution assets, equivalent to e3.5bn, across all markets are from external clients. While there is a distinct lack of penetration of retail networks by external houses in Belgium, Fortis Bank has introduced external funds in both its personal and private banking segments. Fortis Investments is already one of the preferred providers at Dutch institution Rabobank and ABN Amro is also selling Fortis products.

“The trend is there towards separation between manufacturing and distribution,” says Zin Bekkali, head of promotion, segmentation and processes at Fortis Investments. “Banks have opened up, very often in the private banking segment, where there are particularly demanding clients, like UBS has. In private banking, there is a very open architecture, while retail banks all have funds of funds. This is a dramatic change from a couple of years ago. In the future, these trends will accelerate a bit and continue growing.”

‘In private banking, there is a very open architecture, while retail banks all have funds of funds. This is a dramatic change from a couple of years ago. In the future, these trends will accelerate a bit and continue growing’ - Zin Bekkali, Fortis Investments

But a trend is just what the word says, and Mr Bekkali does not expect the two different revenue generating activities to ever totally decouple. The positive thing about this is that an internal asset manager can always dedicate greater resources to serving its captive distribution channel.

“Every asset manager linked to a bank has a big team,” says Mr Bekkali. “We have seven people in asset management just dealing with Fortis Bank. You cannot imagine an external manager providing this service for a single client. So I don’t think that one day, even in 10 years, you will have a major retail bank, even Citibank, working purely with external managers.”

And while it may have been very fashionable for private banks to talk endlessly about open architecture, even a year or two ago, some private bankers visibly cringe when they hear the phrase today. Banks who were once talking about a totally independent selection of products, are now re-integrating asset management with distribution.

Leading to underperformance

At Schroders Private Bank, one of the institutions which touted the ‘best of breed’ concept in a big way three years ago, when it appointed the Russell group to choose its external managers, there has been a re-assessment of what wealthy clients really want and need. “I launched the manager of manager concept at Rothschild in the late-1980s, and can tell you that it is just as likely to lead to underperformance as investing in your own products,” says Rupert Robinson, head of investment at Schroders Private Bank.

“We are a manufacturer and user of proprietary investment, where we fundamentally believe we have a competitive edge. We get approached by a lot of wealthy families, often through family offices to manage specialist mandates, as Schroders has a global asset management brand.

“We also get approached by families who want a multi-manager solution, but it’s not unusual for clients to come to us and say: ‘We came to Schroders, because we don’t want third-party products’.”