Schroders reaps rewards of forays into the East

Fifteen years ago, Massimo Tosato, now Schroders’ vice-chairman and head of distribution, was given the task of mapping out the fund manager’s target markets. After much discussion with staff on the ground, he ranked the UK as first priority, followed by Italy, Germany, Switzerland and France.

While the new European order for product distribution remains similar to the old one, it is the group’s position in emerging markets, and Asia in particular, which marks the biggest change to the asset and business make up of the late 1990s. Asia now makes up the largest chunk of Schroders’ distribution footprint.

Not only has Schroders dramatically reversed its revenue ratios from 70 per cent UK-sourced and 30 per cent international in 2000 to the lion’s share coming from international activities today, but Mr Tosato is particularly fond about talking about his group’s ability to embrace the global West-East trend of economic influence.

Progressing fast from an almost standing start 10 years ago, Schroders now takes £350m (€423m) in annual revenues from emerging markets, more than specialist leader Ashmore, which sells only emerging market-related products to clients.

“You see how much hidden value and growth potential there is if you want to invest in Schroders over the next 10 years? A lot of people are quite surprised by this data,” smiles Mr Tosato, whose company manages £187bn in assets. “Just the emerging market part of Schroders is equal to one Ashmore, which is considered a super-specialist in emerging markets.”

Post-crisis, Schroders’ Asian business has continued to grow, while Europe remains important if not explosive. France is seen as a particular problem-child due to a long-term stranglehold of banks and their captive managers over financial services.

“Two years ago, we had a fantastic time in Europe,” says the Italian stalwart of the investment industry, recently elected as vice president of the European Fund Management Association (Efama). “Markets were more challenging across Europe in 2011, but we have been able to attract a bigger market share in some smaller countries in Asia.”

TARGET MARKETS

Indonesia, with its 237m population and 33 per cent savings ratio is a particular target for expansion, along with Korea and Taiwan. There are several developing markets – namely India, Russia and Turkey – in which the group as yet has no presence. “Over a five-to-10 year picture, you could assume we would enter those three markets in one form or another. We can be a significant player in any of them with two or three billion AUM. That wouldn’t change the profit/loss account of Schroders today, but in 10 years it will make a huge difference.”

The investment in managing both emerging market equity and bonds, which reflects Schroders’ decision to specialise rather than offer a broader range of strategies, has been dictated by changes in the competitive landscape.

Schroders has been fast to adjust its business model and asset composition as a result of the prevailing threat of exchange traded funds (ETFs).“This firm has been built mainly on equities, which still compose 42 per cent of our assets and the majority of our revenues, because they attract higher pricing than fixed income or multi-assets,” says Mr Tosato, who has been at Schroders since 1995, after running his own fund management company in Italy.

“However, within equity, we have started to change, moving away from core to higher alpha, as 20 per cent of that space is now taken up by passive players offering ETFs.”

Schroders had to respond to the needs of private customers, who following the example of institutional counterparts, were increasingly attracted to passive solutions for their equity investing needs. “We were not worried [by ETF providers], but had to take strategic decisions to allow us to compete with them, through a move towards a more active, high alpha component and also to more specialist strategies where we can provide higher value, investing in emerging markets, mid cap stocks and fixed income.”

Many of these changes have been part of a gradual evolution since Schroders sold its investment banking division to Citigroup in 2000 for £1.3bn and decided to concentrate on asset management. At the time Mr Tosato and his colleagues correctly forecasted a number of long-term trends, including the death of defined benefit pension schemes, the rise of higher-fee alternatives business and a new era of mass distribution of mutual funds in Europe, for which they positioned their business accordingly.

Now he is in the midst of a strategic review of the company, “spending 40 per cent of our time with customers, competitors and our new generation of employees in their 20s and 30s,” which should shape Schroders’ future for the next 10 years.

UNFAIR ADVANTAGE

Among the sea-changes he needs to plan for is Europe’s regulatory onslaught, particularly the raft of regulations expected in the Mifid II directive. Mr Tosato is concerned that early drafts, proposing a ban on commission rebates for mutual funds, give unfair advantage in terms of costs to insurance-linked and structured products, with this magnified because insurance companies and banking networks already control the bulk of continental Europe’s distribution channels.

“Some players could gain a huge market share if they are not tied to the same rules,” he notes. What Mifid II does not address is the consequences of changes to remuneration structures, says Mr Tosato. While small institutions are unlikely to depart from the guided architecture model, where a distributor has preferred partnerships with eight to 10 fund providers such as Schroders, BlackRock and Franklin Templeton, larger banks are expected to redraw business models.

“To make economies of scale, I can see larger private banks building up their own retail fund platforms, and for those capabilities they don’t have in-house, buying in sub-advisory strategies.”

This would mean lower fees for the fund manager, as revenue would be shared with the platform provider, but clients of such an arrangement typically hold assets for a longer term, believes Mr Tosato, expecting larger wealth management players such as UBS and HSBC to adopt this sub-advisory approach.

“The nominal price might be lower, but the net price in the value of the business might not change that much.”

With an expected unbundling of fees in Europe, Mr Tosato expects the average of 64 basis points charged by continental managers, according to Efama, to fall by 15 to 20 per cent to match total expense ratios in the US.

In order to maintain profitability, in addition to addressing the remuneration of fund managers, many of whom are only providing average results rather than creating alpha, investment houses must redraw agreements with third party service providers.

“The costs of transfer agency, custody and administration keep increasing with every new set of regulations,” laments Mr Tosato. “But there are the areas with largest potential economies of scale. We are studying how asset managers need to change their business models.”

The key will be greater automation and rebuilding of operational platforms, he believes. “We need to take examples from consumer businesses. We are currently not investing enough in automation.”

CV

Massimo Tosato

May 2007 Massimo Tosato was appointed executive vice chairman of Schroders in addition to his responsibility as global head of distribution. He is also in charge of the alternatives subsidiary, NewFinance Capital LLP

2001 Appointed to Schroders plc Board of Directors and Group Management Committee, having covered various international roles. Since 2000 he has been chairman of Schroder International Selection Fund (SICAV) in Luxembourg

1995 Joined Schroders (Italy) as managing director. Mr Tosato was founder and chief executive of Cominvest S.p.A, an investment banking and asset management organisation, sold to the Cassa di Roma Group in 1991

Educated in economics at the University of Rome, MBA from Columbia Business School (New York)

Massimo Tosato, Schroders