Bringing excellence through strategic partnerships

Participants:

Jean‑Francois Hautemulle, Head of Fund Selection, UniCredit Private Banking

Henriette Bergh, Head of Manager Selection Strategies, Morgan Stanley Private Wealth

Peter Fitzgerald, Senior Portfolio Manager, Multi‑Asset Multimanager, Aviva Investors

Claudia Itschner, Head of Manager Selection, Investment Management, Zurich Insurance Company Ltd

Nick Phillips, Head of EMEA Third Party Distribution Business, Goldman Sachs Asset Management

Raphael Sobotka, Chief Investment Officer, Multimanager (EMEA), HSBC Global Asset Management

Cedric Bucher, Head of Product Design and Business Development, Architas

Panel Moderator: Elisa Trovato, Deputy Editor, Professional Wealth Management

Elisa Trovato: The aim of this discussion is to assess whether the current market turmoil has had any impact on the drivers to sub-advisory, the types of mandates awarded and the criteria of manager selection. We will look at the concept of product innovation and whether sub‑advisory is the most efficient route to respond to market demand. We will also discuss the pros and cons of using segregated mandates, as opposed to distributed branded funds, and how to make the sub‑advisory partnership work for the long term. 

How do you combine the two apparently conflicting needs of establishing strategic relationships for the long term, based on the investment opportunities in the medium/long term, with the need to offer something that appeals to clients today and respond to market demand quickly? 

Claudia Itschner: The decision to sub‑advise has not changed one little bit in our case as the model has served us well. We think of our sub-advisory managers as long term relationships irrespective of what happens in the markets. The key is to find and select those that are capable of bringing you innovative and high quality solutions in different market environments. This ability is a key selection criteria when choosing managers.

I think sub-advisory is a very efficient and flexible way to respond to market demand since you can draw on and combine different talents. If you manage your own assets then you are restricted in terms of ideas and perhaps in terms of problem solving capabilities because you have only one talent pool, which might not be able to provide you with everything that you need. With the sub‑advisory route, you can combine different talents and those discussions can be very fertile and help you find better solutions. I think that diversity is probably one of the biggest advantages of sub-advisory.

Investment Management is responsible for selecting the asset managers for the Group’s own-account investments, which is about $200bn in assets and 70 per cent of that is outsourced. We employ over twenty managers but the majority of our assets is managed by six to eight. We also support some of the business units in selecting the managers for life or unit linked mandates, which are another $60‑80bn.

Cedric Bucher: I think those needs can be quite complementary. By combining sub‑advisers, one can get quite a broad pool of investment ideas that can quickly be incorporated into innovative product design, so this can work hand in hand. At Architas we focus on selecting funds and blending managers, and I rely on new product ideas that have fared well in the short run and hopefully will fare well in the long run as well. Dynamic asset allocation strategies are a big theme coming out of the crisis and that is something a sub‑adviser can implement very quickly.

Elisa Trovato: Is there perhaps the risk that you could miss a good market opportunity because it takes time to do the due diligence and find a sub‑adviser, as opposed to buying a fund?

Peter Fitzgerald: We do both in different product sets. We have products where we do just buy external managers and we have products where we create manager solutions with sub‑advisory mandates.

The selection of a sub‑advisory manager is going to bring you to the best in class of various asset classes and therefore you should be at the forefront of investment thinking when you are discussing current market conditions and opportunities with these individuals.

Then, leading on from that in terms of dynamic asset allocation, there is a perception that sub‑advisory allows you to change more slowly, and for a lot of our manager of managers products we actually do a futures overlay for tactical asset allocation to address that concern.

We use a combination of boutiques and also large asset management houses, but generally to run quite specific mandates. We would tend to identify individual specialists in particular regions or areas rather than delegate a whole sub‑advisory relationship, so we would look for specialists in UK equities or in US small caps or in European mid caps rather than delegate the actual asset allocation on a global level to a sub‑adviser. There are areas where you have one investment house that has a number of different mandates in different areas. If somebody has a robust process and a philosophy that works, in general that should translate from one area to another.

Elisa Trovato: What are the reasons that drive you to sub-advise rather than purchasing funds, in a multi-manager structure?

Raphael Sobotka: When you are small team, and you have limited assets, using funds is quite flexible. However, when you are big, you do not really gain in flexibility with third party funds, because if you own 10 per cent or 15 per cent of a third party fund, you cannot really exit in one day. You have to exit without damaging the fund.

In addition, in a sub‑advisory route, you have more control in terms of operations; you have daily transparency on holdings and on transactions. It is also quite cheaper. The manager of managers route is still the best by far, if you are big, but it requires a lot of resources, especially concerning operations, legal, compliance and due diligence.

Elisa Trovato: UniCredit Private Banking is a pan‑European player. What drove you to use funds as a building block in clients’ portfolios? One of the advantages of sub‑advisory is that you can offer bespoke solutions to your clients. How important is it for UniCredit to provide a fund that is specifically tailored to client needs?

Jean‑Francois Hautemulle: We have over € 120 bn in total financial assets, of which €14bn in funds and €9bn in discretionary  mandates, which are primarily done through funds. We use funds as building blocks in client portfolios. Funds are screened both by the selection team at UniCredit and by our in-house asset manager Pioneer Investments.

In the last 18 months we went through a process of developing partnership with ten managers, plus one now. This gives us more control and enables us to leverage some of the key brands we are working with. We are using quality names and firms. Those brands are helping us develop our relationship with our clients and have given us credibility. We sell the funds under their brand, they are not white label funds. Where we want to make a difference is on the asset allocation side and we want to provide solutions that are best suited for the clients at any specific time.

We want to have a consistent approach across all the markets we operate in. We want to make sure we are offering very similar products across the board, both on the advisory and the managed accounts side.

Because of our size, we pretty much have access to everything we want. I can get full performance breakdown of any fund with most of the managers, so that is not an issue.

However, we are working with some of the 10 partners to offer bespoke solutions to our clients, too. We go to companies like Goldman Sachs, JPMorgan or Pioneer, and we say, ‘This is the product I want; it has to be on your Ucits platform; you can take care of it.’ For us, to build the product ourselves would be quite expensive. Moreover, the core of our service is not the product, but the investment advice we give. The product comes next as a solution to the investment advice.

These bespoke funds are primarily offered through UniCredit private banking, especially in Italy. 

Nick Phillips: The bespoke solution Jean‑Francois described is not common but is probably growing in interest. The work falls on the asset manager to launch the products and go through the regulation process rather than the organisation doing the distribution. They may not have a Sivac family or a Ucits platform and if they do not have that product, and do not want to build the infrastructure to build their own fund, but they would like to offer something which is specific for their particular client proposition, then the would come to us and ask to launch a bespoke product in one of our Sicav families. The fund has to be a certain size to be viable and scalable and where this has happened, the organisation would come to us and say, ‘We expect to raise this amount of money; therefore, the total expenses would be this.’ It is a partnership. If you are only going to raise x and the expenses are going to restrict its potential alpha, then it is not a viable product and would not happen.

Elisa Trovato: What is your business model? Do you use funds as building blocks or do you also have agreements with strategic third party partners and ask them to set up bespoke products for you?

Henriette Bergh: At Morgan Stanley we work with clients on an advisory and discretionary basis using funds as building blocks.

The advantage with funds is the added flexibility they provide. In terms of asking managers to create very specific solutions for you, with that always comes the question of how much time does it take? Why do you need something very bespoke, given that in the UCITS space you have over 35,000 funds already? Also, you have costs associated with setting up a fund. And when the asset base is small, unless the total expense ratio is capped, it affects the performance negatively. Consequently we have shied away from asking a manager to do something specific; we would rather use an unconstrained manager opportunity set, whereby we look at the overall market and see whether we can find what we need.

Also, when you ask a manager to build a fund for you with specific guidelines and specific constraints, you do not see a track record. We all know how elusive track records are and that you cannot rely on them for your future decision making process. Moreover, the manager will tell you, ‘If I have all of these constraints and I do not have an unconstrained opportunity set, we do not know what the performance is going to be.’ We have been using funds and the advantage has been that we do not constrain ourselves to a limited list of managers.

Claudia Itschner: The big advantage of an investment mandate is that you have control over what is actually being invested; it is custom made for your specific needs. The majority of funds have guidelines as wide as the Thames and you cannot control the risk that is being taken and that you want to sell to your clients.

You can also detect risks much earlier not just on the performance side, but also on a lot of other aspects such as portfolio concentrations, sectors you want to keep away from, style drifts and so on.

As long as we keep the different risks under control we are in a better position to avoid harm to our clients and ourselves. That is the most important thing. Secondly, if you have size, it is often cheaper and you can pass that on to clients so they can benefit from it.

Past performance is no guide to future performance, so there is no certainty from that. What you should do when selecting an asset manager for a specific product or mandate is to see whether they have the right ideas, skill set and tools in order to perform. As long as you concentrate that those things are optimally in place, performance should be above average in the long term. If you achieve that you don’t need to change the manager.

Jean‑Francois Hautemulle: The rationale of our model was to be able to find a solution that would reflect our current investment strategy views. We are a private bank and most of our clients are into fixed income instruments. We try and get them into more diversified products that feel, look and smell like bonds, but are not bonds. They are funds and they are more diversified. We have worked with partners and stretched the Ucits rules to the maximum; so far it has worked pretty well. 

I do agree with Henriette that there is a whole array of products or funds that are currently available.  We all have tools available to analyse and make, hopefully, educated decisions on how we choose the funds. There are certain circumstances where you need a solution with a certain level of risk for your clients. The challenge I have, for instance, especially with mandates, is making sure that the views and the positioning of the manager is in line with your investment strategy.

Elisa Trovato: Is it important for a manager to have a flexible investment strategy, especially in the current environment?

Jean‑Francois Hautemulle: To me, flexibility is a challenging concept because if you give a manager a lot of flexibility, when you put the fund on your recommendation list, you have to make sure it is in line with your investment strategy.

This applies to a fund too. If one of our funds is overweight in financials and long duration that is not good for us, if we are telling our clients, ‘Stay away from financials and try to shorten the duration.’  So we have to go back to the manager and say, “We are going to have to put you out of the list for the time being.’.

Managers makes changes to their portfolios all the time. With out preferred partner route, we have detailed and open discussions with every single one of our partners about what their managers are currently thinking.

Henriette Bergh: The way you manage this issue is to build your platform with what we call “pure” strategies, because you do not want a manager to interfere with your asset allocation. And then you need to have solutions where you provide the manager with more flexibility. If you allocate to those solutions you know they may clash with your own internal asset allocation, hence you may want to use them in a different way. You need to be very cognisant of what is going on inside a given fund. 

Claudia Itschner: I think you have to give the manager flexibility in the right areas. We have analysed our partners’ performance in the fixed income space and we realised that a lot of them think they have skills in areas where they don’t.

For example some of them have excellent skills in credit picking but destroyed value with duration and yield curve strategies. If credit picking is exactly what they are good at then I think you should give them more flexibility there but restrict them on the duration and yield curve. That is not always easy as portfolio managers find it often intellectually more stimulating to employ different instruments to create performance. It can be a challenge to implement such restrictions and still keep the portfolio manager motivated and it needs a lot of trust on is/her part not only into the relationship but also into the judgement of the client.

Raphael Sobotka: Yes, our job is to identify managers who have competitive advantages. It does not make a lot of sense to constrain a manager on their key skill-set otherwise the manager will be less focused on your mandate and therefore the alpha you will get could be lower. For instance, if you identify that a manager is particularly good in small cap UK equities or in currency, you should let him provide a lot of alpha on these drivers. Conversely, if you think in general he is not good at allocation, for example, between government and credit or equities versus cash, you may want to constrain it on this side. Another element to consider are “crowded” trades.  In all asset classes you may have growing “crowded” trades (for instance long credit, “risk on”, currency carry-trade). The question is how you monitor and manage these at the multi-asset solution level. Having some constraints at the manager level may limit the impact of these. Concerning the monitoring of these risks, if on the equities side, it is relatively easy to analyse portfolios; on fixed income, if you have not followed the sub-advisory route, it is quite difficult to have a good view on these. This becomes even worst if you are very diversified. If you have, say, 20 equity managers and 20 fixed income managers through third-party funds, then understanding your overall risk exposures in your product – for instance credit, emerging market currencies, small cap, illiquid assets - is quite challenging. Therefore, on these types of issues, the manager of manager route is a lot better.

Cedric Bucher: Over the last two or three years, some multi-managers got caught a little bit with the overall credit exposure at the aggregate level, because whilst every manager had the freedom to move between government and corporate, it was not always sufficiently understood what the overall exposure was at the aggregate level. As a result, quite a few multi-managers re-defined more stringent mandates for managers to focus on government bonds or on corporate bonds separately. As such, the multi-manager gained more transparency, but also more responsibility to manage that credit exposure.

As an example where dedicated mandates can work is in a variable annuity product. This is where you have a multi‑asset fund, which provides some overlay features to the client, such as generating income or protection over a term. In order to achieve those extra features a hedging partner provides a capital guarantee, let’s say, over 10 years. That hedging partner has a limited number of derivative instruments available and in order for him to do the hedging he needs to know exactly what is in the fund and he can only achieve that through sub‑advisory mandates with very clearly defined mandates, specifying metrics such as tracking error or R-squared.

Peter Fitzgerald: I agree, the fixed income is where you get your accidents. It has become so complex and what has happened over the last five years is that as interest rates have come down lower and lower and lower, managers have tried to come up with ways to boost returns in what, traditionally, is a defensive area of your portfolio. Particularly, the off the shelf fixed income products are more akin, in my view, to hedge funds in many cases. I find them really difficult to analyse.

Nick Phillips: Going back to the constraints given to managers, it is important to draw the distinction between sub‑advisory for a multimanager and managing a bespoke fund for a firm. The organisation you are doing the sub‑advisory for has a completely different value proposition to their clients, so they are going to ask you to do different things depending on the environment. If we are doing multimanager and they give us constraints, we do not know who we are being blended with. The multimanager has a product he wants to offer to his clients, and that is going to be a blend of different styles and strategies. In order to do that, they have to have an idea of what the manager is going to hopefully achieve, and that can be good or a bad thing depending on their client proposition. 

On the funds or the unit-linked side, when you are managing a specific product that is going to be distributed, then it is a different proposition. They know their clients better than we will ever know them. Therefore, they have an idea of what they would like to offer them. They may give us complete freedom or they may put constraints on it, depending on how they view us and their client risk tolerance.

Normally managers give you a mandate and then do not interfere, but we have had managers on the fixed income side come to us and say, ‘We would like you to bring down duration.’ That would be an example of a temporary position based on their view.

The most important thing about constraints is that they are designed by people doing the evaluation to draw the best out of the manager they are choosing.

REALLOCATING MANAGERS

Elisa Trovato: Do you focus on a limited number of partners or do you work with a wider range of managers? And what drives your decision to “reallocate” them?

Henriette Bergh: It is hard enough to find good managers so we need to cast our net as widely as we can.

Of course you gravitate towards certain managers, because there seems to be a concentration of skill in certain managers but at the same time, whenever we look at finding a manager in a given asset class or a specific strategy, our starting point is unconstrained. We use any source we can, we use existing managers, we use all the different systems we have and our internal network. 

But the real defining factor is not the number of managers but the number of individual underlying strategies, whether it is funds or sub‑advised strategies.

You need to be able to monitor and understand them, and have a relationship with them, which is very important.

Fundamentally, if you buy an active manager you buy two things: exposure to an asset class and an active investment philosophy. If you invest in active managers you should give them time for the manager to deliver their investment philosophy and process and, ultimately, their performance. If you just want to put a trade on or have a tactical view on something you might want to implement it in a passive way, because then you do not have the uncertainty of the associated investment philosophy of a manager. 

You can reallocate more easily when you use funds whereas on the sub-advisory side you typically have terms in place including cancellation terms, etc.  There you also typically either need to have ready a bench manager or a passive interim manager. I do not think you will be able to switch a sub-advisory relationship within days, it is going to be a minimum of weeks.

Claudia Itschner: We have a different philosophy. We take a long time to select an asset manager and we work only with few but we keep them for years. During the last 10 years we have fired two.

I don’t want to give the impression that we don’t encounter problems: Of course we also have under-performance or difficulties in other areas but changing managers is not the solution because it is not only cumbersome but also expensive also in terms of performance. You only choose that as a last resort. In a way you could compare that to a marriage. You don’t throw your spouse out of the house because he or she came home late at night. You talk and you work it out to the best of your abilities. If you have that “help each other” mindset, then sub-advisory makes a lot of sense despite the disadvantages that Henriette mentioned.

There must be trust but there also must be control. We monitor and measure over 40 key performance indicators on a quarterly basis and we feed that back to the managers so they know where they stand. That keeps them performing but they also appreciate the honesty because it helps them to improve.

Raphael Sobotka: I think it is a lot more difficult to fire a manager than to hire a manager. When you fire a manager, you are very often under performance pressure at the same time. Your conviction about the manager’s ability to generate alpha, may become biased by the current market conditions.

You need to carry out a difficult mental exercise to separate your fundamental view of the manager’s ability to generate alpha, and to what extent the current market conditions are making life more difficult for the manager. However, this is particularly why multimanagers bring added value to the table: they are able to hire, constantly monitor, and take the tough decision when the decision has to be taken.

Cedric Bucher: I think at the end of the day dismissing a manager is an investment decision that must be taken, the same way as hiring a manager. It is probably emotionally sometimes more difficult to fire, but the process should be very similar, whatever the process is, whether it is a mandate or a fund.

Elisa Trovato: How do you define the optimal number of managers or funds to have on your platform or to use in portfolios?

Jean‑Francois Hautemulle: The move in the industry from completely open architecture to guided architecture is partly due to the fact that the distributors and the managers want to have this kind of more in depth conversation.

A number of asset managers, the only thing they care about is whether they have funds on some platform. What I am interested in is building a relationship with the asset managers to actually work together to a common goal.

On the advisory side, I would defy any advisor to be able to offer more than 50-60 funds to a client. They have to understand the products. Therefore you end up with what Henriette was saying: less than 100 funds on your recommendation list.

The issue on the manager’s side is really also a question of size and flows. We have taken the choice of trying to leverage our capabilities. There is a compelling argument about choosing a much more guided architecture. You are better focused and you have better control over what is happening.  Is 10 the right number?  I would be challenged personally to go beyond 10, simply because you need to keep the managers happy. The way to keep them happy is to provide them with flows.. Ten at this moment seems to work for us; it works better with some managers and not as well with some others.

Raphael Sobotka: In manager of manager structures, we are looking for specialists in a certain asset class, or maybe even a certain alpha driver within an asset class. Typically for an asset class we will hire maybe three to five providers. If you add managers which have a strong competitive advantage, which could be back-up managers, we have probably no more than15 managers “shortlisted” per asset class.

Peter Fitzgerald: My view is that you should use the minimum number of managers required to get the job done.  The more managers you have, the greater the risk of an accident happening somewhere that you were not fully on top of. Within a multimanager portfolio, the more managers you use, the greater risk you have of replicating an index with a double cost structure, so it becomes quite pointless. 

I fully understand how private banks work: I worked in one for 10 years. It is important to have the brand. The client advisors who sit in front of clients need to sell product to a client. A lot of private banks will restrict their fund selection based on brand, product range, sales support, whether the product is registered in 10 countries for sale and whether there are 14 different share classes, and whether they pay trail commission.  

Within the multimanager business, the universe is much bigger. We are looking at individual fund managers, not at the businesses. We have put in place a rigorous process that we call the ‘Six Ps’. We do look at the parent company: we want it to be stable, to make sure that the fund manager knows he will have a job get paid next month. We look at the people: the fund manager and the people around him. We look at philosophy: does it make sense?  We look at the process. We look at historic performance and we look at current positioning. We buy retail funds, we buy institutional funds and we allocate mandates.

In an ideal world, the marriage analogy would apply whether you invest in a manager’s retail fund or give them a segregated mandate. One thing I fully agree with is that you do not allocate tactically to active managers. That is done through ETFs or futures.

Cedric Bucher: I think there are two answers to that question. From an investment perspective there should be no constraints, and that is one of the advantages of such an investment approach – finding these new and exciting managers. The role of the investment team is to screen the whole market, which is where their strength and skill are. The question is then how that research can be made available in an efficient way to the private banker or to the advisor dealing with the end clients. If you have an advisory channel, as in a private bank, you want to limit the number of funds. We too provide recommended lists of roughly around 100 funds.

Otherwise you have literally thousands of funds that have been advised to clients at some stage, and at some point you lose control. In terms of the risk management, the ongoing process and controls, it makes sense to limit the number of funds.

Elisa Trovato: What characteristics are you looking for in an asset manager? And how important is the brand?

Jean‑Francois Hautemulle: I do not like best in class because there is always somebody who is going to become better in class. What we are looking for is a quality manager: the quality of the products they offer, the quality of the investment process they have in place, as well as the quality of the people you work with.  At the end of the day, it is a people business more than anything else.

Brand was a selection criterion for us for the very simple reason that we have financial advisers selling products to a client. An asset manager may have the best European equity fund in the world but if the financial advisers cannot sell that brand to the client, it will be very challenging. We have probably removed ourselves from a number of great managers. But in order to be able to get the buy-in from the advisers as well as the clients we need to have asset management companies that are good, solid brands in the market place.

After all, the quality of the brand does not come overnight; behind strong brands there is quality in the people, their process and the way they do business.

Claudia Itschner: I guess especially on the retail side it is important that you associate yourself with brands that have a good standing in the market and that hopefully match your own brand and ambition. That is less of an issue on the institutional side but irrespective of which, sub advisory is also a people business. Whether in product design or sales support if you really want to be successful you need alignment on many levels.

It starts with common goals, believes and philosophies: What goals are important for them and does that coincide with what is central to you? How do they prioritize things; is it the money more important or the client? How do they manage the relationship and how do they manage themselves: their staff, their problems etc? Ideally people on both sides should be on an equal footing in terms of experience, education but also chemistry wise. It’s difficult but if you get those things aligned then you feel “at home”, good solutions start coming and you keep going back for more.

Peter Fitzgerald: When you are putting together a multimanager portfolio, or a manager of managers portfolio, or a hybrid, brand actually is not important and the ability or the scale of a business to have their products registered for sale, as some clients insist, is not a requirement. It is actually the Aviva Investors brand that goes out to the market place.

Cedric Bucher: We see different business models in the UK versus Europe. In the UK, I fully agree that the multi-manager firm very much has an investment and performance led strategy, which comes first in the manager selection, with the brand second.

In continental Europe, I see more need for strong brands, even in a multi-manager product; we call that a more distribution-led approach. Our Dublin‑domiciled funds are marketed into continental Europe and they will quite often be structured in different ways, to accommodate to the needs of the distribution channels.

There is definitely a stronger focus on brands in the marketing as well; if you go out to talk to the advisers, talk to the clients, customers want to see a brand name in their fund.

That is the challenge we have as investment managers. But you still have to do due diligence, select the right managers and be measured against the performance of these funds.

Nick Phillips: Whether brand is important, it will depend on the type of partnership. It really depends on the strength of the brand or the business of the organisation that are doing the outsourcing, both their perception of our brand and their perception of their own brand in their market. If you are managing somebody else’s product in the entirety, if it is a retail bank their brand will be way stronger than ours is in their domestic market. We are somewhere deep in the prospectus and the client would not know unless the client adviser told them, or it is a co-branded product.

You get more value from a partnership the more you understand each other, and the more you understand each other, the more services you can bring to the relationship to try and add value. That could be product development, training the sales force of the organisation in different sales skills or in investment asset allocation. Or it could be talking to the end client or reporting. This is based on the requirements of the people doing the outsourcing.

EXAMINING CHALLENGING AREAS FOR SUB-ADVISORY AND INNOVATION

Elisa Trovato: Are there asset classes or geographies where finding a sub‑adviser is proving more challenging? 

Claudia Itschner: It is a challenge to find a sub‑adviser suited to your needs in emerging markets because the industry is not so developed and there are just not that many choices. We have cancelled searches in the past because we could not find the right partners.

Raphael Sobotka: A lot of money has gone into global emerging markets, not necessarily local countries or even regional products, but global emerging markets equity has seen a lot of inflows, and some good managers are closed. They have been closed or half closed for some time now, regardless of whether you try to access them via fund or via mandate. You can look at accessing emerging market via more local regional mandates, but it is not so easy. For example, in Latin America managers tend to be very focused on their local country – Brazil for Brazil – and then you have to reconstruct Latin America from that, which is not so easy. In some other small regions within global emerging markets is difficult to find a manager.

Jean‑Francois Hautemulle: An area I find personally quite fascinating is the European corporate bonds area: there are a number of very good funds but very small.  If you have a portfolio, let us say, of €800m to invest, you cannot have more than 10 per cent in any fund, and you end up with a lot of funds. I would have expected the European corporate bonds side to be a much broader universe than it actually is. Some of them are just not available, because they are just too small. The real performing ones are not that big.

Elisa Trovato: Do you see potential for innovation today in the sub‑advisory space?

Nick Phillips: The question is: what is an innovation?  Is it a new product or is it a theme that clients want? With the changing economic landscape we have seen demand for mandates in emerging markets, both credit and equity products. We have also seen Asian currency baskets over the top or the Renminbi hedged share classes and so on. That would be an example of something that we probably would not have been asked to do two or three years ago. I do not know if that is innovation or a trend. That is not creating a new asset class; it is just products that are now in vogue and our clients want to offer them to their clients.

Jean‑Francois Hautemulle: One area I am currently struggling with is products that can generate income for clients. Yes, everybody has dividend‑paying share classes or that type of product, but there is nothing there that actually works for what I am looking for. Therefore, we are talking to our partners about creating products that would combine a number of asset classes with the goal of achieving a certain level of income for our client base. I have always been dubious about the word innovation when it comes to funds, because it has always been created somewhere else already; you just have to look in the right place to find it. Interestingly enough with this dividend story, this is something the Japanese and Taiwanese have had for the last 10 years. For some reason it never came to Europe, and people are starting to get into it now.

Cedric Bucher: I think the majority of the sub‑advisory market at the moment is mainly in long only mandates and I see two areas where sub‑advisory can potentially develop. One is asset allocation, where a manager or a multi-manager could potentially sub‑advise asset allocation to someone who has got real skills in asset allocation strategies. There are also potentially different types of asset allocation. Portfolio protection, for instance, is something that needs a very specific skill, such as developing and managing CPPI-type strategies. It might make sense for a multi-manager to ask another asset manager who has the quantitative skills to run these types of models and to outsource that part as a component of the portfolio.

The other one is on the absolute return side. At the moment, if somebody builds a fund of hedge funds, typically that is a fund of funds and not a fund of segregated mandates. Most hedge funds are somewhat reluctant to provide segregated mandates. The main barrier is the intellectual property on the actual trades.  Hopefully, as the industry develops, in terms of size and as the hedge funds start to get into the Ucits compliant hedge funds space, we will be able to move into a territory where we have segregated mandates for these strategies. That would be very beneficial for clients and for fund analysts in terms of the transparency.

Peter Fitzgerald: The problem you have there, though, is that the successful hedge funds are earning two and 20 on their offshore vehicles; why would they ever enter into the absolute return Ucits space and then take another level down and do sub‑advisory?  We think it is interesting, but we cannot find a compelling manager to allocate money to in that area. This is for those very reasons: 2 and 20 offshore or 50 or 60 basis points plus a small performance fee with full visibility of all the trades. 

Claudia Itschner: We are thinking very much about risk factor based investing and we see managers starting to do the same. There are still many open questions but I think the concept is gathering speed and has the potential to have a big impact on the industry.

Raphael Sobotka: I think innovation will be more focused on the solution side, rather than the pure asset class side. For example, there is so far little academic research on what are “efficient” portfolios with income an additional factor, in addition to risk and return. There may be innovations regarding risk parity or how to capture better market risk factors premia. Traditionally the aggressive risk profiles in multi-asset funds have a large proportion in (developed) equities because we believe equity has a premium.

However, the 10 years or so of bad returns on equities in the developed markets has raised some questions of how to build a multi-asset product, in terms of balancing and leveraging the different risk factors. In addition solutions will be designed for retirement, wealth protection and education funding. Clearly it will be expected from our preferred partners, typically large companies, to discuss these ideas and potentially build a bespoke solution for us on these terms. 

Elisa Trovato: What do you see will be the future developments for the sub-advisory business?

Nick Phillips: We are still to find out what the new legislation on Ucits IV means in terms of what impact it will have from a business perspective, but eventually, with the feeder fund structure, it could be a benefit to a sub-adviser such as ourselves.

From our point of view, the important thing is to understand where our value is and making sure we have the right number of partnerships based on our capability and skills. The depth of the relationship and the partnership is what makes this business successful.

Peter Fitzgerald: For me, regardless of whether you invest into a mandate or a fund, what is important is the communication with the asset manager to understand what they are thinking, what they are doing. If you do have to fire them, you need to explain clearly your reasons for doing so, and be nice, because you might want to come back. You need to explain what your thoughts are, they need to explain what their thoughts are on the asset class that you are operating in.  They need to be honest with you about changes within their business. Are they having changes in personnel or in process?  We will find out, and it is worse for them if we find out without them telling us. It happens more frequently than it should.

Cedric Bucher: I think there has been a broad trend over the last five to 10 years or so. I would almost describe it as a division of labour. In the past, the same team or firm would often do investment management and give advice at the same time. Whether it is in the financial advisory area or in the private banks, distribution and relationship management have become separate from the investment management. Sometimes that is supported by regulation: in the UK we have the Retail Distribution Review, which really drives that trend, where financial advisors, particularly the smaller ones, start outsourcing their investment work to asset managers. That is something driving the growth of the sub‑advisory business. That is a trend that has happened, is still happening, and I expect it will continue to happen.