Industry must pull together to save open architecture

The junction at which today’s investment industry finds itself is very reminiscent of the late 1990s, when fund groups were forced to reshape themselves to survive. But the drivers of that change and the measures which must be taken today are different and more complex, according to Massimo Tosato, vice chairman of global investment house Schroders.

Mr Tosato sees a large scale change in business models and product design as necessary to transform the industry and create new opportunities. He expects sales of cross-border mutual funds, currently responsible for 65 per cent of Schroders’ business, to grow to more than 70 per cent, while the 25 per cent of profits derived from Asia will also continue to rise. “But we need to change and adapt,” he warned fund professionals gathered at FT headquarters in London.

During the 1990s, Mr Tosato was charged with helping transform Schroders from one of the Big Five companies serving a grand but fast-declining UK investment industry based on defined benefit pension schemes, into a group that would eventually derive the bulk of revenues from cross-border distribution of mutual funds through banks and other intermediaries.

The logic ran that investment groups must be prepared to sacrifice assets from low-fee generating institutional mandates in order to gain higher revenue business from private banks and multi-manager groups. The shake-up, deemed necessary due to accounting and demographic changes, has proved immensely successful for Schroders. But today, asset managers must react to changing economic and regulatory circumstances.

Mifid II will prove particularly challenging, said Mr Tosato, with distribution power likely to become even more concentrated in the hands of banks. Private and retail banks will need to have a more targeted range of products, which their advisers are familiar with, threatening the ‘open architecture’ model which has developed over the last 10 years.

On top of this, products designed by insurance companies and investment banks are likely to be exempt from new regulations for at least two years, so putting mutual fund groups at a severe disadvantage. “There will be an incentive to offer insurance and structured products sponsored by banks, without transparency of fees and total cost,” he said, with clients also paying higher fees than they would on mutual funds.

These trends would present a “negative evolution” which the industry must join ranks against, said Mr Tosato, a leader in 1994 of persuading banks to sell mutual funds from outside providers.

“I have great faith in open architecture as a driver and changer of business. We must fight to preserve it,” he said. But external managers will still get a look-in, as more fund groups are expected to choose the sub-advisory route, contracting out management to a range of partners, while overseeing and taking a fee for the overall management.

The use of passive solutions is also becoming more prominent, with most private banks now using exchange traded funds (ETFs) at the core of client portfolios, with actively managed bets in the periphery. “I believe we should be advocating the reverse,” said Mr Tosato.

The concentration of assets in a small number of funds – 14 ex-US products accounted for 100 per cent of net flows over the last five years – is also expected to continue. “These are funds worth 10, 15 or €20bn each. That shows the power of the brand and track record in a time of uncertainty.”

This overwhelming reliance on brand and reputation was underlined by Diana Mackay, CEO of fund-tracking consultancy Mackay Williams. “Brand, for the first time, has become the most important determinant of fund sales success,” she said, having overtaken previous leading factors of performance and price.

Groups identified in her survey of distributors as having the best prospects included BlackRock, Franklin Templeton, Carmignac, DWS, JP Morgan and Schroders. “Distributors and their clients don’t like surprises,” commented Ms Mackay. “Stability can count for a lot.”

While the long-term trend among banks away from restricted to independent advice may be disrupted by new regulations, this might not be a permanent obstacle. “Open architecture has been used by banks for the last 10 years and it will be very difficult for them to back-track,” she said. “How can they say to investors: ‘You are better off just taking our own product’? They will need more sophisticated arguments.”