Lombard Odier values freedom of life in the open

Private banks have been reviewing business models to face soaring costs of compliance and in anticipation of Mifid regulations, expected to extend the ban on inducements to the whole of Europe. Many are cutting down the number of third party funds available to clients, moving from ‘open’ to ‘guided architecture’ in a bid to reduce costs. 

Retrocessions – ‘kickbacks’ which distributors receive often secretly from asset managers when they sell their funds – were first outlawed in the UK two years ago, by the Retail Distribution Review, with continental jurisdictions including the Netherlands and Switzerland following suit, giving customers more transparency.

As a consequence, an increasingly popular option for private banks to increase margins, as well as meet client need for more customised solutions, is to create their own products and outsource the management of assets to a few carefully selected external sub-advisers. This delegated approach enables distributors to embed the advisory fee into the mandate. 

But sub-advisory and open architecture approaches are not necessarily mutually exclusive, claims Laurent Auchlin, head of Open Architecture at Swiss bank Lombard Odier, which manages SFr115bn (€108bn) for private clients.

“The first question every private bank needs to ask themselves is whether open architecture is just a trend or an added value,” he argues. The bank took the strategic decision to keep open architecture, recognising “it adds value, if done properly,” offering more freedom in fund selection, and the possibility to use both small and large, global or specialist managers. 

On the bank’s recommended list, there are currently 88 third-party funds, managed by 65 external investment houses, for a total of SFr8.4bn in client assets. Less than 15 per cent is allocated to sub-advised products, but this proportion is expected to increase. 

In January 2014, Lombard Odier launched a Luxembourg ‘PrivilEdge’ platform of individually sub-advised funds, exclusively for private clients. Today the structure has $1.2bn (Ä1.05bn) in assets across seven white-label funds. 

“Our platform is the natural extension of Lombard Odier’s strategy for the past 15 years,” says Mr Auchlin, who joined the firm in 2000, after stints at private banks Credit Suisse and Ferrier Lullin. 

Lombard Odier Investment Managers, the bank’s asset management arm, drove the use of sub-advisers for a handful of funds in the past. Sub-advisory agreements are still in place for two products, the Japanese equity fund managed by Alpha Japan Asset Advisors in Tokyo and the gold fund, managed by Van Eck investments in New York.

Three other sub-advised funds focusing on US and global equities, in which the bank’s private clients “were heavily invested”, were moved to the new structure. 

The decision to separate the sub-advisory business dedicated to private clients away from the asset management arm was taken to avoid any conflict of interest, says Mr Auchlin. “For an asset manager it is not easy to promote its own DNA and third party asset managers.” 

Today, it is the private client business that drives manager selection, as opposed to pre-2008, when the asset management arm was the investment engine serving institutional and private clients, and the open architecture team was part of it.

The bank’s sub-advisory business will grow, expects Mr Auchlin. Client money flows have been shifting from off-the-shelf to sub-advised funds, especially in the US equity space. And the firm is now seeking suitable managers to launch additional products.

“The plan is to insource two to three new managers every year, that is the ideal pace, but ultimately it is a manager discovery challenge,” states Mr Auchlin, insisting he has no specific revenue targets to meet in this area. Sub-advised products will be launched only when a compelling opportunity arises, with no compromise on quality.

Key to this expansion is the private bank’s ability to maintain a low product and manager turnover. This is the result of both extensive due diligence and efficient communication with private bankers. The costs of selecting and monitoring a manager and then launching a fund are “huge” and would be unsustainable with a high product turnover. 

“The secret for keeping clients invested is complete transparency and no hard push,” he says. Product creation and distribution is always “a pull and push type of approach”. 

It is paramount to “educate” private bankers about the reasons for product or manager selection, and set up meetings with fund managers who can explain their approach. Therefore, even if funds underperform, clients will be persuaded to stick with them for the medium to longer term.

In Europe, distributing underperforming products is not an issue. “We explain we are strong believers in returns to the mean,” he says. In Asia, where the bank has a well-established presence, it is more challenging, as investors are more short-term oriented.

“Before launching a new fund, we need to have the conviction of the sustainability of the asset class on a five year-plus investment horizon,” states Mr Auchlin. This means that for tactical calls, client demand for new products has to be met through ETFs. 

In the sub-advisory space in particular, “the secret recipe for a good partnership is that managers select you as much as you select them,” he says. Topics such as target clients, or exclusivity must be discussed and agreed upon before making any commitment. 

All other factors being equal, a sub-advised fund is more profitable for a bank than an off-the shelf one, acknowledges Mr Auchlin, but the decision to outsource is not just driven by profitability reasons, but also by “feasibility and easy access”. 

For example, products on the PrivilEdge platform are available to all clients, as they are registered in all the relevant countries, both in Europe and Asia. 

Daily access to underlying assets and in-house risk management provides additional benefits, and fees charged by sub-advised funds are the same as the ones for off-the-shelf funds, he states.

A segregated mandate can help avoid concentration risks in funds – the risk of owning too much of the fund – especially when products are comparatively small. 

However, not all banks are able to set up a sub-advised platform. “Size and competence do matter in sub-advisory,” warns Mr Auchlin, who can count on a team of 15 analysts conducting 1000 manager meetings each year.

Sub-advisory will grow in mid-sized banks in particular, he predicts. “Regulation is getting more complicated and a small bank cannot cope with operational costs,” he says, explaining that last year, for example, he had to make two additional hires, law specialists, in order to free analysts’ time, increasingly taken by legal issues. 

Big banks, on the other side, may encounter capacity constraints in certain investment areas.

“As a mid-sized bank, I have never had difficulties in gaining access to managers,” adds Mr Auchlin.

Bespoke products

Five of the seven sub-advised funds on Lombard Odier’s Luxembourg platform invest in US equities, which have drawn considerable client interest in the past couple of years. 

These include the US Core equity fund managed by Neuberger Berman, the US Growth managed by Sands, the US Large Cap Value by Delaware Investments, the US equity opportunity product by Jennison and the US small cap equity fund managed by WellsCap. 

Income Partners, a boutique based company based in Hong Kong was appointed last summer to run an RMB credit and high yield bespoke product. 

“Most of our sub-advised products are bespoke and the aim is to create more of them,” says Mr Auchlin. 

William Blair manages a global equity fund, a mandate it has held since 2006, when the fund selection team was sitting within Lombard Odier’s asset management arm.

In the alternative space, Mr Auchlin’s team also selects third-party funds of hedge funds, which today run around $200m in client assets, including names such as Oakley Alternative Investment Management and Permal.

But not all products are suitable for this delegated approach in asset management, he states. In mandates, there is a minimum level of assets to reach, ranging from $50 (Ä44m) to $100m and it is very difficult to sustain that level of assets in a thematic, niche country or sector fund. “On the other hand, you’ll always find good managers in the US or Asia for example, who seek to gain access to the European market.” 

As not all asset management firms are willing to manage products on a sub-advisory basis, the best solution is likely to be a combination of both approaches. “In the next five to 10 years, we will still have both sub-advisory and off-the shelf funds,” foresees Mr Auchlin.