Asian players plan to leapfrog European distribution model

The trend towards decoupling between manufacturing and distribution of investments has consistently driven sub-advisory activity in Europe since the turn of the century. European banks and insurance companies have increasingly identified their core business as servicing clients, rather than managing assets, explains Lloyd Reynolds, managing director at Goldman Sachs Asset Management (GSAM).

The tendency of these financial institutions, is to keep their sub-advisers at arm’s length and invisible to the end consumer. “Understandably, the distributor will nearly always want to keep control of both the client interface and brand experience,” says Mr Reynolds.

Moreover, the increasing popularity of cross-border funds allowed by European Ucits regulation often leads distributors to view sub-advisers, who may distribute investment products in the same markets, as rivals or competitors. This explains why many sub-advisory relationships are not widely disclosed, believes Mr Reynolds.

In Asia, however, the numerous and strong local and pan-regional players certainly do not fear competition from foreign asset managers in their domestic markets. This marks a huge difference to the European experience.

NEW MARKETS, NEW PRODUCTS

“In many ways, Asia is leapfrogging Europe and has the opportunity to go ahead of Europe in terms of its sub-advisory relationships,” says Mr Reynolds, explaining that the most demand for sub-advisory is in those markets where it is still difficult to sell cross-border funds.

Sub-advisory drivers differ greatly between Europe and Asia. In the old continent, asset managers or distributors often sub-advise specific products to enhance or complete their product range, with the aim of at least retaining their assets.

They are likely to employ a sub-adviser to manage an existing pool of assets, which may be already run in-house or by another sub-adviser, whom they may want to replace.

In Asia, the sub-advisory experience is much more about asset gathering; it is about bringing new products to market and accessing new segments, such as the rapidly growing high net worth space, into which sub-advisers can bring their experience. In some Asian countries, firms will specifically employ a sub-adviser to build up their asset management business.

THE FULL SERVICE EXPERIENCE

This different approach to sub-advisory has a strong impact on the service that distributors require from their asset managers. “In Asia, firms want the full service, they want the expertise, the knowledge, the educational capability. There is much more partnership in Asia than in Europe,” says Mr Reynolds, who notices that recently there have been signs of sub-advisory evolving in this direction in Europe too.

“In Asia, distributors really value the sub-advisers that liaise with their adviser networks and offer their support through educational programmes,” he says. They also appreciate help and support in the provision of the marketing material that goes to the end consumer.

“This is why any bank, any insurer looking to sub-advise in Asia wants to know that the asset manager is committed to the region and that it has local people and local presence.”

The acquisition of a South Korean asset management firm and of an Indian asset management licence further boosted GSAM’s widespread presence in the region. The international fund house, which has $690bn (€495bn) in assets under management globally, employs 100 people, across both distribution and portfolio management, in Asia ex-Japan.

Having a strong institutional background is a key strength for GSAM in the sub-advisory business, Mr Reynolds believes. “The due diligence that asset managers or distributors employ when appointing a sub-adviser is the same employed in any institutional mandate,” he says.

Product quality, good performance is paramount but not enough, says Mr Reynolds. “In sub-advisory relationships, you have got to have the ability to run the mandate the way the client wants it to be run; you need transparency on the sources of return and to be able to explain them to your client; you must have really robust risk management systems to enable the performance to be repeatable and explainable,” he emphasises.

GSAM has been making large inroads in Europe in recent years, particularly in the Italian and German markets, where it has gained considerable experience in selling funds to distribution networks. Being a big player in the US retail market, it has also a long track record of running educational tools and programmes for its US distributors, which are then made suitable for its European and Asian distributors, maintains Mr Reynolds.

REDUCING FIXED COSTS

In Europe, asset managers or insurers view sub-advisory as a valid solution to reduce fixed costs. During 2003, sub-advisory activity was largely driven by the fact that many banks - which had built their own asset management capabilities in-house in the bull market of the years before - were forced to shut down their manufacturing arm or reduce their asset management capabilities in the subsequent bear market.

Likewise the bull market that ended in 2007 drove banks to build up their in-house capabilities up again, causing a plateau in sub-advisory mandates in Europe, explains Mr Reynolds.

“I think we are about to see the next cycle of sub-advisory,” he says. “Distributors will be looking at the costs of running their teams in-house,” says Mr Reynolds, who expects to see new mandates perhaps in those asset classes that have reduced to a sub-optimal size to be managed internally, because of the market downturn or clients’ redemptions.

In Asia, sub-advisers are generally employed to run a range of products. This also enables distributors “to have a stronger say in the fee discussion”, says Mr Reynolds. Indeed, the debate on fee levels forms part of the partnership’s long-term growth plans, where targets for gathering assets and accessing new market segments are set.

NEW OPPORTUNITIES

Thanks to changes in regulation, it is now possible to invest in international markets in a number of countries in Asia. This will generate new opportunities in the sub-advisory arena, believes Mr Reynolds. Local players wanting to invest in overseas markets may have built their own products or simply accessed them through passive products such as exchange traded funds (ETFs), but the market downturn has made them realise the importance of alpha-generation capabilities, he says.

Indeed, in Asia there is clearly far less demand for international products today than 18 months ago, acknowledges Mr Reynolds. The focus is now on the pan-Asian investment opportunities, partly because Asia is expected to drive the global economy out of the crisis, ahead of the Western countries. But those players that are interested in Asia for the long term will see investors’ interest in the global markets increase as the months go by, he believes.

Moreover, the collapse of Lehman Brothers and hedge funds frauds like that allegedly perpetrated by financier Bernie Madoff has made people increasingly more aware of counterparty risk. “The consumers, the distributors, the advisers will want a diversified counterparty exposure going forward; they will not want all of their eggs in one basket,” says Mr Reynolds.

“Sub-advisory can be very transparent; more so in the master feeder structure, distributors can work with the sub-advisor to make sure they build a portfolio that is bespoke to their clients’ needs.”

Once the dust of the financial crisis settles, and investors’ risk appetite rises, there needs to be a rethink around how best to serve the client, believes Mr Reynolds. “Distributors are recognising that having a strong reputation for advice and education will enable them to offer a differentiated proposition in their market.”

In Asia, in particular, over the next years, the asset management and mutual fund areas will grow tremendously, says Mr Reynolds. “And in a phase of high growth it is vital for a distributor to have a differentiated proposition,” he adds.