Handing it over to outside specialists

Why are banks and insurance companies increasingly contracting out the

management of some of their core assets to external specialist asset

management groups? How do they choose these groups and which groups are

winning the most sub-advisory business?

In this pioneering piece of new research, PWM was looking to pinpoint

the drivers behind the ongoing trend towards sub-advisory business. We

were keen to discover why the term “sub-advisory” was becoming

increasingly mentioned in conversations with asset management groups

and how the relationships between the parties worked in practice.

As can be seen from Charts 1 and 2, the groups given the most

sub-advisory mandates by our pan-European panel of banks, insurance

companies and fund houses were Schroders, Credit Suisse, Invesco,

JPMorgan Fleming, Merrill Lynch, Goldman Sachs, Templeton, UBS,

Fidelity and Morgan Stanley.

But when it comes to how sub-advisers are actually rated by the

respondents, the highest approval rating is for Goldman Sachs Asset

Management, followed by Pimco, JPMorgan Fleming, Merrill Lynch and

Schroders.

Economic decision

This difference encapsulates a key dilemma of the sub-advisory

business. To outsource assets to an external manager is an easy

economic decision to make. (Of course, there are still those houses

such as German giant dit, asset manager of Allianz Dresdner, who never

use external sub-advisers. “Specialists” in every asset class can

apparently be found in-house.) But finding a sub-adviser with whom you

can have a good, working relationship is harder.

The decision to outsource, believes Paul Burik, managing director of

Commerzbank Asset Management Group in Frankfurt, should depend purely

upon its impact on profitability. This in turn depends on:

• The amount of new business likely to be gained, or existing business retained by outsourcing

• Resulting changes to revenue from providing a higher quality product and volumes sold

• Savings in production costs paid to a sub-adviser rather than the in-house team.

Relationship difficulties

“Outsourcing is easy, if you can cut production costs or avoid

incurring them to establish a new non-strategic capability and you can

either gain or avoid losing customers,” believes Mr Burik. “But it is

not always so straightforward.”

The problems of the practical relationship alluded to by Mr Burik were

already rumbling below the surface when outsourcing began to gain

currency among European financial institutions in the late 1990s.

Italian multi-channel bank Mediolanum sub-contracted management of

E6.5bn in retail client assets to SEI, Northern Trust and State Street

Global Advisors (SSgA) in 1998. This early model tried to restrict the

influence of sub-advisers, and bury their brands and marketing

influence in the midst of the host company’s literature. Partners such

as SEI, who were driving this business, preferred to concentrate more

resources on other Italian banks such as Bipiemme, who would hand over

less money, but in bigger accounts and give them more influence over

staff and customers.

Matching the agendas of bank and sub-adviser would always be a sticking

point. God forbid that Mediolanum would allow any outsiders to come in

and train their salesmen.

“It is dangerous for people to do things of which they have no

experience,” warned Ennio Doris, the Milan-based bank’s charismatic

founder and chief executive in an interview with PWM. “For this reason,

we have partners in managing assets, but don’t like to have partners in

distribution. Liaison with customers has to be 100 per cent ours.

Management of sub-products can be outsourced, but a direct link can

never be outsourced. We need to know customers and what they need in

order to increase their loyalty.”

This approach proved a successful one commercially. Immediately after

the tragic events of September 11, most Italian banks suffered huge

fund outflows. But Mr Doris, once a close associate of Italian premier

Silvio Berlusconi, made a presidential-style address to his sales force

over Mediolanum’s internal TV channel, instructing agents to get out

and see all clients, tell them to sit tight and keep assets in the

group’s sub-advised products. The result was that many clients even

committed new money.

Brands are generally very jealously guarded. Most Italian houses will

sub-contract only to foreign players, and even then, there is often an

added twist. RAS, for instance, has used Pimco for emerging market

bonds since July 2003. There is crucially a group connection – both

Pimco and RAS are part of the Allianz group.

Similarly, Pioneer outsources niche products, including US equity

growth funds to US boutiques such as Oakridge and Papp’s. The products

are marketed Pioneer-Oakridge and Pioneer-Papp’s for legal reasons, but

the plan is to eventually use the Pioneer brand only.

Only a handful of the institutions we surveyed would appoint a

sub-adviser with a competing brand. Most cited “customer confusion” as

their excuse. Crédit Agricole’s fund of funds operation is an

exception, with a clear objective to invest clients’ money

successfully, overriding any brand issues.

‘Management of sub-products can be outsourced, but a direct link can

never be outsourced. We need to know customers and what they need in

order to increase their loyalty’

Ennio Doris, Mediolanum

Making a distinction

Many French and Italian players seem to draw a distinction between full

sub-advisory outsourcing and fund of funds, although they clearly have

deep partnerships with providers.

Natexis Asset Square, for instance, was created more than three years

ago by Natexis Banque Populaire specifically to set up funds of funds,

and combine the expertise of different fund managers. However, the

bank’s strategists claim they will “never outsource a product”, viewing

funds of funds as a totally different animal, allowing them to actively

and efficiently allocate assets. However, they have a partnership with

Goldman Sachs Asset Management, whose representatives take part in

their monthly investment committee meetings and give them investment

ideas.

This new acceptance of external influence is also typified by the

old-style private banks, which have re-invented themselves around the

concept of “independent advice”.

Playing to strengths

When Andrew Ross took over Cazenove’s fund management arm, he found an

organisation trying to be all things to all people. Far Eastern

specialists were rubbing shoulders with US fund managers, all in a

supposedly “boutique” brokerage.

He decided to concentrate on the things that were done well internally:

pan-European equity, fixed income and UK equities. The rest could be

farmed out to specialists.

“We had the position of a trusted adviser in the corporate world,”

reveals Mary-Anne Daly, head of private wealth management at Cazenove,

responsible for around half the bank’s £7bn (E10.5bn) in client assets.

“There was no reason why we shouldn’t translate that to the asset

management side. As your trusted adviser, will we be the best manager

of US equities and private equity? Probably not, so we hired core teams

and then multi-manager teams, to find the best solutions externally.”

The theme is drawn out by Martin Theisinger, head of Schroders for

Germany and Austria. “If we look back in history, most banks and

insurance companies attempted to build up their own asset management

entities,” says Mr Theisinger. “But it’s not that easy to do something

that is not their core business.”

He believes the last two years of poor markets have highlighted this.

“Insurance companies need to focus on insurance business and banks on

banking. They cannot be everything to everybody. Why should they manage

money across the globe? Maybe they should concentrate on European fixed

income. What can they know about US small caps, which is new to them?

Their strength is not production, but client relationships and

distribution.”

Drivers for outsourcing

The head of one of Mr Theisinger’s domestic German rivals puts it in

even simpler language: “Insurance companies have outsourced because

their distribution is good and their management stinks. They don’t

invest any resources in asset management.”

The main drivers for outsourcing, they believe, is the cost and

efficiency of production, which is being re-examined in the strategic

restructuring of core businesses.

This was one of the tasks facing the management of UK bank Abbey

National, which has decided to exit the asset management business

completely, and outsource £30bn to external sub-advisers. The initial,

transitionary, sub-advisory mandate, went to SSgA. But soon afterward,

£1.2bn in UK unit trust money was divided up between SSgA, JPMorgan

Fleming, and BGI.

Abbey’s chief investment officer, James Bevan, talks about the

outsourcing decision and the mechanics of choosing sub-advisers in our

pan-European round table (pages 8-12), specially convened in Frankfurt

to address the trends towards externalisation of asset management.

It appears that this strong trend has elevated sub-advisory business to

the top of the agenda of many cross-border groups. SSgA, which has done

so well from the Abbey deal, was always seen as an institutional

manager in Europe, yet was keen to get more retail and private client

money into the coffers.

Disillusioned with distribution

A distribution push was organised from Brussels in the early years

of the new millennium, but business was slow and the operation was

scaled down. Alongside this disillusionment with distribution came a

positive belief that bidding for assets of financial institutions that

were outsourcing, such as the UK’s Royal Liver, which handed over £850m

to SSgA, was a more roundabout, but more profitable route to private

client assets.

“We don’t know enough about brand management and distribution,” admits

SSgA’s global chief investment officer Alan Brown. “What we think we

know about is manufacturing investment returns. The sub-advisory side

is much better suited to what we do. The beauty is we don’t need to

devote a whole lot of people to it. Essentially, it’s the difference

between wholesale and retail business. People say we are a low margin

business. We are not. Our margins are just fine. We are a low cost

business.”

The sub-advisory bandwagon continues to roll through much of Europe.

Denmark’s largest fund group, Danske Invest, has already outsourced

selected niche mandates to Aberdeen and Schroders, with internal group

resources re-directed to developed equity markets.

‘As your trusted adviser, will we be the best manager of US equities

and private equity? Probably not, so we hired core teams and then

multi-manager teams, to find the best solutions externally’

Mary-Anne Daly, Cazenove

‘Insurance companies need to focus on insurance business and banks on banking. They cannot be everything to everybody’

Martin Theisinger, Schroders

Stark contrast

There is a stark contrast here to traditional open or “guided”

architecture, where products of rival institutions are sold over the

counter in branches of European banks such as Deutsche, ABN Amro and

Commerzbank.

When it comes to fund distribution, there is much secrecy and more than

a few political sensitivities involved in selling products, not created

in-house, through your own shop window. However, selling your own

products, but managed by somebody else, seems to be a much more

acceptable state of affairs.