Identifying the fund industry’s problems

The long-standing decline of the Italian funds industry has been further aggravated by the sub-prime crisis, which has caused sharp falls in assets under management. In the first three months of 2008, fund outflows in Italy were E40.6bn, which already represents a staggering 77 per cent of the total E52.4bn fund outflows registered in 2007, according to mutual fund association Assogestioni. Leading economist Luigi Spaventa, speaking at the fourth annual European Fund Series of afternoon conferences in Milan, invited the industry to carry out a “soul searching” exercise to identify the causes of this “U-turn of the managed savings sector in Italy,” which started in 2001, after the strong expansion in the years before had shot the country to become the third largest fund market in the world. One explanation could be the unsatisfactory relative performance of Italian funds when compared to the risk-free products, said the emeritus professor at Roma University and president of Sator financial group. According to data from investment bank Mediobanca, over the period 2000-2006 the returns delivered by Italian mutual funds were inferior in the medium term to the risk free rate and the return of the equity funds was inferior to the benchmark. Even using more sophisticated calculation techniques than those used by Mediobanca, strongly criticised by Assogestioni, results remain disappointing, said the former Chairman of Consob, the regulatory authority of the Italian Stock Exchange. But what are the causes of this underperformance? The penalising fiscal treatment for Italian funds, often pointed at as the main evil, does not explain outflows from funds registered abroad by domestic fund houses, the so called “roundtrip” funds, which do not encounter this problem and also have been in the red since 2007. Reduce commissions “Commissions are a sore point,” said professor Spaventa. “They are really high in absolute terms.” They represent an average 1.4 per cent during 2000-2006 of total assets, net of upfront commissions. TERs are higher than the European average and they do not vary with market performance. This means that fixed costs prevail on performance commissions. “If commissions halved, the negative gap between fund performance and risk free rate would zero,” estimated professor Spaventa. A reduction of total commissions should start from a reduction of the percentage given back to the distribution networks, which in Italy are captive in 90 per cent of the cases. This would be necessary but not sufficient to improve the situation, he said. “I have the impression that the banks think of their asset management arms as cows to milk, when they need to swell their coffers in the short term,” he said. Many times the banks have asked their management arms to increase commissions, which explains why the asset management arms have little money to invest in production. Investment in funds should be a default option for a medium term horizon, but often the Italian investors have an attitude towards these instruments not different from someone operating on the stock exchange, but with less insight. Italian retail investors sell up immediately after the market has slumped, and buy up after a period of good performance. Greater transparency and daily nav (net asset value) on funds have increased this short-term attitude of investors, who surely do not monitor daily the quotation of a government bond in their portfolio. The unrestrained launch of fashionable sector and country funds, offered as unique opportunities to investors, led in reality to an “unwise concentration in portfolios of idiosyncratic risks of segment and country, being neither beta nor alpha,” said professor Spaventa. On the other side, sales of structured bonds and insurance products with financial content, swelled. While banks make the most of opaqueness in this market to make immediate money with high upfront commissions, Italian investors like these products for their capital guarantee at maturity element. “It is a mixture of offering policies of the banks and a problem of investors’ optical illusion” he said. ETFs and government bonds have become very popular with retail investors. Hedge funds are the only asset class which have registered positive inflows despite market turbulences but these instruments, with a high minimum entrance, together with other alternative investments are bought by the high range of Italian families. “I haven’t got any conclusions,” said professor Spaventa. But to fight this crisis, appropriate legislative interventions are necessary on fiscal treatment, to simplify procedures and guarantee a level playing field with those forms of investments alternative to funds, which are not covered by MiFID yet, he said. All industry players should meditate on the stern warning of Banca d’Italia governor Mario Draghi to separate production and distribution to limit conflicts of interests, he said. It is also very important to educate the distribution networks and the investors, who show a remarkable risk aversion, he added.