Is the market on the other side always ‘greener’?

Selling funds, whether domestically or cross-border, has become increasingly competitive. The marketplace is in a constant state of flux, and trying to keep abreast of the trends is a challenge in itself.

The good times are now a distant memory and after three years of bearish conditions, it is much harder to find that patch of green grass. To do so, we need to step back and take a much wider view of the field.

Money flows and equity funds – the grass grows slowly

Let’s start with money flows in Europe and the US. Their strength is a useful indicator of the dynamics driving the markets. Where the US goes, Europe follows – sometimes two or three months later – and as you can see from Chart 1, the sales patterns for both are very similar. Interestingly, total money flows in Europe have been far stronger than those of the US.

If we look beneath the headline data at pure equity flows, the situation is reversed and European equity sales are surprisingly weak in comparison. It looks as if US investors have dived back into equities with very little hesitation whereas European investors have been reluctant to commit. So, once again, it appears the US industry is forging ahead and leaving Europe standing. But is this the full picture?

In percentage terms, the US asset base grew by 16 per cent during the course of 2003 and Europe also grew by a comparable 14 per cent. In real terms, as the US industry is twice as large as Europe’s, so too was the growth. But while new money accounted for 48 per cent of Europe’s asset growth, it accounted for just 3.5 per cent of US growth. So US investors have simply been shifting money from one pot to another.

Europe is a market that is undoubtedly expanding and likely to expand further as the pressure to save for retirement intensifies. But where exactly is the money going?

Chart 2 shows that as flows into equity funds began to improve, they were matched by flows out of money market and bond funds. In this instance, fixed income has increasingly been dominated by short-term bond funds or near money market funds. So although lower than US activity, equity fund flows are also the most dominant factor in the market.

Each European market has a different take on this broadly similar theme. However, in the equity arena, we are looking at a dividing dynamic with two distinct types of participants. On one hand we have a local/domestic Europe and on the other, the international or cross-border groups.

The common perception is that the banks dominate the Continental European markets and that is true, certainly if you are looking at distribution, but they are not dominating the field in terms of business generation. In Chart 3, you can see the net sales of equity funds across Europe but this time divided into those sourced by domestic players and those sourced by cross-border ‘International’ groups mostly operating out of Dublin and Luxembourg, but not round-tripping.

Two thousand and three started badly, but as the year unfolded, sales volumes for the domestic groups began to plateau with domestic investors generally taking a very restrained view on the opportunities that equities offered. At the same time, however, the international groups were improving momentum and by the end of the year and into 2004 they have been trading higher volumes than the domestic players.

Equity expertise is one of the international groups’ key strengths and the more specialist the opportunity, the more likely it is that a domestic distributor will source the skills externally and as equities have come back onto the investment radar screen, so demand for these specialist skills has accelerated. Essentially, Europeans are buying equities from international groups in increasing volume and although the domestic groups are also attracting increased equity volumes, the scale of their activities has been rather meagre.

To put this into slightly sharper focus: in 2003 the average net sales for a domestic European equity funds was E2.3m. The equivalent figure for cross-border funds was E17m – seven times more than the domestic equity offerings. So what is going on exactly?

Two types of european investor

The answer is that there are two Europes, an ‘amateur’ and a ‘professional’. The first Europe comprises the bulk of the investing public; people who source most of their investments from their local bank branch advisers. These are the amateur buyers. But the second Europe is the expanding professional buyer community that includes discretionary advisers, the more sophisticated IFAs or private banks. These are the professionals.

But the two Europes are increasingly interlinked through product packaging of our analysis.

Guaranteed hybrids – equity style returns at minimum risk

This is the creation of packaged products and pre-packaged advice. In this arena we should be aware of two different developments.

Firstly, there are products that fall within the embrace of regulated mutual funds such as funds of funds, unit-linked activity, and Italian GPF activity – in other words activity that directly or indirectly contributes to the mutual fund numbers that have been illustrated here. Secondly, products that are paper structures of one kind or another and which are generally unregulated but nevertheless feed through to our ‘amateur’ investor community.

The first is really a story about guaranteed funds and it occurs particularly in France, Belgium and during 2003, it was a really big story in Spain. In each case, fund promoters are offering exposure to the stock markets but for limited down-side risk.

The scale of this activity is becoming quite significant: in 2003, pure equity sales were in the order of E32.6bn, whereas guaranteed/other products were not far behind with E24.2bn.

The second part is a difficult development to calculate because there are no verifiable numbers or reliable data. However, it is known to be a particular issue in Germany and in the Netherlands. Both markets were extremely disappointing in 2003 and the explanation is generally accepted to be investments into unregulated structured notes.

What is important, though, is that these instruments offer the same or similar features to guaranteed and other like products – ie. exposure to the equity index for a limited or no downside risk. In final analysis, the ‘pure’ equity figures are really an inadequate measure of investors’ return to equity exposure. But they remain a good indicator of the willingness of investors to take any further risk… at least for the time being.

What’s in your neighbours’ fields and who are the haymakers

So how does this affect the individual markets? Chart 4 outlines the market share of the international groups versus domestic groups for all funds and equity only. It confirms the view that cross-border groups are increasingly sought after for their equity expertise and they are rapidly gaining ground on their domestic counterparts. This is particularly evident in countries such as Spain where the success of packaged products has been very good news for cross-border groups.

Chart 5 analyses the top cross-border operators in Europe. These 10 groups alone attracted sales of E29.3bn in 2003, 13 per cent of the total sales for Europe.

In conclusion, the marketplace is changing, not just in terms of money flows but also in terms of investor categories and the types of products into which investors are either steered or advised. Is the other person’s grass always greener? Only you can tell, but for all of us the wider the horizon we can study, the better we might know what grass to grow… and where.

Bella Caridade-Ferreira, editor and research manager, FERI Fund Market Information