Keeping hold of clients

Imagine your supermarket only offers one type of cheese. You want to buy some but you would like to have more choice – maybe because you want to taste something different, or perhaps because that particular cheese does not agree with you.

This is the example that Juan Alcaraz, CEO of Allfunds Bank in Madrid, and one of the key speakers at the PWM Open Architecture Forum 2004, uses to explain the importance of open architecture for investors.

“For investors, open architecture is vital. It’s like moving from communism - where you go to the supermarket and there is only one type of cheese of a government brand – to being able to choose from 800 different types,” Mr Alcaraz says.

But before improving their cheese range, supermarkets have to be efficient when it comes to selection, to maintain quality and advantageous pricing in order to avoid disappointment for their clients.

“Of course you should give your clients access to the best products in the world, but first you have to do your homework internally,” he says.

Model mechanics

During the last five years the development of open architecture has been changing the relationships between manufacturers, distributors and investors. The question now is to find out how well these new business models are working.

The same way supermarket owners search for the best groceries among a huge number of providers, fund distributors need to screen the funds universe to detect the most efficient products for their clients and businesses.

The drivers behind banks and insurance companies opening up to third-party providers of investment products are investor demand and competition from rival institutions. This means that in many occasions open architecture is embraced as a defensive reaction to avoid being left out for not being able to provide the most complete product range. In many cases, it is the only answer to the increased pressure to remain competitive.

“On the one hand, you have the private banks offering third-party products and advice, and on the other you have the international fund managers making more noise,” says Mr Alcaraz.

Marketing campaigns by the world’s largest fund management houses mean investors are becoming more familiar with their products, and most importantly, they also know where they can find them. If their banks are unwilling to offer them choices, they can always go to someone else who does, whether they are private banks or independent advisers.

In theory open architecture can bring endless advantages for those willing to go down that route. It can make banks more competitive, retain clients and attract new accounts, ultimately resulting in larger market share. “This is the nice part of the story, but what is more complicated are all the efforts you have to make to enter open architecture in an efficient way. If you enter without the right team behind all the different levels, including analysis, back office and IT, you can end up harming your business,” says Mr Alcaraz.

He points to three areas where more investment is needed when contemplating the distribution of third-party products: dealing and settlement services, research and advisory services. He believes the complexity of the infrastructure needed for doing this means using a platform, such as Allfunds, makes much more sense than trying to do it internally.

‘Banks think: should we have a deep relationship with one provider or should would have multiple shallow relationships?’

Mike Harding, Mercer Oliver Wyman

‘Insurance is a growing channel in Germany, especially with the development of unit-linked life insurance products’

Alan Crutchett, DWS Investments

Fund platforms in general have been a catalyst for open architecture across Europe. In Spain, for instance, when Allfunds was launched in 2001, the market for third-party funds represented just €8bn. Today it accounts for €30bn, and around 50 per cent of these funds are sold via Allfunds. The firm is also present in Italy, where it already processes €2bn of third-party funds.

Platforms are helping to ease the distribution burden and facilitate manufacturers’ expansion across Europe, claims Mr Alcaraz. DWS, Europe’s largest fund house, has electronic links with these platforms, which can be used to order Luxembourg-domiciled funds from various local market jurisdictions. “That part of our business has been improving nicely,” says Alan Crutchett, managing director at DWS Investments in Frankfurt.

DWS represents one of the best examples of how open architecture can contribute to business growth. Long before its parent company, Deutsche Bank, announced its move to embrace external providers in addition to internally-manufactured products, DWS was already placing its products through different channels. Today only a third of its fund assets are sold directly through the Deutsche Bank network and this figure will come as something of a surprise to those critics who believe that all DWS products are simply pumped through the branch network.

“In Germany we have been fully multi-channel distributors for at least seven years, reflecting the move to open architecture amongst German banks, but also showing the distribution partnerships we have with insurance companies and IFA groups,” says Mr Crutchett. “Insurance is a growing channel, especially with the development of unit-linked life insurance products that are much more popular in Germany than they were 10 years ago.”

Mr Crutchett adds: “DWS has a huge advantage because we are local providers in almost every market, but we also offer pan-European products and we have distribution partnerships in all of those countries.”

Distributors, even more importantly than manufacturers, must also choose the preferred route to create an efficient and profitable operation.

“You need to think about the economics of your own business, and the economics of shifting to open architecture, because inherently you are losing some of the revenues from manufacturing, and you need to make that up in terms of additional assets under management,” says Mike Harding, managing director at strategy consultancy firm Mercer Oliver Wyman in London.

“Inherently, it is more efficient if you focus on small funds that have fixed costs, particularly international funds or sector funds where you don’t have the right sort of fund product yourself.” Mr Harding says that banks need to optimise the level of open architecture they want to offer because “there is a difference on how much you offer and how much gets purchased”.

Jumping on the bandwagon

For Mr Harding, many of those embracing open architecture are doing so following others, without having necessarily thought through the specific strategy they want to implement. “In order to select partners you need to have a systematic process, and in most cases, we don’t think people have that, and they tend to jump at ‘we know these people reasonably well, they’ve got a reasonably good track record’”, he explains.

He also adds that there is a rational reason why they tend to concentrate purchasing into one group rather than having multiple relationships. “They think: ‘should we have a deep relationship with a provider or should would have multiple shallow relationships?’ Shallow ultimately means more expensive because you get a less good negotiating position.”

Revenue margins will always be important when considering distribution strategy. In many cases banks decide not sell third-party funds directly through their own networks, because there are no financial benefits for the company to do so.

‘Guided architecture is positive and it is an important first step, but it has to be done in an efficient way’

Juan Alcaraz, Allfunds Bank

The critical thing is the content of the open architecture platform, because it only makes sense if it really gives genuine choice

Trevor Matthews, Standard Life

Multi-management and wrap products in the form of funds of funds, managed portfolios of funds and unit-linked vehicles, are often chosen by banks as the best way to satisfy customers’ demand for third-party flavour.

“This has been the first step taken by some of the large networks, including Santander,” Mr Alcaraz says, referring to his platform’s parent institution. “But recently, we have started to see other strategies, what we understand by guided open architecture, where large banks sign agreements with five or seven managers to sell their funds through their branch networks.”

Guided architecture is now being employed by the branch networks of Commerzbank, Deutsche Bank and ABN Amro. HSBC has also stated its desires to introduce a guided model next year. But in many cases, says Mr Alcaraz, the criteria used when signing agreements are very much focused on how banks can benefit themselves, in terms of commission rebates, image and other commercial considerations.

“Guided architecture is positive and it is an important first step, but it has to be done in an efficient way,” says Mr Alcaraz. “It would be interesting to analyse how these institutions are doing it and which are the criteria they use for the selection. The key would be to know whether this selection is active or static,” he explains.

Mr Alcaraz believes there is a danger of institutions using guided architecture as a marketing tool to keep clients happy by showing them their commitment to offer third-party products, while “what they are really doing is to sign agreements with five fund managers, and choose a number of funds that curiously are not core but only cover some very specific niches. I wouldn’t say this is a deceit, because it’s better than nothing, but it is not open architecture.”

He adds: “I would be worried if the trend is to close agreements with fund managers, obtain the best possible margins with them and forget about the end objective which is to offer the best product to the client.”

If European banks think that by signing these type of agreements they can then relax for five to 10 years, the industry will have a problem, believes Mr Alcaraz, “because most entities will end up choosing the same managers and they won’t be doing what I think they should, which is to have internal teams to continuously select the best products for their clients”.

What is clear is that open architecture is the way forward, but it is still too soon to know which model will be the most popular in the future. However, we know that its arrival and recent development have already impacted in the way the industry is operating. “It is relatively early days even though people have been talking about it for along time. Open architecture continues to evolve and new models are emerging,” says Mr Harding. “What is true is that the basis of competition is shifting, and it is really coming down to your ability to select managers and negotiate with them.”

The important thing, as far as distributors are concerned, is not to try and reinvent the wheel, says Trevor Matthews, chief executive for the UK life and pensions business at Standard Life in Edinburgh. “You can use some of the platforms that are already available following criteria that suit you,” believes Mr Matthews. “The critical thing is the content of the platform, because it only makes sense if it really does give genuine choice, because if it’s too restrictive is not good for the customer.”

Looking to the future Mr Matthews says: “I think there will be a dislocation in the short term, because instead of companies providing retail products direct to the customers they will have to provide wholesale fund management services to the platform and there are some fundamental advantages there from the customers’ and the distributors’ points views. We see a movement along the value chain.”

Satisfying demand

Whether distributors opt for multi-management options, wrap products, fund platforms or guided architecture, the truth is that no-one can ignore the fact that investors want more choice.

The way open architecture is developing across Europe varies from country to country, but the one thing in common is that the decision to open up to third-party providers is always a tough one. Banks and life insurers need to consider how they can give choice while boosting revenue, but in the long term keeping customers happy will be the key to success.

“There is no doubt you have to enter open architecture because it brings huge advantages to your company,” says Mr Alcaraz at Allfunds Bank. “You can transform your business into a much more competitive one, but you need to get ready for it and do it efficiently.”