Keeping up with the next generation

The European investment world is undergoing a major transformation. To cope with their changes in circumstances and expectations, retail and high net worth investors are demanding different types of investment strategies. Consequently, the distribution channels used to service these clients are also changing. To keep up, manufacturers must mastermind the development of a new generation of more sophisticated products. Then they must ensure they market them correctly to the right gatekeepers.

Shift in focus

Bob Parker, deputy chairman at Credit Suisse Asset Management (CSAM), highlights a number of key emerging and future trends in client demand for products.

The most important change is that clients are switching focus from relative to total returns. “Relative investing is where I appoint an investment manager and their job is to outperform the benchmark,” says Mr Parker, describing the old-school, widely-accepted standard of investment. “If the benchmark is down 10 per cent and the manager is down 8 per cent, the manager is still seen as a success. But this approach will no longer wash with clients in the present low return environment.

“Total return investing, on the other hand, is about clients wanting to capture the upside in good markets and to do anything to avoid the downside and remain in positive return territory, whatever happens,” explains Mr Parker.

A clearly defined “risk budget” is the cornerstone of total return investing. “Products need to be much more risk-focused,” he elaborates. “Clients need to be able to specify how much risk they are prepared to take, say, a maximum of one year of under-performance or being no more than one per cent down.”

Mr Parker is adamant that clients are already sufficiently clued-up to this sea-change in investment. After all, it is their mentality change which has led to the rebuilding of product development strategies.

“They are becoming increasingly conscious of risk management and also the need not to confuse good risk management with a strategy that involves taking no risk at all,” believes Mr Parker.

Out of favour

In line with this, investors are moving away from traditional plain vanilla products. In the fixed income portfolio they are looking wider than just government bond investments and in the equity portfolio, core, developed equity markets are falling from favour. “Niche products are increasingly becoming core products,” says Mr Parker. “Big money is flowing out of developed markets and into emerging markets, because the latter is where the growth and capital earnings are.”

Emergent views

Clients are approaching European emerging markets from two perspectives. Either they are investors in European equity, seeking to diversify their exposure to developed European countries, or they are emerging markets investors looking for more than just the Far East and Latin America.

Property is also becoming a very popular investment class because investors are seeing low bond yields and using real estate as a proxy for fixed income, according to Mr Parker.

And within fixed income, investors’ search for higher regular payouts is drawing them to high yield and emerging debt. Funds investing in the full spectrum of debt are doing particularly well at present because they offer returns beyond traditional single asset class fixed income without investing in equities, says Mr Parker.

Equities have not entirely fallen from favour, but investors want a new approach to the market. “The trend is towards focused and less diversified portfolios with around 50 positions. You can generate more alpha by concentrating your bets,” says Mr Parker.

Equity income products are another new favourite: “In an environment of weaker economic growth, you need to focus on generating income, as capital gains may not be there,” ventures Mr Parker. “This is why investors are looking at funds dedicated to equities paying out the highest dividends.”

Risk and comfort

According to Ian Chimes, head of European distribution at CSAM, such products sit somewhere between core and high alpha. “You are taking more risk than you would with a traditional equity fund but with the comfort of a dividend stream,” says Mr Chimes.

He reveals that CSAM has more high alpha products on the launch-pad and has recently recruited Jeff Cunnington from HSBC to spearhead this effort as head of European equities. “We will still do core products but if you want to get a share of the new money being invested, you’ll definitely have more success as a manufacturer of higher alpha products,” affirms Mr Chimes.

Investors also remain keen on the diversification characteristics of multi-manager funds. But CSAM’s approach to this strategy is a fund that invests in a number of boutique managers, which require more research, and are not so easily accessible to end investors, rather than the more traditional “best of breed” philosophy.

The group is also preparing for a surge of interest from retail and high net worth investors in commodity-based products, a theme already being played out among institutional clients.

“There have been huge rises in prices in commodities. Oil, for instance, was around $25 a barrel in 2003 and went up to $41 a barrel in 2004,” states Mr Parker.

“In the short term it’s unlikely that commodity prices will continue go up, but if we assume that China, India and other emerging markets continue to grow, we could argue that over three to five years commodities will go up. In that case, we could see another wave of demand for commodity products.”

For individual investors, funds are the necessary route to investment when it comes to commodities, according to Mr Parker. “It’s not easy to invest in commodities, as you can’t take a delivery of coffee or oil in your living room.”

But he warns that future interest in such products is not guaranteed: “Commodities do have a low correlation to fixed income and equities, which makes them attractive, but you need to make sure you do not just diversify for its own sake. You need to diversify into something that is going up.”

Once the product range is in place, it needs to be marketed to the right people. “There is increasing sophistication at the buying end as the distinction between retail and wholesale distribution becomes blurred,” says Mr Chimes. “Buy-list coordinators are developing a much more institutional mindset. They now have a rigorous approach to processes, risk controls and product controls.”

Transparent approach

In the new market conditions, the one thing all products must share is transparency in the eyes of the end investor. “The fund needs to do what it says on the tin,” says Mr Chimes, and this starts with a transparent approach to the distributors who sell the funds to the investors.

It is particularly important with asset classes that have been traditionally more mysterious. “For our emerging market products, we spend a lot of time with distributors. For instance, we do a monthly ‘talking head’ with them, where we tell them what we see happening. We’ll talk about ‘the China effect’, the urbanisation of emerging markets, steel, oil and so on.”

When it comes to equity products, the investment process must be demonstrated to add value, and the distributors must be convinced of this. “You are not going to win new money by hugging the index, especially when charging active fees,” believes Mr Chimes.

He also believes that distributors are increasingly looking for a holistic investment process. This contrasts with the billboard-led market of old, which could persuade direct retail investors to place their savings with well-known individual managers.

“The sophistication of retail gatekeepers means that the days of an inspirational star fund manager sitting on their own are behind us. You still need ideas people of course, but you need to show that your process is repeatable and scalable.”

Products need to be packaged in a way that local distributors recognise. “Our motto is think global but act local,” says Mr Chimes. “We have a team of distribution leaders in Europe. While we coordinate campaigns, they work on a country-by-country basis. We want to make sure we are not launching things where there is no demand, so we ask our clients about demand in their area and try to be the first to meet it.”

Products launches also require the correct support, including fund fact-sheets printed in different local languages.

Changing patterns

The distributors are also metamorphosing. Pension funds for example are moving to defined contribution (DC) structures, where members select funds, effectively creating their own retirement schemes. Mr Parker says: “Europeans tend to view retirement provision in terms of the three pillars concept: the state pension fund, the company or industry pension scheme and the personal pension plan. But there is generally less confidence in state pensions and reliance on them is decreasing, while companies and industries are worried about taking on the market risk associated with pension schemes. They are increasingly transferring the risk by setting up DC structures.”

It all means that the big growth area will eventually be ‘personal investment products’, argues Mr Parker. These will take the form of either pensions, life insurance or simple savings products. “There are huge opportunities in working with life insurance companies. We’ll treat them as an institutional client, but they sell our product on an individual basis.”

Mr Parker says that in the emerging investment world the key to success will be close cooperation between fund manufactures and distributors. For example, CSAM has been working with insurance companies and DC pension schemes to design products suited to specific types of individual client. The products so far developed through this close co-operation process include a high income European equity product, a total return fund, and products investing in emerging markets and real estate.

It seems clear that this level of product innovation is likely to continue to evolve in conjuction with changing distribution channels.