Make your choice

European financial institutions claim to provide a comprehensive array of products backed by professional advice. Anna Bawden weighs up the claims and probes the often secretive selection process.

European investment funds are in the spotlight. Falling stock markets and uncertain pension scheme pay-outs mean that increasing pressure is being put on banks, insurance companies and advisers who sell investment products to their clients. Do they offer the best funds they can? Do they offer open architecture – shelf space to all products designed by their competitors? And, most importantly of all, how do they select their funds?

For the first time, the selection process has been subject to rigorous scrutiny by an independent observer. “The PWM Open Architecture Report 2002” reveals some startling findings and shows distributors how their competitors approach the selection process.

In Europe, financial institutions generally fail to live up to their own hype. Only one fund supermarket, Germany’s Direkt Anlage Bank, and one private bank, Coutts of London, bankers to the Royal Family, offer the entire investment universe of mutual funds. Private banks and fund supermarkets have tended to market themselves as providing access to a wider range of products than other financial service providers. Yet, as the results of the survey show, this is not the case.

The other institutions that offer a full range of investment funds are French retail bank BNP, German insurer Allianz, and independent advisers Epicon of Austria and Gerrard of the UK.

Every European institution questioned in PWM’s survey of private banks, retail banks, insurance companies, independent financial advisers (IFAs) and fund supermarkets – apart from Milan’s San Paolo IMI – offered externally-managed funds. These were in addition to and sometimes in place of their in-house product ranges. The extent to which third-party funds are offered varies widely from distributor to distributor.

The key trend, though, is a more subtle one: a growing differentiation between the product factories and the shops that sell their wares. “European distributors of funds are increasingly moving away from creating products to focus more on distribution,” says Ian Woodhouse, director at PricewaterhouseCoopers (PwC).

The survey results show that European insurance companies distribute an average of 24 in-house products, retail banks 79 proprietary funds and private banks 118.

Paul Gillet, senior manager at Generali International, says: “Insurance companies still tend to have a core of their own life or mutual funds but this is beginning to change as companies realise the advantages of distribution alongside other strong brands. This is particularly true for high net worth products being distributed through professional advisers, where clients and advisers are looking for increasing investment flexibility.”

Commentators predict this trend away from product creation to distribution will continue apace. Thomas Marsh, senior analyst at Cerulli Associates, says: “We are starting to see distributors recognising the strong revenue stream that can be garnered by third-party funds. There is a management trail fee for offering these funds and it removes the trouble of fund production. In the future, houses will have to decide what they want to be: a fund manufacturer, which involves a game of expertise, or a distribution channel, which involves a game of scale.”

European banks have traditionally offered limited numbers of funds but distributors in Germany are becoming gradually more liberal, as they take these messages on board. Diana Mackay, director at consultancy Feri Fund Market Information, says: “In most markets, fund distribution has traditionally been via the leading retail banks and they have offered only their own proprietary product. There has been no need for them to include the funds of one of their domestic competitors because their fund ranges will be largely comparable.”

However, as table 1 shows, BNP in France and Hypovereinsbank of Germany offer the entire investment universe. Ms Mackay says this is a growing trend in Germany, where a number of banks have taken the open architecture route. She estimates that third-party products account for almost 14 per cent of the German funds market.

Advisory capacity

The problem with these open architecture models is that they have yet to offer sufficient advice. Patrick Rivičre, Paris-based director of Invesco’s European operation, identifies this problem. His company has recognised that it needs to offer more choice in Europe but decided to add just four external managers to a high value retirement product to be sold through independent advisers, so it does not confuse investors with too much choice.

“French clients have been accustomed to buying products from just one firm,” says Mr Rivičre. “For them, to eventually have a choice of five or six products is a very positive move but they are not ready for more than that.”

European distributors, particularly retail and private banks, do not have the capability to offer advice on all the funds they sell, whatever they may claim. Only Allianz, Epicon and Gerrard give clients a full advisory service on the whole investment universe. IFAs are an exception to the inertia of the retail and private banks and could grab increased market share in years to come.

Only six institutions in Europe can offer advice on more than 500 funds. Most European distributors provide advice on significantly less than that; and 12 distributors, less than half the survey respondents, advise on less than 100 funds.

As the number of distributors embracing open architecture increases, good advisory capacity will be essential to differentiating companies. Mr Woodhouse at PwC says: “For distributors, the value proposition and brand is vital. The greater the number of products offered, the greater the amount of advice needed.”

Large-scale advisory capacities are costly, however. To continue to deliver quality advice, Mr Woodhouse believes companies will explore how this can be delivered more effectively through financial planning software and education materials. Also many distribution models are not backed up by a scientific selection process.

Selection criteria

Fund selection, although driven by performance, investment process and risk control procedures, still relies to a certain extent on brand. The costs of funds are important but not primordial.

Total expense ratio (TER), a measure developed to calculate all expenses incurred on a fund, and commission paid to distributors are factors to be considered but are not the primary concern. Our survey found taxation implications and domicile of funds to be of least importance.

Distributors look primarily for top-quartile performance and solid investment process. Brand is still a key way for fund houses to differentiate themselves to distributors.

Brand was the second most important issue for IFAs and fund supermarkets, of medium importance to retail banks and of less importance to private banks, when choosing third-party managers. A report from Sector Analysis on third-party distribution, “European Investor Focus 2002”, found that Fidelity, JPMorgan Fleming and Morgan Stanley are the best known suppliers of third-party investment funds in Europe.

Magnus Spence, director of Sector Analysis, says: “Any firm that ignores the importance of brand and thinks it can prosper as an undifferentiated third-party fund supplier, without having name recognition and eventually a brand, does not understand these markets. The single most important skill for these firms to develop in coming years, to differentiate themselves in Europe and achieve success as third-party fund suppliers, is brand building and marketing.”

Insurance companies in particular have mixed emotions about the importance of a strong brand. Ironically, those with possibly the strongest European brands attached the least importance to it. Fortis and Storebrand ranked brand as the least important criteria in selecting external funds. But Scottish Life International, which has developed a fund supermarket-style capacity, sees brand as the primary reason for selection.

After investment process and performance, correlation to existing products is the most important selection criterion for retail banks. For Crédit Agricole, making sure the product fits with the rest of the range is of the utmost importance. Merrill Lynch and Crédit Suisse are the only private banks to place this correlation factor above fourth position.

Retail banks, fund supermarkets and insurance companies do not attach huge importance to fund managers’ ability. The institutional practice of evaluating fund manager performance as well as fund performance has not filtered down uniformly into the high net worth/retail market. Hypovereinsbank is the only retail bank to accord the fund manager a prominent place in the selection process. Private banks Credit Suisse and UBS both see the fund manager as the most important criteria; Coutts and HSBC regard it as of medium significance.

The only group that places significant importance on costs (TER) during the selection process is fund supermarkets, represented by Charles Schwab, Egg and Direkt Anlage Bank. Commission, tax implications and domicile are largely peripheral concerns when selecting funds.

Survey conclusions

Asset managers and fund providers should use different sales techniques to approach different types of distributors. The emphasis should be on investment process, fund manager and risk control procedures when selling to European distributors but brand should not be ignored. And when dealing with IFAs and fund supermarkets, brand should be emphasised early on. Retail banks will also want to see evidence from the outset of a product’s correlation with other products they offer.

Open architecture has not yet won the day. Banks and fund managers are too jealous of market share to allow open competition, particularly in traditionally protectionist France.

Many houses take the “what’s in it for me?” approach. They prefer to have distribution agreements rather than offer every competitor’s funds.

“Most Europe-wide distributors are now looking for partnerships rather than open platforms. They want to work with a limited number of partners,” says Mr Rivičre at Invesco. “Some of the bigger distributors have 75 per cent of the market and there is no incentive for them to move into open architecture. They have more power and control if they can select a few top players and work with them.”

French banking powerhouse Crédit Agricole is a typical follower of this philosophy. “In other markets, the product/ distributor link has been broken but we thank God that this is not the case here in France,” says Paul-Henri de La Porte du Theil, managing director of Crédit Agricole Asset Management. “We have agreements with many other French distributors but not competitors, such as BNP, Credit Lyonnais or Société Générale. This is not possible with the French mentality.”

Additional reporting by Yuri Bender

Key findings

• 99 per cent of European distributors offer third-party funds

• Private banks distributed the least number of funds. IFAs and fund supermarkets distributed the widest range of funds

• European distributors do not provide sufficient advisory services. Private banks lagged behind IFAs and insurance companies in the number of funds on which they offer advice. Only six distributors can advise on more than 500 funds

• Distributors are moving from product creation to concentrate on product distribution

• Private banks have the largest number of proprietary funds (on average 118), insurance companies have the least (on average 24)

• Performance, investment process and risk control procedures are the most important selection criteria overall

• Brand continues to play an important part in fund selection. IFAs and fund supermarkets rated it second most important and retail banks and insurance companies of medium importance. Private banks consider it to be less important when choosing third-party managers

• Correlation to products they already offer are of high importance to retail banks

• The least important selection criteria are commission, taxation implications and domicile

Methodology

This survey is PWM’s first in-depth study of the dynamics of decision-making procedures in third-party fund selection.

It relies on proprietary research, undertaken through questionnaires and interviews with executives at more than 25 major financial institutions: six retail banks, six private banks, six insurance companies, five IFA networks and four fund supermarkets.

The aim of the study was to establish to what extent open architecture is being used in Europe and which criteria European distributors consider the most important when selecting which third-party funds to offer.