Roundtable: Industry talk

Yuri Bender: Many banks, fund houses and insurance companies

have reached the conclusion it is no longer necessary to manufacture

every product or strategy internally. But how should they choose an

outsourcing partner or sub-adviser? We have gathered an eminent panel

of senior representatives of banks and asset management companies from

Germany, Switzerland and the UK to address this question. We hope you

will share your experiences of both internal management and outsourcing

with fellow panel members and with PWM readers.

Abbey National’s outsourcing of £30bn (e45bn) in unit trusts and

insurance products to external managers has led to the most excitement

which the investment management community has seen in many years. What

was the toughest part of the decision to outsource, made against the

background of inevitable redundancies and accusations that Abbey has

thrown in the towel as far as asset management is concerned?

James Bevan: Abbey has been considering what it is doing across

every business with an open mind and a cultural imperative to consider

change. We had to decide whether the needs of both customers and

shareholders were best-served through investing in in-house operations.

But the £30bn we managed internally was a non-core activity for Abbey,

so we could serve a customer better through using sub-advisers.

It was hard logic and very straightforward. There was substantial pain

at a human level for those previously employed by the company but they

would not have security of tenure in any case if the needs of customers

are not being met. Our industry can be judged clinically by numbers.

Unless you start from the premise that you can be an outstanding

manager in all markets, you need to go down the outsourcing route.

No-one here can hold up their hand and say they are outstanding in all

asset classes.

Yuri Bender: Why did you opt for the multi-manager route rather

than the over-the-counter external funds promised by your rival bank

HSBC for next year?

James Bevan: The HSBC model involves three-year contracts with

managers of external products. We are not signing three-year contracts

with anybody. We can cancel our contracts with sub-advisers at any

time, as we have a fiduciary responsibility to our clients.

If one of our customers buys a product and the sub-adviser does not

deliver, we can pass the assets to a third party. But with HSBC, if a

customer buys a product managed by Threadneedle and HSBC then decides

this is not the best product, the logistics and implications of going

back to a customer and telling them to switch products can be very

painful and expensive.

‘No-one here can hold up their hand and say they are outstanding in all asset classes’

James Bevan, Abbey National

Yuri Bender:Other investment houses, such as BNP Paribas, have

decided to outsource particular asset classes to sub-advisers. Why not

develop internal expertise in these classes instead?

Josef Altmann: We have been using sub-advisers such as Neuberger

Berman for 10 years. BNP Paribas believes there is no asset manager who

can manage each asset class and style the best. Of the E15bn in our

Parvest Sicav, E1.5bn is sub-advisory. For some asset classes, we are

not the right manager, as we have a “growth at a reasonable price”

style.

For instance, we gave a Japan small cap sub-advisory mandate to

Sumitomo Mitsui, one of the biggest asset managers in Japan. For other

specialities such as US high yield we use T Rowe Price as sub-adviser.

So we have open architecture not only in front of distribution

partners, but also in our own product range. You can only compete if

you have a good product in each asset class.

As a growth house, we can’t switch to a value approach internally every

time this style comes into favour, so what some consider a core

competence may actually be sub-advised.

Hansjoerg Borutta:But if we make a mistake in choosing a manager

who does not provide alpha for some period of time, for whatever

reason, it is we who have to explain, so we cannot really hide. Imagine

what we would look like if we said “it was him, not us!”. When you make

your choice and do your due diligence, you always need to be thinking

whether what these people are doing is transparent, and whether you can

stand up and explain it.

Unfortunately, you need to make decisions. You may find an extremely

bright manager who you think is good, but does not reveal what they are

doing at all. You might be happy with them for many years as long as

they provide double-digit returns, but once it turns sour, people ask

questions.

If, at that point in time, you are unable to explain what they did, you

will be asked why you ever let them in. People never question things

when they are going well, but this is a reputational risk that you run,

and you assume the responsibility of having selected people you trust

in and give your name to their decision.

James Bevan:Can we explore the issue of relative cost, because

there is a danger of a customer paying twice for an outsourced product.

In our model, we have a single charge to the customer, and we then pay

a sub-adviser out of what we take, just as if we were discharging a

cheque to our in-house team. The issue is whether we want a set of

people sitting in an office outside our organisation, who are paid a

fee, or whether we want them directly as a fixed cost on our schedule.

No customer pays twice in my world.

Moz Afzal:We are a private bank and do not have as many assets as

you, but it is quite an interesting situation, in that we have a single

fee and that we do our own manager selection work, and we can charge 10

basis points, for example, keeping five basis points for making that

decision. The margins are actually very wafer-thin.

We have studied the big players in this market, such as Russell or SEI,

and their inability to move quickly is very apparent. If, for an

example, a manager who has underperformed for one or two years needs to

be dismissed, there is a question around the timing of that decision in

terms of moving assets.

Also, the big trend over the last two or three years is the emergence

of boutiques, very focused on a particular area due to management

style, who do not want mandates as big as E5-10bn and really only want

smaller amounts. During our selection process, especially over the last

four to five years, we found that, within our portfolios that were once

managed by Fidelity or Schroders, we now have a Thames River or a

Cazenove. They are more performance-orientated, and our performance has

improved as a result.

Josef Altmann:The sub-advisory choice is not only about alpha

generation. The selected sub-adviser must share the same culture. For

example, we deliver to our clients all stocks in the portfolio within

10 days after the end of the month. It is completely transparent. A

sub-adviser must deliver these figures to us in the same way.

Secondly, we come from the institutional business, and our aim is to be

fully invested. We may have one or two per cent in cash, but no more.

The sub-advisory manager must have the same process, and not have rules

which allow him to drift up to 10-15 per cent. There are many points

during due diligence which must match with your own goals.

‘The sub-advisory choice is not only about alpha generation. The selected sub-adviser must share the same culture’

Josef Altmann, BNP Paribas

James Bevan: We spend a huge amount of time setting up a

relationship with sub-advisers such as Goldman Sachs, “lifting the

bonnet”, understanding exactly how you take your decisions and how they

are implemented, then simulating what we think your returns should be,

relative to what they are, and seeing how tight that fit is. If it is

tight, we know you are doing what you say you do.

I do not think there are many in-house managers who would do that,

which is a real problem for the industry, because understanding talent

and identifying it is as much of a problem for an in-house as an

outsourced operation.

Yuri Bender: I have had several discussions with senior

strategists at UBS, many of whom remain very uncomfortable with the

notion of outsourcing. Some of them really cannot comprehend that an

organisation of UBS’ stature and size does not have the best product in

every asset class in-house, and that some may need to be outsourced.

How do you win this internal battle?

Hansjoerg Borutta:It is almost too good a question to be spoilt by

an answer. It is clear for us that we have to evaluate and assess

outside opportunities. It is not about finding another product we can

put on the shelf. We are client-centric, and we think about what the

best solution is that we can offer for a client, and then try to find

the right building blocks to actually produce that kind of solution. If

we find an absolutely satisfying economic solution internally, we are

happy. There is really no point in outsourcing everything we do to

somebody else. We have a core offering that we do not want to

jeopardise, in terms of our programmes and capabilities.

We are not forced to outsource, but clearly not all opportunities lie in-house.

Therefore, we added a capability of selecting managers who can add additional value to our offering. It is a healthy process.

James Bevan:There are two slightly different models at work: one

where there is an expectation that it is best to outsource all of the

implementation, which is our model, and the other model, where a

profound in-house competence already exists and which you are seeking

to complement. Where you have a house style that delivers absolutely

what it says, were you to attempt to do other things in other ways, you

would threaten the culture that creates the excellence you can

currently provide.

Yuri Bender: I would like to bring Michael in here. From a

sub-adviser’s point of view, I am sure you would very much prefer a

deal like the one you have with Skandia, where you sub-advise for them

provided you can also sell your funds through their platform. Would

that be typically how a sub-adviser works?

Michael Klimek: That would be the ideal scenario, without a

doubt. In Germany, we are in a transition phase, or probably in a

structural crisis. One of the reasons is that the big six distributors

own the big six manufacturers, so there is the potential to gain some

further mandates from their manufacturers, at the same time

distributing own-label

funds through the distributor. The reality is that the

distributor/manufacturer takes some time to check the quality of your

own-label product, sold through their network. As a matter of fact, it

is probably the most prominent market entry strategy in Germany. After

some time, you talk about sub-advisory opportunities.

In Germany, there is also a trend from more open architecture toward

more guided architecture. In the case of the big six, there is a trend

toward a preferred partnership system, involving the distribution of

mutual funds, plus sub-advising of some of the mutual funds of the

manufacturer from that big six.

Yuri Bender: Is there a €1bn minimum within a sub-advisory relationship?

Michael Klimek: Again, that would be an ideal scenario. Germany,

per se, is probably an underdeveloped country with regard to

sub-advisory or outsourcing. The willingness to outsource does not yet

exist, in contrast to markets such as Austria. There is a psychological

barrier.

There is a pricing problem too, especially on the institutional side.

There is also a problem around the fact that many investment processes

need to be restructured to provide more quality. However, none of these

internal discussions has been finalised. It will take some time before

we have developed into a market such as the UK, but we have big

potential.

‘Germany, per se, is probably an underdeveloped country with regard to sub-advisory or outsourcing’

Michael Klimek, Goldman Sachs

Yuri Bender: Germany has had several attempts at outsourcing. We

had the Dachfonds, but what has happened with those? They did not

really achieve their expected success – was that due to costs, or was

it through poor choice of external managers leading to poor performance?

Paul Burik:I cannot speak broadly about what was expected, since I

only know about our experience. We have several Dachfonds, and they

attracted substantial assets in the early part of this decade. Their

performance has been quite good, and it is not a performance issue.

However, in the press, the cost issue that was brought up earlier,

specifically around the layers of fees, has arisen, and even if you

have good performance, if there is a lot of attention given to the

expense base, you can lose assets, which has been the case for us. We

have been losing funds from Dachfond products, despite good peer group

rankings, which is counterintuitive, but it has been happening.

On sub-advising generally, if you look at the United States, it is

actually not all that common. If we think of sophisticated markets, the

one that is usually held up as the most sophisticated does not have a

great deal of sub-advising in it. Guided architecture is common, but

sub-advising is not.

In our particular case, Michael talked about a bifurcation between the

factory and the distribution, and there is certainly a split. Our

retail side is very committed to guided architecture, and is probably

the most committed of the big six. We have guided architecture with six

or seven firms, which are known brand names, and our retail group

focuses on working with known partners.

The factory side’s attitude is somewhat different. For us to bring

value to the table, we need to bring someone that the distribution

side, or institutional customers, would not find on their own,

otherwise we are not contributing value-added.

Our situation is analogous to what one finds in private banking. The

more sophisticated customers do not give you credit if you bring in the

capital group. They expect you to bring a boutique, whom they have

never heard of before, that is just as good, if not better than the

capital group. Therefore we are looking for very high levels of quality

or performance and service, but put less weight on brand recognition.

‘The more sophisticated customers do not give you credit if you

bring in the capital group. They expect you to bring a boutique, whom

they have never heard of before’

Paul Burik, Commerzbank

Yuri Bender:Heinrich, can private banking clients compare the

performance of the funds – of say five separate sub-advisory managers –

through a global custody system? If so, if Pictet is underperforming,

will they see that immediately, and might you have to sack yourselves?

Heinrich Adami: Pictet is primarily a European private bank, and

secondly an asset manager. This occasionally leads to a

misunderstanding when clients who we would love to have tell us that it

is “too bad” we are only a global custodian.

That is not true – we manage close to SFr225bn (E146bn). But global

custody has helped us to attract very important fortunes, particularly

from clients who sold their companies and who are now in a position to

ask for help in organising their fortune and looking at the roughly

100kg per month of reports.

The global custody system we developed is extremely good at

streamlining that and coming up with two or three pages at the

beginning, where you receive a very good impression of what your 10

managers do around the world.

However, this alone is starting to become a commodity. What we do are

the add-on services. A group in Geneva specialises in taking all these

numbers, which is very easy, once you have everything in-house. We have

a lot of information from which we can make an analysis, and question

why, for example, a certain manager always underperforms in fixed

income, yet still has a balanced mandate.

All these added services are very interesting to the client, and

perhaps more interesting than just receiving a nice report explaining

what their money is doing. I think global custody is moving towards

making reallocation proposals based on analysis.

On the second point, if we, for example, are managing European

equities, underperforming another manager, we would see this

immediately, and the group doing this analysis has to be very honest,

otherwise we would lose our credibility.

‘It would sometimes be easier for us to farm out to excellent

managers, but we would lose clients, because we are perceived as a

relationship bank’

Heinrich Adami, Pictet

James Bevan: I think the sophisticated client will expect you to

underperform from time to time. If we go back to first principles, it

must be that you are selecting external managers who have low

correlation with your own house, on the very expectation, from time to

time, you will have a difficult period, as a house provider, which is

exactly why you have other managers to ensure your overall customer

proposition is not damaged. That is why I do not think that a

sophisticated client has a problem with periodic underperformance from

a manager within a multi-manager or multi-asset framework.

Yuri Bender: Is there still a very strong emphasis within Pictet, and other private banks, in manufacturing products for internal clients?

Heinrich Adami: There is a nuance there, because we are

responding to what clients want. For instance, nobody would expect us

to be the best US equity manager. We are a European bank, so it is

perfectly acceptable that we are not the best in US equities, for

instance. However, if we could not show a decent product, we would lose

clients. It would sometimes be easier for us to farm out to excellent

managers, but we would lose clients, because we are perceived as a

relationship bank. It is not because we would make more money and we

want to push our own products, but rather it is really responding to

the client. That does not mean that we would not farm out in areas

where we cannot prove to be among the better performers.

Yuri Bender: You have several external relationships, Moz,

representing over $1bn (e825m), I would have thought, in assets farmed

out, one of them being with GAM. I have heard voices, within your

group, saying that GAM have performed so well for so long that they

will have to be sacked eventually, because they cannot continue being

so good. Is there a limit to the period of time over which you would be

loyal to a relationship with a partnership such as GAM?

James Bevan: I would say no, rather than yes.

Moz Afzal: Absolutely. The reason why we selected GAM was really

for our clients to have a very good alternative to an in-house

proposition, and because their performance was very good. However, it

was not just the performance aspect that was important, but their

transparency, and the technology they had invested in, in terms of

offering internal and external clients excellent evaluations, internet

reporting, and all the things that internal sales managers could obtain

from an external basis.

We found that performance was important, but so were the other pieces

that accompany it. Therefore, a client coming to EFG now has two

choices: they can decide on an internal solution, or on a standard GAM

product, where they can pick out three or four different GAM strategies

on a platform that is co-branded. For example, the client will receive

a co-branded valuation and a co-branded website. It is integral to the

whole process.

In answer to the question around how long we would remain with GAM, we

are actively monitoring their performance. We follow up with quarterly

meetings and have regular meetings with GAM management. It is “joined

at the hip” in some respects, but performance is not the overriding

aspect. If it starts to deteriorate, then clearly we have a fiduciary

responsibility to offer an alternative.

Interestingly, and going back to a point made earlier, there is a

question as to why we do not farm everything out externally. However,

the key point is that clients expect you to know the markets and to run

your own money. They expect you to offer them ideas and solutions that

you have formulated yourself, rather than from farmed out processes.

Therefore, managing money internally is just as important as offering

an external product.

The high net worth clients are sophisticated enough to know an

underperforming in-house product, but they equally want you to

understand the markets and to have the experience and knowledge base to

offer internal products as well as external products.

‘Clients expect you to know the markets and to run your own money.

They expect you to offer them ideas and solutions that you have

formulated yourself’

Moz Afzal, EFG

Yuri Bender:How much marketing are manufacturers expected to do

within a sub-advisory relationship? Are they right there in the

prospectus, or is their name buried somewhere? Do they receive full

credit for what they do? How much involvement is there, typically?

Hansjoerg Borutta: We certainly would give credit to the

managers who have helped us to perform. We are always clear that this

is part of the offering. If, for instance, Goldman Sachs has

significantly contributed, it would be mentioned in the report, and we

would explain how the performance came about.

However, we do not appreciate seeing external sales forces being able

to go anywhere within the organisation and make their own pitches,

since it would fly in the face of the whole concept of offering

investment solutions for our clients. That is also why we developed

packaged offerings, which is something which “sits on the shelf” and

can be used for wrapping up and being part of an individual solution.

If people want to have the third party experience, it would be foolish

of us to withhold that information, because that is part of what people

have paid for as a private investor. However, there is a distinction

between an open shelf and open distribution.

‘Clients expect you to know the markets and to run your own money.

They expect you to offer them ideas and solutions that you have

formulated yourself’

Moz Afzal, EFG