Combined pressures driving the outsourcing of fund manager selection

Private banks will be increasingly outsourcing their fund manager selection process to consultants, driven by the desire to rise above the competition, anticipates Michael Curtin, head of European wealth management at Mercer. “The world has become much more complex and competitive. Regulatory wise, it’s getting more onerous and private banks need to differentiate themselves. The outsourcing decision will come from end user pressure and competitive pressure within the industry,” he says.

Mercer has traditionally provided institutional clients with consulting, outsourcing and investment services and only recently entered the European wealth management business, although it has an eight-year track record in this space in Asia.

The firm has recently sealed deals with private banks such as Coutts in the UK, RBS Coutts globally and Investec Private Bank and has relationships with a number of Swiss and Nordic wealth management groups.

Most commonly, at a basic level, private banks tap into Mercer’s investment manager research engine, the global investment manager database, and its manager performance analytics system, to aid their selection process.

Servicing private banks is different from servicing pension funds, explains Mr Curtin. “With a traditional pension fund, we bring in the strategic asset allocation ideas. We then populate those ideas, while trying to optimise the risk-return pay off.

“Private banks however, will want to generate ideas themselves; they will have their own modelling techniques, but what they may or may not have is the expertise to decide who to outsource the management to, and that’s where we come in,” he says. “The servicing is more dynamic and faster, and private banks typically use a wider range of asset categories,” adds Mr Curtin.

Increasingly private banks seek external expertise on portfolio construction - often to validate what they are doing and to get an independent view - and rely on Mercer for operational due diligence, he says. “The advisory space is where we become more integrated in the process and where we see ourselves having a significant number of relationships.”

At the next level, the relationship enters a form of partnership, where the private bank or wealth manager decides to focus more on distribution, client service and marketing its brand, and outsources more investment functions to a third-party. A couple of wealth managers and retail multi-managers in Australia have gone down this route with Mercer, says Mr Curtin.

The decision of South African bank Investec, which last year subscribed to Mercer’s global investment management database and its manager performance analytics tool, was driven by the desire to improve the quality of its investment process and research, explains Andrew Summers, global head of product and research at Investec Private Bank in London.

“We decided that engaging a third party might be an interesting addition to our toolkit. Mercer provides an extra input, a second opinion, but it is definitely not a substitute for in-house manager research,” he says.

Investec, which has recently acquired Rensburg Sheppards in the UK, has its own fund selection team in-house and an internal quant system too. “All the hard intellectual work, you have to do it in-house, you have to do it yourself, you can’t outsource to anybody,” believes Mr Summers. “But even if you have the largest fund selection team in the world, there might still be some incremental value to you from getting an opinion from somebody who is not in your organisation.”

However, historically, private banks have rarely bought into consultants’ products or services, and have always regarded manager selection and portfolio construction as their core expertise.

At Bank Julius Baer, the core investment due diligence is fully executed in-house, explains Lorenz Altwegg, head of the bank’s funds solutions unit in Zurich. “In special cases we use external specialists for operational due diligence only, in the hedge fund area, but for our core fund offering we prefer to keep our investment know-how in-house. In-house expertise is crucial for serving our clients and consultancy companies would dilute our investment know-how as a bank.”

Although there are no plans to hire classical consultancy firms, Mr Altwegg explains that in the future, the bank might consider cooperating with investment boutiques on special investment solutions for large clients, such as customized hedge fund portfolios, to fill some niches in its product offering. “Our philosophy is to provide in-house investment know-how in core areas and to provide access to our established network of investment boutiques for special client needs,” he says.

The value of qualitative analysis

With a global team of 100 research analysts, split into four different boutiques - equity, fixed income, property and alternative - and $3,000bn of total assets under advice, mainly coming from institutional clients, Mercer’s services are highly portable into the wealth management space, especially in the area of manager selection, explains Michael Curtin. The firm’s forward looking qualitative analysis of specialist investment managers is equally valuable for both types of clients, he says.

On Mercer’s research engine sit around 20,000 investment strategies. Based on the information gathered and input given by managers themselves, analysts have selected the best 6,000, on which they carry out the due diligence process.

“It is up to the managers to decide whether they want to be included in the database, but they do not pay us to be included in it,” says Mr Curtin, stressing the independence of the service.

The managers on the database are rated across four key factors. These are idea generation, which involves evaluating people and the process, portfolio construction, implementation and business management. Only 1000 managers, scored across these four factors, have reached the highest rates.

“There may be a manager on that list that suits a client in Singapore and one that suits the UK based client, but all of our clients get the same list of best managers, globally.” explains Mr Curtin.

“With private banks, the main challenge is that they tend to select managers mainly based on past performance, and it’s hard to move away from that,” he states.

Manager performance is very often cyclical, and managers who have just produced significant alpha can struggle to maintain it for a number of reasons, for example because their investment style becomes out of favour. The other challenge that managers face, which needs to be taken into account in the selection process, is capacity management. “Successful managers tend to start small and get very big, and as they get big, they find it difficult to add value, as it is harder for them to trade in and out of markets without moving prices.”

Past performance is important but it needs to be used just as a supporting element to the qualitative research exercise, to assess manager performance in different market cycles, he says.

Lorenz Altwegg