Time for a change

Asset management models are in transition, and it is time for them to be re-worked, according to the latest study from Create-Research, backed by Citi’s Global Transaction Services unit and Principal Global Investors.

Key catalysts for future growth will be recovery in the US, China, Europe and Japan, plus rising prosperity in emerging markets, according to the report, generated by interviews with 237 manufacturers and buyers of asset management.

Growth in the wealth management and private pension segments, as responsibility for long-term saving to fund retirement swings from state to individual, will drive the restructuring of the funds industry for years to come.

But there is a healthy dialogue about the ideal template for long-term savings products and whether the American blueprint is suited to Europe.

“Everyone in Europe wants to assume the American 401k defined contribution system, but the reality is it doesn’t work,” was the provocative message from Daniel Enskat of consultancy Stategic Insight during a heated debate on product innovation, at the recent FundForum in Monaco.

“Americans are not generally worried about retirement,” was the message from Mr Enskat, who stresses 90 per cent of long-term US savers fail to switch from default allocations during a product’s lifecycle. “They think ‘we have 401k plans, so we’re OK,’ but at the end of the term, they might have $10,000 when you need $1m (€780,000) to live.”

Banks in Europe will not switch to independent, fee-based advice unless they are forced to, which is what happened in the US, he says. The level of kick-backs from fund managers to intermediaries will continue to play a huge role in asset allocation strategies.

The negativity often surrounding 401k plans has been put into context by Principal Global Investors’ CEO Jim McCaughan. “Switzerland, the UK, the Netherlands and Ireland are all going down the US route,” he says. “They are creating viable tax breaks for DC plans and building a regulatory system which suits them.”

Yet Principal itself decided, 10 years ago, not to become a major pension provider in Europe, as the markets were too fragmented. Instead, they will concentrate on countries such as Brazil, where such skills are more in demand.

The defining factor in the debate is whether the banks and investment houses which make asset allocations can ever be truly independent. The onus will be on asset managers, whose asset allocation skills are now developing to a much greater level than the intermediaries they service, to show they can match strategies, with a fiduciary mindset, that is always in clients’ best interests.

The involvement of distributors and asset managers in a new-style allocation process will be crucial to the development of the industry, with the Create survey’s respondents aiming to blend caution, diversification and opportunism.

Liquidity and capital protection will top the client agenda, with beta absorbing the lion’s share of new assets, forewarns the report’s author, Create-Research CEO Amin Rajan. “Complex overlays will be shunned; they cost too much and deliver too little. Boring will be beautiful, as investment becomes more nuanced.”

In this not-so brave, new, beta-led world, highly disillusioned with active investment by two recent bear markets, a wall of “dumb” money will flow into passives.

Yet the subsequent price anomalies which will emerge will create a once-in-a-lifetime set of opportunities for active participants in high-risk strategies such as distressed debt, hedge funds, real estate and private equity.

It is for these opportunities that private clients may increasingly be looking to family offices, rather than established private banks, according to Dale Gabbert, partner and financial services lawyer at Reed Smith, specialising in setting up bespoke investment structures for

wealthy families. Where multi-family offices are currently challenging wealth managers, believes Mr Gabbert, is in their flexibility and willingness to make responsible calls on specific deals.

“A lot of them are sitting on large levels of cash,” he confirms. “If you set up a family office, you are more interested in being opportunistic. It’s not really about traditional asset allocation any more, as the informed consumers know where to go for the more standard stuff. You go to a family office for opportunistic deals in private equity and insurance. The truth is – there is nothing they won’t look at. They do more interesting stuff than the private banks, although they discard a lot. You see a more bespoke type transaction.

“The minute you start to worry about theoretical considerations of asset management, the more you limit the opportunistic type approach and the less chance you have to make money. It will be interesting to see if family offices remain more buccaneering than the institutions.”

A more scientific approach to asset allocation sounds great in theory. But it can result in shadow-tracking rather than absolute performance in long portfolios, pushing more private clients to conclude they can get the same performance from low-cost ETFs.

“In future, private clients’ assets will be split between passive products – which are cost effective – and absolute return strategies like commodities, hedge funds, private equity and property. These might be quite illiquid, but they have potentially big capital gains,” insists Mr Gabbert.

The question for private banks and asset managers is how to re-style their business models and re-stock their product shelves to benefit from the asset allocation and investment requirements of their potential clients.

Managing this cultural shift is vital for the wealth management groups, many of whom have consolidation issues of their own. BNP Paribas is a good example, faced with absorbing the private banking arms of Fortis and Insinger de Beaufort, while also giving the business a more international appeal, further from its Franco-French roots.

There is something of a dilemma here. Banks are embracing segmentation of client groups, rather than the one-size fits all, factory mentality of the past. For instance, BNP Paribas is likely to expand from the high net worth and family office space deep into ultra-wealthy territory favoured by competitors Goldman Sachs and JP Morgan.

But expanding in this way, while promoting complex solutions from an investment banking arm, yet avoiding the “product push” mentality which so clouded the fortunes of major institutions in the past, provides an almost insurmountable challenge.

Ligia Torres, who has recently taken over as CEO of the London-based private banking offices at BNP Paribas, is faced with this structural conundrum. In her favour is the perception among wealthy families that London is a centre of excellence for international clients, wary of sourcing advanced financial techniques from Paris or Madrid.

Against her will be the reluctance of clients to listen to presentations about group products. “We have a strong investment bank platform. We need to leverage that part of the business and work together,” admits Ms Torres, herself previously head of fixed income sales in the Emea region for the French investment bank.

“This is not about the old product push. We need to provide the clients with the right type of solution,” she insists, with private bankers able to make the right diagnosis of a client before applying a relevant investment strategy.

The way which private banking is perceived within BNP Paribas is changing fast, believes Ms Torres. Before recent senior management changes, it was no secret that it was seen by board level as a distribution channel to maximise the sale of investment products.

That these universal banking groups must go further than cosmetic managerial reshuffles and make major changes to their structure is of no doubt to Mr Rajan, whose team at Create interviewed 40 private banking divisions during the recent research project.

“Private banks really need to cut the umbilical chord which ties them to their in-house fund managers, as the conflicts of interest are so broad,” believes Mr Rajan.

He sees the successful private bank of the future developing as a “virtual” fund manager, specialising in asset allocation decisions in a multi-manager format.

He advocates a “three strikes and you’re out” zero tolerance policy pioneered in the US, where a third party portfolio manager is kept at arm’s length and immediately sacked if performance lags in three consecutive quarters. “The move towards a fee-based model is inevitable,” suggests Mr Rajan. “The private bank’s alliegance must be to the final clients, not the fund managers. If the banks themselves don’t act, then the regulators will not allow the current, cosy relationship.”

A bright future

Indeed it is the medium sized Swiss banks – the likes of Pictet and Lombard Odier – whom he believes can play the strongest role in the future of wealth management. “They have very long time horizons and only attract investors who have similar horizons. They are in the same category as Scottish fund house Baillie Gifford – strong partneship, highly consensus driven, which have never promised exceptional returns. But the alignment with investors is always there.”

At Reed Smith, however, Mr Gabbert warns that while there are strong benefits for boutiques and large banks, some mid-market players may struggle in current conditions. “It is the people in the middle who will suffer. For the likes of mid-size Swiss private banks, differentiation is becoming more and more difficult. If you start to have more and more knowledgeable customers, they will shop around, so the banks need to focus on differentiation. The fact of the matter is that a lot of them do very similar things and offer similar products. Price differentiation is not the way to go. You need to differentiate the brand.”

But the leading Swiss and global banks will still have a key role to play, despite some poor decisions in asset allocation and product selection for clients and the resurgence of family offices as a wealth management force.

“Don’t write off the big private banks just yet,” warns Mr Gabbert. “They have a lot of coverage and know how to deal with customers.”

Distribution power

Money belonging to high net worth investors will increasingly be channeled through wholesalers, according to the Create report, vastly increasing the power of distributors. Most leading asset management groups have begun to orientate their marketing to face a much smaller number of gatekeepers than in previous eras, when there was more of a scattergun approach.

With the top five distributors in Europe now responsible for 48 per cent of fund flows, compared to 30 per cent five years ago, according to the European Fund and Asset Management Association, marketing efforts are clearly structured to service the most active fund platforms run by the likes of Deutsche Bank, Citi, ABN Amro and Santander’s Allfunds franchise.

Because these platforms tend to change funds relatively often, each provider must have a large, dedicated team to service a small number of key clients, meaning only the strong will survive. “If you are not in the top 15 players today, life is not much fun in terms of distribution,” says the CEO of Invesco’s European business, Jean-Baptiste de Franssu.

While many fund houses are reluctant to close down funds because it sends out a negative message to the fund-selling banks, Mr de Franssu says this elementary housekeeping and product management is vital to the manufacturer-distributor relationship.

Where products such as Invesco’s 130/30 fund, launched in 2006, fail to catch the imagination of distributors, they are invariably terminated, while another idea is developed for the launchpad, in close consultation with the middle-men.