issues such as regulation, asset allocation and industry cutbacks were discussed at the Fund forum international in Rome
With equity markets in their third year of providing negative returns, an increasing number of pundits and commentators are comparing the end of the tech bubble with the crash of 1973-75.
At the Fund Forum International held in Rome at the start of the month, a group of CEOs from some of the largest asset management firms in Europe discussed what the future holds for the industry.
Industry cutbacks, asset allocation, regulation, demographics and independent financial advice were among the topics covered. This is an edited transcript of the discussion.
At the moment, when it comes to markets, there is a strong sense it is all tunnel and no light. If we have years of poor returns, it could lead to a lot of regulation, just like the 1930s. We are now coming into the third year of negative returns. What is the panel's view of the outlook?
The consensus for returns is 5% per year but the consensus is always wrong and I think it is too optimistic.
There is something of a crisis in the industry, which has seen returns in the past 30 years but maybe wasn't adding value at all. The markets were just going up.
There is a lot of articulate pessimism from the commentators, so why didn't they say it a year ago?
The demographics behind the industry are very strong. Pension reform is slow but it is inevitable. Better asset managers are working on cost control and risk management. From 1995-2000, they didn't need to worry about it. Cost was not really an element in management schemes.
The long-run demographics are very good for the industry. The State won't provide for you so you're obliged to go and save. But where are you going to put the money? What we have seen in the past couple of years is just what happens from time to time.
CF: Is long-term volatility a problem for retail savers?
DB: There are not many believers in long-term risk at the moment. There is a very short-term focus and this means we will have extreme volatility. This will turn off lots of savers and a major concern is that they will save through cash for longer than they should.
It will come back because capitalism is not dead. Hedge funds may be part of the answer but there is a major capacity issue there. Customers will want benchmarks on hedge funds too. European regulators will get interested in them. If there is a retirement crisis, regulators in Europe will do more to achieve political aims.
RJ: Regulation is altering the behaviour of pension funds. When retail has lost on stocks, it is pension plans that take the long-term view and act as a stabiliser to the market.
The question being asked is whether regulations and the likes of FRS17 have changed the natural stabilisers. Are institutions being pushed into bonds at the same time as there is no retail appetite for equities?
The good news is institutions can't be net sellers, but they can sell to each other. What can happen is that they are holders at much lower prices. Due to the equity decline, the switch to bonds is happening automatically.
CF: What is your view of the effect of financial scandals and mis-statements?
JP: I can see money coming out of equities and into property or cash. Economic forecasts are relatively bullish on the US economy but the accounting scandals have been quite a kick to asset management. The economy will be the one thing that gets us out of this.
CF: Will earnings go lower as a result of accounting changes?
JP: Sectors that depend on judgmental accounting will trade on lower multiples than in the past.
LT: If you have a long-run bull market, the same issues build up. I don't think there is anything wrong with US-style capitalism but I do think things have come too far and need to be pulled back.
CF: What is your view of the size of the European pensions shortfall?
LT: People are going to live a long time. They will need to fund retirement and the State won't do it. That is most important for Continental Europe. Significant private sector savings are needed. The first example of a conference I went to on this was in 1987 so we could wait a long time for it to happen.
JP: There seems to be a major opportunity at the moment for management firms from outside Europe, especially in Sweden and Italy.
CF: What about the move towards advice? Some players have moved away from giving advice, which is easy when markets are going up. Where do you see advice going in the next three years?
DB: Whether people will pay for advice is the issue. The price of charging for it will be hard to understand after the past 18 months.
Two years ago, most of the sales in the UK were all from discount brokers but today it is all coming from advice brokers. Retail has definitely moved back to taking advice.
CF: So cost is key?
JP: I think the DIY model is over. Even Schwab has moved towards having advisers.
CF: That means more cost. So how are fund managers going to manage that?
MG: They are going to cut costs. In the fund management industry, there is a lot of cost cutting is going on quietly. Remuneration will be down this year in the industry.
Communication costs are being looked at, as are marketing and advertising. You have got to keep marketing and advertising but you do it at a much lower level.
CF: If active managers are more important, what does that do to index funds?
LT: I am not sure I agree. There will be a focus on where people add value. At the moment, they are really looking for alpha.
For pension funds, and probably retail too, people are prepared to lock up part of the portfolio in index funds and then move out to higher risk strategies such as hedge funds, where they can see the alpha. Cost control is important and indexation offers that.
CF: Are hedge funds the way out and what will drive industry growth?
RJ: You have to wonder if everyone can get into the hedge funds business and add value. The next problem in the industry will be the bankruptcy of a number of hedge funds.
The number of fund managers who think going underweight a market qualifies them to go short is amazing.
DB: We will see the increasing regulation of hedge funds.
CF: Will all this drive consolidation?
MG: Acquisitions are good for a business, if done properly. We have been able to rebalance our business from equities to having a larger proportion in property and bonds.
RJ: A lot of banks and insurers that said a couple of years ago asset management was a core business are now beginning to say it isn't and are starting to divest. Many fund management players won't make it at their current size.
CF: Maybe they won't want to sell out for a price that is less than they bought for originally.
DB: I think we are past that point now. They are holding businesses that are not making money. I think a number of people will decide to fold and go home.
JP: Consolidation will go on as there is a lot of capacity in the industry. The large global platforms will figure out a way to do well and the boutiques will do very well.
The big financial institutions will want to get into the business of fund management as the money is sticky and it is an expanding industry.
CF: What about the issue of whether you should you be a distributor or manufacturer? In the past few years, firms have taken some different views.
JP: A merger between distribution and manufacture is ideal. It is a more challenging business assignment and it means you get the profits of both.
DB: At times like this, excellent performance and product may be more desirable to distributors than at any time in the past decade. This gives more pricing power to manufacturers.
JP: For a top distributor, the sales force would much rather sell third-party product that goes bad than its own funds. Otherwise the client might be asking whether they got the wrong adviser.
LT: We have gone open architecture. The culture of manufacture is very different from distribution. It eased my life when we decided we were really a manufacturer.
(Question from the floor) What about the need to review the level of automation in the industry?
RJ: You have to invest year after year in technology. For fund managers that means spending on communications and so on, which costs a lot of money. Often it is one of the first things to be cut in difficult times. This means the outsourcing industry will grow. Not because it is cheaper but because development costs can be spread across the industry for the future.
MG: Outsourcing is the best decision we ever made when it came to our back office functions. Without it, we couldn't have grown. You save no money but you concentrate on bits of the business you are good at.
JP: It focuses your people on the key things such as investment performance. In 1999-2000, the industry probably spent more on technology than it should have. It had its own mini bubble.
CF: Performance and client service are two areas you can differentiate yourself on.
DB: We have got Brussels, which wants to speak to an industry. This affects us and increases our costs but, as yet, there is no single industry it can talk to. Otherwise, we will end up as part of the insurance companies and be regulated like them.
(Question from the floor) Who are best placed, pure or integrated players?
JP: I'm not sure standalone versus integrated is the dividing line for success. You see failure on both sides. You need to make sure the people in asset management know they are there to get excellence.
When you are part of a large group and bad things happen in other bits of the business, for instance some poor trading days, how do you buttress your bit of the operation? You need a strong bill of rights.
DB: You have a risk to your brand that you maybe would not have if you are standalone and something goes wrong elsewhere in the organisation.
(Question from the floor) Does the industry need more business leaders from outside?
LT: We have not found it to be a tremendously successful strategy. Fund managers have been under-managed in the past but it is not easy to get senior people into the organisation and have them accepted as real players.
RJ: Pension consultants are attaching more importance to seeing senior managers with good management skills on the floor. The track record in running people is increasingly important.
(Question from the floor)
How do you keep your costs down and pay your top managers?
DB: Pay the ones who are not good a lot less.
JP: Portfolio managers are giving shareholders good value. They are far less costly than, say, the M&A department. It is still good value against other financial services businesses.
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