US fund groups are exploiting their greater experience of new distribution channels and open architecture systems to make serious inroads into the pan-European mutual funds market, says Banita Shinh
Last year's trading scandals rocked the investment fund industry to its roots, yet US fund business has been hugely successful over the past year. US business has been so strong in Continental Europe's biggest international financial centre, Luxembourg, that the US threatens to supersede Switzerland as the premier player.
This is partly because investors are prepared to forgive much when their funds perform well. It is partly success by default, because European asset managers still tend to concentrate on their home market. And it is also partly because US players excel at exploiting developments in fund distribution.
Last year the duchy captured nearly 50% of new money invested in equity, bond and balanced funds in Europe. An obvious factor in its attraction to US groups is that it offers a good range of accommodations to foreigners, including a unique new double taxation treaty with the US. Among the top ten US issuers of Luxembourg-domiciled funds (by number of sub-funds) are Citibank International, State Street and JP Morgan.
US fund sponsors may not quite beat top player Switzerland in terms of their market share of total assets under management in Luxembourg, but it is a very close run thing. The US could well overtake the Swiss this year. At the end of the second quarter 2004, according to Association Luxembourgeoise des Fonds d'Investissement (ALFI), the Luxembourg fund regulator, the market share of fund sponsors by country of origin - in terms of assets under management - were:
n Switzerland: €232,339m (22.2%);
n USA: €189,941m (18.2%);
n Germany: €177,068m (16.9%).
But since September 2003, the USA's market share has increased from 17.6% whereas Switzerland and Germany's has fallen markedly from 23.6% and 17.5% respectively.
For US fund groups there is everything to play for. Europeans have only 13% of their household financial assets invested in mutual funds, compared with 22% in the US. If Europeans were to put the same percentage of their assets in mutual funds as Americans, they would invest an additional $1.6 trillion over the current £4.6 trillion. Europe is also where many Asian investors also look to invest, because, perhaps surprisingly, they place more trust in Europe-domiciled funds than domestic products.
The US market is ferociously competitive. Over 50% of US households already hold mutual funds, according to the Investment Company Institute, and there are more than 8,100 funds competing for business.
In Europe, where fund assets rose 7.8% in the first three quarters of 2004 according to FEFSI, the opportunities are immense for any firm wanting to market funds throughout Europe, whether they are European or non-European players. But then, the barriers to effective pan-Europe penetration are also formidable and this is where US willingness to exploit all possible distributions channels comes in.
Europe's UCITS III Directive, which came into effect in February, is designed to eliminate regulatory barriers to cross-border sales of funds by harmonising rulebooks, but this is not expected to happen overnight. At present, less than a third of the 25,000 mutual funds sold in Europe are actually sold in more than one country. Most major international fund groups have found it necessary to set up and operate funds in each the European countries to which they wish to sell.
Standard & Poor's manages registered-for-sale fund databases, which contain all the funds available to investors in each relevant country. Of the funds not domiciled in the local country, many are Luxembourg-based, thereby taking advantage of favourable tax and regulatory rules.
Even when the multiplicity of discriminatory and anti-competitive tax and regulatory practices are harmonised, language and cultural barriers remain and may have been intensified by the accession of 10 new EU members in May. Add to this country rivalry, varied and complex operating and technical platforms, different marketing and service requirements, and diverse appetites for investment risk and it is easy to understand why a single market in financial services is so difficult to achieve.
US firms looking to participate in Europe's high-growth market are adept at exploiting the open architecture trend now established across the European distribution scene. In the US, 80% to 90% of fund products are already sold through fund supermarkets and although supermarket momentum is increasing in Europe, US distributors' experience gives them the edge.
Further, many European distributors are investing in open architecture systems, not because they want to compete as true supermarkets, but to retain clients and cross-sell a broader range of financial services products. They recognize that they need to offer products from other providers to meet investors' growing demand for diversification across asset managers, but it is US distributors who appear keener to get their products onto as many 'supermarkets' shelves as possible.
European groups also widely recognise the operational efficiencies offered by straight-through processing (STP) and that the need for automation is growing as fund offerings expand. Although Germany is implementing open architecture the fastest, again, one of the most comprehensive supermarket-style offerings so far comes from a US company, Brown Brothers Harriman. BBH's FundWorldView product combines a wide range of funds with advisory tools and STP capabilities, allowing clients to research funds and place orders online.
Already, though, caution is being voiced about the effect of fund supermarkets sidelining the fund manager. The manager loses direct contact with investors and the manager's brand is swallowed by the supermarket's identity. This limits the fund manufacturer's cross-selling opportunities in favour of the supermarket and supermarkets are already beginning to exploit this. Not only does the asset manager lose touch with clients and their preferences, but private investors also lose their direct relationship with the manager, possibly receiving less information about the fund - just when regulators are insisting that they receive more.
The ease with which supermarket investors can switch between funds is predicted to intensify swings in cash flows to and from specific funds as market sentiment changes. And pressure will grow on the fund managers to maintain a level of performance that draws in the newly-mobile cash. When fund supermarkets first emerged, consumers were expected to plunge into buying funds directly but, in reality, the sheer choice of funds available has increased demand for advice. The ability to add value through quality of service is likely to become increasingly important. For many fund buyers that means direct access to real people at the end of a telephone line.
At no level is good investor relations an optional extra. The welter of new regulation hitting the funds industry, in Europe and the US, imposes heavy know-your-customer requirements both for consumer protection and as part of the international anti-money laundering campaign
Mutual fund assets worldwide rose 3.6% in the first quarter of 2004 to $14.46 trillion by quarter-end, assets increasing in all regions. But this growth was fuelled by positive stock market returns in almost all reporting countries, which may not be repeated in future. If the fund industry, having already suffered damage to its reputation, also loses its ability to achieve acceptable real returns, business could be very tough indeed. At least US groups are off to a flying start.
Despite all the difficulties with cross-border distribution of funds, US fund groups continue to push into Europe - because it is a fast-growing market.
Luxembourg, the main fund centre in Europe, has an asset share of 18.2% by US-owned companies, higher than Germany (16.9%) and only just less than Switzerland (22.2%).
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Report to be written by TPR
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