Over-capacity, not a creaking infrastructure, is the main problem in European fund distribution: too many fund managers are chasing too few customers. Although distributors are ostensibly happy to distribute third party funds, universal banks continue to source four in every five euros under management from proprietary networks, and appear to believe that openness to third party fund managers and funds-of-funds are only means of increasing in-house sales. Or so says a new study published today by PricewaterhouseCoopers (PwC).
“Open architecture was the buzzword at the dawn of the millennium,” says PwC. “Since then, the stock market environment has been crueller than expected. Pressure on margins is fierce, particularly when charging advalorem fees on a falling asset base. The `rules of the game’ for European fund distribution are changing subtly but profoundly.” The key points of the study are:
– The difficult market conditions have aided the adoption of open architecture, which provides choice and useful “good news” to discuss with clients when in-house investment performance has been poor. Generally, when it is difficult to achieve good equity performance, there is a push for more choice and search for other asset classes.
– Banks continue to dominate distribution but IFAs have made inroads in some countries. While those with limited in-house investment (“manufacturing”) expertise, such as some regional banks, have been open to third party funds for some time, the biggest change is seen among those with both manufacturing and distribution capabilities. The survey discusses a range of both openness and structures to incorporate open architecture (making third party funds available to clients). The most welcoming division of universal banks continues to be private banking, while retail banking is the holy grail. In the PwC sample, proprietary channels have generated more than 80% of total fund assets under management of which more than 70% have been sourced in retail banking. While competitive concerns remain for some, in the words of one respondent “open architecture is a means of increasing the scale of your own products. If you look at the US, you will see that those that have opened up are those than have sold more of their own funds.”
– A major influence in encouraging banks to adopt open architecture has been the introduction of open products such as funds of funds or multi-manager programmes. This enables the bank to retain the client relationship while providing more choice. Again, banks differ in how they incorporate this into their structure and also how independent such an open product is from their own manufacturing capability. Also, wide country differences prevail as to which type of product is used.
– Of crucial significance, distributors are narrowing the number of fund manufacturers (providers) with whom they wish to deal, and the selection criteria are more demanding. Gone are the days when this was essentially a transaction; this is now about building long-term partnerships. There is a keen interest in going to more standardised requests for proposals (RFPs), which would save time for both buyer and seller. After an initial focus on best-of-breed products, performance is now almost a given. The distributors’ concern has shifted to which providers will best support their sales efforts, with a preference for strong brand for easy sale to the customer. Importantly, there is also repeated emphasis on service that includes, but goes far beyond, reporting to incorporate services such as company extranets, training, etc.
– For the fund manufacturers, there are real challenges in how to service these distributors profitably, particularly in light of the high level of retrocession agreements that were discussed by the PwC interviewees. In these market conditions, manufacturers no longer have the option of increasing fees to incorporate these marketing expenses. Those with strong brand are in a better negotiating position as distributors seek their product for legitimacy in the eyes of distributors’ clients.
– Fund manufacturers are also becoming choosier about their distribution partners, going through a selection process focused on size and likely assets delivered, and spending more time on devising incentive arrangements to achieve desired end. They also are recognising that these new arrangements bring their own risks, including to reputation and compliance.
– Fund holdings remain very low in Europe. With less than 20% of households holding funds in most European countries, the market still has a large untapped potential. Even in the affluent market segments, total market penetration rates are still shockingly low compared to the US. Although under current market conditions, cost control imperatives are pressing, it also presents a lull for the industry to address long-overdue fundamentals, says PwC: product simplification, investor education and increased transparency. Creating trust will take time and effort but it is the prerequisite for long-term sustainability.
– There appears to be little appetite for increased product choice of a “line extension” variety (i.e. a more esoteric investment area) says PwC. However, there are significant opportunities for providing customers solutions through improved wrappers, for example packaging funds in a capital-protected product or through a unit-linked arrangement. The exploration of the spectrum of products from the financial services industry or even beyond that can be included in a flexible wrapper to provide customer solutions is only beginning. These products also may facilitate reaching out to new distributors. Both at the manufacturer and at the distributor level, skill in product assembly and solution development will become powerful differentiation tools. Identification of target groups and understanding of the target groups’ needs and lifestyles will provide a competitive advantage. Since most of the final investor contact will continue to be concentrated at the distributor level, close co-operation and regular communication between manufacturers and distributors will be essential.
– With product – and now relationship – complexity, the full spectrum of risks is widening and spreading beyond company boundaries. The most-talked about risks are financial and easily quantified. But additional risks need to be monitored in the distribution of funds. Pan-European distribution presents a wide array of compliance risks since regulatory and tax requirements still vary significantly between European countries. In addition, when entering outsourcing arrangements, careful selection, including thorough due diligence, of outsourcing partners is crucial. Multiple relationships with distribution partners can create exponential risk for the investment manager.
– With ever-increasing pressure on fees, controlling costs is becoming paramount across all business areas. For effective cost control, the essential starting point is knowing your detailed cost breakdown. This then forms the basis for identifying services which might benefit from outsourcing. However, these measures need to be coupled with more fundamental changes to make cost management sustainable in the medium and long term. Investment managers need to critically review their existing business processes to address potential inefficiencies. Opportunities for operational restructuring and product rationalisation should be explored.
“Close co-operation coupled with sustained cost control are emerging as the new imperatives to move the industry from product-driven definitions to customer-centric solutions,” concludes PwC.