On Investing

Which came first: the chicken or the ad?

How performance, marketing and flows relate to one another is a fascinating problem. Which came first: the chicken or the ad? Or indeed the chicken or the ed(itorial)? By tracking ad appearances and editorial mentions across the trade titles, Research in Finance endeavours to help groups better understand the interplay between press advertising and asset movements.

Looking at flows first, equity funds have seen substantial redemptions in recent months. Notably, Japan funds and Europe funds have bucked the overall trend – unsurprising given their strong YTD performance. ‘QE To The Max’ and changes in corporate governance have encouraged investment in Japanese companies; investment in Europe has also been spurred by QE, as well as some attractive Price/Earnings ratios.

Meanwhile the mixed asset space continues to report healthy net sales figures. A flurry of multi-asset income marketing campaigns have launched in response to the new pension freedoms. Many advisers voice scepticism around new fund launches and say they prefer to focus on tax planning (in particular IHT planning), cashflow modelling, risk profiling and increasingly ‘bucketing’ clients’ short-term and longer-term income needs. As such, multi-asset income funds may not represent a panacea for drawdown, but there is evidently a place for these funds as a relatively low-cost solution for smaller pension pots.

Honing in on the RiF Tracker data on advertising, we can see that general brand building and multi-asset funds – largely represented by the Mixed Investment 20-60% Shares IA sector – were big focal points for fund houses in H1 2015. Naturally, the biggest sectors in terms of number of funds and assets have strong ad representation. Interestingly, Japan and Europe Ex UK have not been heavily advertised in the trades relative to other sectors, despite inflows. US funds have enjoyed good ad representation, over a period where the NASDAQ has been performing well compared to the S&P, encouraging a move from passive to active for US equity. However, it’s really just a couple of fund houses driving ad activity in this sector: Artemis and Fidelity to a lesser extent.

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Intuitively, one would think that editorial sentiment is typically more strongly correlated with performance than advertising. Overall the UK Equity Income sector has had a great year so far for positive coverage. Performance has been reasonable, but lagging UK Smaller Companies, which has had comparatively stellar performance in 2015 and a fraction of the coverage. True, the UK Equity Income sector is much larger and thus attracts more attention, but there is still a bit of a disconnect between performance and positive trade press mentions. Moreover, the ‘Woodford factor’ cannot be ignored: trade journalists have been writing reams about his funds. Unfortunately this concentrated focus may have been at the expense of other good investment ideas receiving coverage.

Funds in the Europe Ex UK sector have been getting a high number of positive mentions across publications, and performance has been very respectable. Conversely, Japan funds are very low down the priority list for the generalist mags despite very strong performance, although coverage has been better in discretionary mags.

Many of the funds in the Mixed Investment 20-60% Shares sector received strong positive mention in H1, although less so across publications targeting discretionaries than more generalist titles. YTD performance has been muted, but one acknowledges that shoot-the-lights-out performance in rising markets is often not the primary reason behind investing in a multi-asset fund.

The Global Emerging Markets sector does well in terms of both trade ad and editorial coverage, and yet has experienced negative performance YTD. Short-term spikes in performance a few months back could be responsible for some of the positive mentions in magazines; sadly indications of economic slowdown in China were quick to extinguish any short-term gains.

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These are just a few high-level take-outs from the RiF Tracker, underlining the complexity of monitoring the impact of trade press coverage, and what drives coverage in the first place. Sometimes flows, performance and coverage all seem to move in tandem; other times the feedback loop leaves room for improvement.

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Asset managers must adapt to new gatekeeper approach

Asset management businesses are grappling with some serious challenges at the moment. Reshaping their relationships with intermediaries in a post-commission world and identifying who the investment decision-makers really are in the remodelled advised market are arguably chief among these.

The starting point for meeting such challenges is understanding the increasingly important role being played by the company-wide, or centralised, investment process (CIP). For the majority of advisory firms, this has become the way that investment business is done. Almost four-fifths of advisers report that their firm has a centralised investment process in place; 84 per cent of advisers adhere to one if you exclude one-man bands from the numbers. These stats are encouraging. Many firms have responded to regulatory change and gone a long way to implementing processes that help individual advisers deliver investment advice consistently across a firm’s client bank.

The acronym CIP is bandied around, reverberating off the walls of City offices when talk turns to how to engage with today’s (and tomorrow’s) brand of advisory firm. But what actually is a CIP?

Sometimes the P stands for process; other times proposition. Thinking about process, firms are increasingly implementing measures that allow them to deliver consistent investment advice: an investment committee with ultimate decision-making power, risk profiling to help determine asset allocation and a centralised investment proposition to map on to the desired asset allocation. Often, there is also a process through which advisers can make a special case for deviating from the centrally-imposed parameters.

CIP

A rising proportion of advisers are buying into the concept of a CIP – both process and proposition. Waning support for bespoke portfolio design is indicative of this general trend, with Platforum research proposing a ratio of bespoke to model solutions (including model portfolios and fund of funds) of 45:55.

Many advisers are embracing model portfolios on the grounds of business scalability. Using an attitude to risk questionnaire linked to a set of model portfolios means that advisers can take on more clients and give more attention to the wraparound financial planning service. This point is of growing relevance to DFM businesses providing investment management for advisers’ clients – there will be a limit to the amount of outsourced bespoke business they can take on. DFMs we speak to echo that bespoke treatment for asset allocation and fund selection isn’t necessary in the majority of cases. Moreover, the additional cost for a bespoke portfolio that looks very similar to one of the model portfolios is being called into question. A minority of clients have particularly complex needs, or simply want the experience of bespoke because they like the feel of the premium customer service. For the rest, bespoke portfolio services probably don’t represent good value for money.

Growing support for model portfolios goes beyond pragmatism, or fear of the regulator. To some extent, the shift seems to reflect a relatively new philosophical belief in how investment advice should be given. Exemplifying the point, one adviser told me: “I believe in a replicable process. I previously worked at a firm where two virtually identical clients were invested in different funds – why would that be? Why would you have a bespoke approach for everyone? You bespoke the tax wrappers but not the fund selection.”

Investment decision-making is becoming increasingly centralised within advisory firms, as well as more broadly. Similarly, client portfolios are purposely being designed to look more alike within individual firms and across the advised market, thanks to CIPs and the shift towards model solutions. Change has been positive insofar as firms have undoubtedly become more professional in how they handle investment business. However, change is also driving greater fund concentration, which in turn raises a number of issues for the industry.

What we’ve been preaching for some time now is that fund houses need to refocus their sales efforts. The challenge is no longer how to sell to individual IFAs; it’s how to sell to investment committees and gatekeepers, as well as individuals in some instances. Moreover, salespeople need to be more alert to where advisers perceive gaps in their in-house or bought-in fund panels, and conversely the product areas for which they really don’t require a ’me too’ fund. Thinking about the implications of fund concentration for the investment team, difficult decisions have to be made about capacity issues, and how one accommodates increasingly lumpy inflows and outflows as funds are added and removed from CIPs. Such are the ugly truths about advisers’ model behaviour.

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Follow the leader

For an investment-related topic worth pondering, I’ve been inspired somewhat by this article on the negative impact of fund manager moves – both from the losing fund house’s and the end-investor’s perspective. Substantial outflows occur; investors missing out on the news of a move are caught out; and those in the know can be confused regarding the best course of action to take. Meanwhile, Woodford Equity Income has swelled to £6.2bn, with Jupiter AM’s Merlin range accounting for almost £1bn of that overall figure.

Some high-profile fund manager moves have evidenced the propensity of both intermediaries and direct investors to follow individuals. These real-life, modern-day Pied Piper of Hamelin figures put money in motion and shake up researchers’ recommended fund lists. Understandably, fund houses are now looking to downplay star quality, and instead emphasise team approach and investment process.

Advisers tell us that fund manager personalities don’t hold sway when they’re selecting funds, and that consistency of team and process matter to them. Yet stated intention and actual behaviour – as any good little researcher knows – often don’t align perfectly. Over 70 per cent of advisers consider three-year rolling averages an important factor when assessing fund performance; commonly a minimum track record of three years is a baseline requirement. But when a ‘star’ manager ups sticks, individual track record can trump all other fund selection criteria. In any case, almost three-fifths of advisers consider individual fund manager track record when assessing fund performance.

It is questionable whether we should revere fund manager track record in the first place. This isn’t something I’d really thought about before, until an adviser pointed out, “I’d rather have Harry Kane in my [football] team than Beckham… It’s taking a bit of a risk because he’s only had half a season, but I’d like the performance of Beckham from a 21-year-old.” Fresh talent is great, but it comes with risks attached.

Does anyone in fact benefit from fund manager upheavals, apart from the individuals themselves? Maybe boutiques do. Managers from the largest fund houses can crop up at smaller outfits – think Julie Dean’s move from Schroders to Sanditon AM. Personally, I quite like this kind of redistribution of talent – it gives the smaller providers a better chance of gaining traction with advisers and perhaps even end-investors.

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Advisers’ platform choices reveal their colours

The type of platform favoured by an advisory firm is usually a good indicator of what type of firm it aims to be. The platform due diligence required by the FCA means that advisers have to document the reasons behind their choice of platforms – this forces them to evaluate their client book and select the platforms that best meet their needs.

All 20 or so adviser platforms have their peculiarities; however we can categorise the platform market in a number of ways: size, relative suitability for different client segments, degree of vertical integration etc. Most simplistically, the industry tends to make a distinction between the oldest, biggest three platforms in the market – Cofunds, Fidelity FundsNetwork and Old Mutual Wealth – and the newer offerings. These first three are commonly referred to as fund supermarkets, which offer fewer types of investments and tax wrappers and historically ran a remuneration model based on rebates.

Conversely, the ‘wrap’ platforms are so-called because they are seen to offer a wider range of investment options – ETFs and DFM access, for example – and tools. These platforms have operated an explicit charging model since their inception.

Advisers still predominantly using the fund supermarkets look quite different from those wedded to the wrap platforms. Segmenting the two groups by the platform they use the most, we can learn a fair bit about the different types of advisory businesses in the market. The chart below illustrates how investment propositions vary depending on primary platform used. Bear in mind that although an adviser may tell us that their primary platform is Cofunds, they are still likely to be using one or even multiple other platforms.

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Still, the disparity between the two groups is stark. In the wrap camp, advisers are placing significantly more assets through in-house model portfolios. The fund supermarket loyalists, on the other hand, still have the bulk of clients’ assets in bespoke portfolios – mostly designed in-house. Roughly a fifth of the wrap group’s assets are managed by DFMs on a model or bespoke basis, compared to a tenth of the fund supermarket group’s assets.

What strikes me when looking at these research results is the extent to which a certain segment of the advisory firm has changed little in response to the RDR. These – mostly one-man band or similarly small firms – have not left the profession in droves as predicted. Yet the sustainability of their business model has been thrown into question. Very recently I spoke to an adviser at a mid-sized firm, who made the point very clearly to me: “Most IFAs don’t have a research team that is big enough or a process that is robust enough to strip out fund managers they know and enjoy, and pick the best funds for their clients. Advisers should be out seeing clients and winning business.” On the flip side, it may be more difficult to articulate one’s value as an adviser if this doesn’t include fund selection. Damned if they do, damned if they don’t, you could say.

Over the past few years, consolidator firms have been hoovering up some of these smaller firms. This acquisitive activity looks set to continue. Consolidators seek to bring acquired business into the fold of their centralised investment process. This is a challenging task involving a lot of extra communication with clients to convince them to accept a portfolio revamp, but once achieved it will see a shift away from bespoke portfolios.

A potential decline in the number of one- or two-man bands will have an impact on the platform market. One may expect wrap platforms to be the main recipients of new clients; net sales data over the past 18 months supports this, and for the first time in the first quarter of this year, the collective market share of the three fund supermarkets fell below 50 per cent. However, Old Mutual Wealth now offers a host of OMGI-managed investment solutions that could plug the gap. I also suspect that over time, portfolios built via fund supermarkets will start to look more like those on wraps. Many advisers now believe that for accumulation portfolios at least, there is less need for individually-tailored portfolios – the bulk of clients have quite similar needs and fall into a narrow band of risk profiles.

And if nothing else, regulatory pressure will drive conformity. “If you don’t want to get shot, don’t go into a warzone,” exclaimed one high-end IFA to me. Unless, I suppose, you have a sufficiently substantial battalion in tow.

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Drawing to a close or just beginning?

6 April came and went and incredibly, no one spontaneously combusted as a result of flexi-access drawdown-related over-excitement. While product providers and platforms were busy gearing up for the new opportunities presented by the pension reforms, some financial advisers were nevertheless reporting ‘business as usual’ to us.

Of course the reforms do have a substantial impact on the adviser community, and some of those that disagree may simply not be fully aware of their implications yet. But it’s true that for certain segments of the market, 6 April passed uneventfully. Advisers at the top end of the market were already managing drawdown portfolios for clients, and were not bombarded with requests for cash withdrawals. That said, they can get excited about the new possibilities for intergenerational planning: the potential to pass clients’ portfolios down to kids and grandkids free of inheritance tax. Growing the portfolio and managing it in the most tax-efficient way are paramount for such clients.

Other advisers have very different considerations for their (potentially new) retirement clients, who will need to significantly draw down on their portfolios to have an income in retirement. Pound-cost ravaging and capacity for loss are key concerns here; consequently long-term cashflow planning is coming more to the fore. Some firms are planning for a lifespan of 95 years, or 105 years; others are even looking into using a third party to underwrite their clients as part of their cashflow planning efforts.

In terms of the products advisers use to populate drawdown portfolios, advisers are wary of product innovation overkill. Some top-end advisers argue that they should simply aim for total returns from well-designed portfolios to meet any investment need – whether it is derived from capital growth or pension drawdown. Others distinguish between drawdown strategies that are based on the natural yield from sustainable income-related funds and feel that regular capital withdrawals add substantial risk.

A number of product types appear to carry an ‘approach with caution’ label in the drawdown context. Many advisers are concerned that very high yield funds eat into capital value to boost their income yields artificially. Bonds are also commonly seen as problematic in the current market climate, with some advisers picking absolute return funds as substitutes. Few advisers appear game for so-called third way products, i.e. products providing exposure to equity-based returns with guarantees of income and/or capital. They feel that guarantees come at too high a price – monetarily and potentially in regulatory terms as well.

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How will European IFAs fare post-Mifid II?

Talk of Mifid II has finally hit UK shores, having seemingly taken some time to travel upstream. Perhaps this is due to preoccupation with RDR and the sense we have already implemented the “tricky bit” of the new regulatory requirements: the commission ban.

Mifid II will require all European IFAs to forgo commission. Some may well forgo their independent status instead: “restricted” or “tied advisers” can continue to receive fund manager rebates under the current rules.

Some markets have moved beyond the minimum requirements. As you know, the UK commission ban applies across all financial advice and has been extended to the execution-only space. Elsewhere, the Dutch market has banned rebates for non-independents too, while the Swedish regulator has recently announced it will be enforcing a more all-encompassing ban.

Some believe that Mifid II is a slippery slope to an RDR-like commission ban across Europe. However, our research shows the majority of distributors, platforms and fund managers believe different markets will respond differently to the new rules.

Many envisage a kind of north/south divide, with big retail banks and life companies in France, Germany, Italy and Spain hoping to protect the status quo as far as possible.

While opinions differ on the likely implications of Mifid II, there is consensus IFAs have significant challenges ahead of them. IFAs on the continent already struggle to gain significant market share in retail distribution, overshadowed by the banking giants and their advisory networks. Rather than continue with generalisations about the fate of IFAs in Europe, it is probably best to focus on a few country examples – starting with our neighbour across the Channel.

In France there are around 3,000 IFAs (or CGPIs), which account for roughly 5 per cent of total fund assets. Larger IFA groups are beginning to emerge as a result of consolidation.

We anticipate the consolidator firms will do well in the run-up to Mifid II implementation, as some smaller IFA firms find it difficult to reshape their business practices to comply with the new rules.

At the same time, CGPIs are partly shielded from the changes because most new business goes through unit-linked insurance contracts, which the European Parliament decided should not be subject to Mifid. The major French insurers are lobbying hard to keep themselves out of scope of any kind of commission ban.

Meanwhile, the German IFA market is the largest in Europe, with roughly 40,000 registered, although banks still account for the lion’s share of retail fund distribution.

Both Germany and Austria have moved ahead of Mifid II in implementing a ban on IFAs receiving commission payments. New regulation also requires IFAs to obtain a licence, which entails having damage liability insurance, demonstrating an advice process and sitting an exam among other stipulations aimed at increasing professionalism.

These new requirements are too onerous for many IFAs. Some are tackling the additional regulatory burden by entering into a kind of liability umbrella provided by an IFA pool (similar to our advisory networks), which fulfils some of their compliance-related obligations on their behalf.

Others are outsourcing investment management altogether by arranging for a discretionary manager to run their clients’ money. We anticipate huge contraction in this market, not least because the majority of German IFAs are approaching retirement and reluctant to change their business practices.

Elsewhere, IFAs account for roughly 10 per cent of retail distribution in Sweden. The more “professional” firms already offer a fee-based rather than commission-based service, making them more geared up for Mifid II.

There has been a trend towards vertical integration in the IFA channel, with firms of sufficient scale taking on an asset management functions. Some have been building their own fund-of-fund ranges, while others have been putting together Nordic country ETFs.

Interestingly, the very nascent Italian IFA market has little to lose post-Mifid II.

Established in 2008 following Mifid in its initial carnation, this is a niche, typically fee-based channel consisting of 300 or so individuals across circa 20 firms. Mifid II could in fact give a boost to Italian IFA SIMs if consumers begin to open their eyes to the true cost of investing through banks, factoring in hefty front-end loads and more expensive share classes thanks to relatively high rebate demands. SIMs are also waiting for a public register to be established, which would give them the legal recognition currently lacking.

Each IFA market has its nuances. Overall, we expect some movement of business from the advised market to the D2C channel as a result of Mifid II.

However, the extent to which this takes place depends on the ability and willingness of IFA firms to adapt their business models and embrace new professionalism requirements, as well as the level of prior D2C culture in their home market and whether the banks will eventually have to offer fee-based advice.

In the meantime, expect the European distribution landscape to resemble a patchwork quilt, with cross-border fund houses and platforms responsible for stitching it all together.

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Platforms: A Euro-Vision of Open Architecture

It’s time to admit to one of my guilty pleasures: the Eurovision Song Contest. The early heats are in full swing, building up to the grand finale at the end of May. In tribute to this auspicious pan-European competition, whose geopolitical point scoring, questionable music picks and tacky ensembles oddly enthrall (some of) us every year, I’ve crafted my own European Open Architecture Contest. The three categories are: Most Open Architecture, Biggest European Platform and Platform of the People – the last being entirely subjective but important all the same. Forgive me for being not as funny but just as dry as Terry Wogan or Graham Norton!

While in recent years the UK has consistently disappointed on the Eurovision stage, I’m pleased to award our island nation the coveted Most Open Architecture award. Often we use the investment platform market to gauge the opportunity for fund managers without – or looking beyond – captive distribution channels. The UK platform market is £331bn (€430bn) according to our data at 30th September 2014, taking into account D2C, adviser and institutional platforms and removing double-counting where possible. For example, we have included the all-encompassing assets under administration figure for Cofunds and left out the figure supplied to us by D2C platform Willis Owen, as Cofunds Institutional is the engine behind it.

This market closest in size to the UK is Switzerland with €283bn, followed by Italy at €265bn and then Germany at €207bn – less than half the size of the UK.

Lipper data supports the UK’s victory in this category. The top five fund managers in the UK commanded a 31 per cent share of the retail fund market collectively at the end of 2014, excluding money market funds, fund-of-funds and ETFs. Having almost a third of the market sewn up by a handful of groups does not sound like a particularly ‘open’ situation; however compare this to Switzerland where the top five accounted for 80 per cent of the market, or in Italy where they were 69 per cent.

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he UK open architecture market currently has around 30 platforms, but none of the home-grown providers have made it big on the European stage (yet). At 30thSeptember 2013, UBS Fondcenter was the big (Swiss) cheese, with AUA of €122bn. A year on and Santander/Intesa Sanpaolo-owned Allfunds has overtaken to win the Biggest European Platform award, with €147bn in assets versus Fondcenter’s €144bn. Strictly speaking, a small proportion of this total is not European – Allfunds has some business in Latin America – but as some other cross-border platform titans don’t provide a country or continental split to us, we’d be remiss to punish the platform for their transparent reporting to us.

The great shame of Eurovision is the discrepancy between who scoops up points and who actually provides entertainment value – Finnish heavy metal band Lordi’s 2006 win being the notable exception. In the European platform arena, it’s the large, ‘serious’ institutional platforms that dominate. So to shine the spotlight on a smaller platform with a big personality, I award IFA and D2C platform Nordnet with the Platform of the People title.

With 371,000 end users across the four Nordic markets at the end of September, Nordnet has better penetration than Hargreaves Lansdown with 653,000 clients – impressive considering the UK population is more than twice that of Sweden, Norway, Finland and Denmark combined. Now that the Swedish regulator will be implementing a full commission ban on investment advice, we also anticipate a future boost in D2C business as some investors shun explicit adviser fees.

Yet the really interesting thing about this platform is how it is trying to encourage consumer engagement, which I first wrote about in February 2014. By acquiring and integrating social investing site Shareville, users now have the option to share the breakdown of their portfolio in percentage terms and transactions real-time, and ‘follow’ the activity of others on the platform. In addition, Nordnet recently launched a suite of four white-labelled index funds with zero management fees to attract new users. The platform makes light of this ‘try before you buy’ strategy in its marketing comms.

So there you have it – a clean contest where political point scoring didn’t feature at all.

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