Money managers under the microscope
The pressure to perform
By Ed Moisson. The opinions expressed are his own.
In a recent television programme, Outside the Court (BBC, 31 January), one man, when asked why he was standing outside Highbury Magistrates Court in London, replied, “It’s an occupational hazard. If you’re a thief you’re gonna get nicked now and again, ain’t you.” Surprising candour, if an unsurprising reality.
While fund managers’ first aim is to generate money for investors, not take from them, the reality of “occupational hazard” is worth considering. Most obviously, this manifests itself as the pressure to perform, but also, linked to this, the pressure to justify the fees being charged and the range of funds on offer.
First up some context is useful in seeing the types of funds that investors have been choosing. Just taking equity funds investing globally as an example, sure enough, the pressure to perform manifests itself with most money clearly flowing to first quartile funds (the best performers). Adding further pressure in 2010, 1 percent of funds in the UK hoovered up around 30 percent of inflows to the industry.
Zooming in on some of classifications (or sectors) that have seen most activity, a comparison with pre-crisis sales in 2006 highlights both the increased size of inflows in 2010, as well as the shifts in fund classifications being favoured.
Two themes emerge; the first is those investors willing to take on risk and searching for returns in emerging markets, while the second is other investors wanting to manage potentially volatile returns by investing in balanced funds and the “new breed” of absolute return funds. On the flipside, developed market funds, most obviously the UK (All Companies and Equity Income), have generally suffered.
Shifting attitudes to different types of funds and asset classes reveals some of the ways in which the industry is evolving. For example, at the end of 2001 80 percent of mutual fund assets were invested in equity funds. By the end of 2010 that figure has dropped to 65 percent (albeit that mixed asset funds will inevitably hold equities too).
So, on the face of it, the risk profile of a typical UK investor has changed quite significantly over this period. The trend also suggests that investors, or their advisers, may well be using mutual funds to create diversified portfolios across asset classes, where previously funds were used primarily as a means of gaining equity exposure alone.
Fund companies are also broadening their reach: groups with UK parent companies now generate a similar level of sales in their cross-border (sometimes referred to as ‘offshore’) ranges as they do for their UK ranges. In 2009, the former actually exceeded the latter. UK groups with a pan-European, indeed an international outlook is not a new phenomenon, but it is becoming an increasingly important dimension of the funds industry.
As market conditions change, inevitably impacting on fund performance, and different classifications gain favour with investors over time, the attraction for a fund company to launch new funds remains strong. And even though the UK stands apart from most other European countries in that sales of funds are generally weighted to those products with a performance history, still around 30 percent of flows in any given year relate to new fund launches.
Activity in 2009 suggested that the brakes might have been applied to product development as fund companies took the opportunity to prune their fund ranges and tried to reduce costs. But 2010 saw a rise in new launches and a reduction of closures, leading to a net increase in the number of funds once more. One can expect this trend to continue this year.
Finally, a word on fees. The imminent arrival of the RDR obviously plays its part here. But this is not just the story of index trackers, it is also the potential rise in competition from investment trusts or from actively managed open-ended funds with lower fees, or from Funds of ETFs. And this isn’t solely to do with relations with intermediaries: the FSA’s Discussion Paper on Product Intervention suggests that the regulator may intervene on pricing in areas such as performance fees and high cost index tracking funds, which would represent a real change of tack.
It cannot be forgotten that, based on the returns that the best performing managers can boast, and the way money is invested in funds, so far it has simply not made business sense for active fund managers to take the hatchet to fees in the UK. The argument that a fund manager can add value and overcome the drag on performance of costs remains very powerful.
The client does remain king, although a fund company’s client is normally an intermediary rather than the end-investor. Market conditions or regulations or some of the recent innovations may change investors’ attitudes in time, but profitability will remain the most powerful justification of a fund’s fee level — performance is still the biggest influence on the bottom line.