Funds Hub
Money managers under the microscope
How much do UK investors care about costs?
One way of measuring this is to look at the assets invested in index tracking funds (where minimising costs is a core part of the product) and compare this to funds of funds (where the importance of professional fund manager selection entails an additional cost).
With 30.5 billion pounds invested in the former and 56.6 billion pounds in the latter as of November 30 2011, it would seem that retail investors in the UK are almost twice as likely to pay more for active management and fund selection than to minimise costs and seek to mimic the returns of an index. A similar picture is revealed for sales activity in 2011.
Having been researching this subject since 1999, I continue to believe that transparency and awareness of the ‘drag’ of charges on returns are crucial for long-term investors. Of course cost awareness cannot guarantee investors’ happiness and neither will greater transparency inevitably lead to greater competition. But both are powerful selling points for the mutual funds industry.
Other comments on the current debate:
· Fiduciary responsibility. This concept is acknowledged in the UK – to act in the best interests of investors – but it has not been extended to the oversight of fees. This surely needs further consideration.
LIPPER: Equine vs equity investing
Is betting on horses very different from picking stocks? Can understanding a gambler’s approach and mentality give a better understanding of fund managers?
In searching for answers to these questions, I spoke to Paul Moulton, a professional gambler who originally worked in the fund management industry. He then set up a fund research company (Fitzrovia International, which he eventually sold to Reuters), although his working life began with an attempt to become a professional chess player.
Most of the fraternity of professional gamblers who make a living from horse racing are what Moulton describes as ‘traders’ or ‘chisellers’.
This group do not really look at horses at all, but look at market movements, hedging back their bets, and aiming to make tiny but regular profits with much less risk. They remain tucked away in their homes in front of an array of computer screens.
Moulton sees himself as part of a second, smaller group of professional punters, those he refers to as ‘judges’, some of whom look at horses in the paddock to assess their physical condition and thus their chances, while others are more reliant on assessing form based on previous races.
Some of them may even be conscious of the FSA’s warnings on funds’ past performance, which is deemed to be no guide to future returns. Although past performance does tend to shorten a horse’s starting price.
As part of this approach, Moulton has gathered vast amounts of data on all aspects of racing (jockeys, trainers, pedigrees, speed figures and so on) in a database that covers all horses in all races in the UK and Ireland since January 2005.
LIPPER: Are ETFs in trouble?
By Detlef Glow, Head of EMEA Research at Thomson Reuters fund research firm Lipper. The views expressed are his own.
Exchange traded funds (ETFs) have found themselves under ever more scrutiny from regulators and market participants this year and expectations are that new rules for the sector are just a matter of time.
It’s tempting to think of ETFs as unwilling victims of new regulation, but to my mind, ETFs have much to gain.
The point is that it isn’t just regulators who are seeking improved transparency on fund holdings and on the use of derivatives by mutual funds, crucially it is end-investors too. And once the fog has cleared, they might come to see ETFs — with daily published portfolios and clearer statements on the use of derivatives in general — as a role model for all kinds of mutual funds.
The discussion surrounding ETFs could leave you with the feeling that they are unregulated products; that fund promoters can go wild when creating new products and with the use of derivatives in the portfolios. In reality though, ETFs follow the same local and/or international legislation of any other mutual fund; the EU UCITS regime for example.
So, why all the fuss around ETFs? In my opinion, there is nothing uniquely wrong with these products as they are using the same tools and techniques used by other funds under the UCITS regime. Some authorities, however, have raised questions as ETFs grow in popularity among professional investors. A deeper look into the questions posed shows that the points made by the critics are not only applicable to ETFs, but to any mutual fund.
CONCERN
GCC fund firms face structural flaws: Lipper
By Dunny P. Moonesawmy, Head of Fund Research for Lipper in Western Europe, the Middle East and Africa. The views expressed are his own.
Spare a thought for the fund managers trying to make their business work in the Middle East and north Africa (MENA) this year.
Those investing in home markets have faced the uncertainty and drama of the Arab Spring and the wear and tear on affected markets. The Egyptian Stock Exchange was closed for several months while in the Gulf Cooperation Council (GCC) countries, all markets ended the first half in the red (even if the Abu Dhabi index and the Saudi Tadawul All Shares resisted well, down 0.57 percent and 0.67 percent respectively.)
Moreover, the fund industry in the region faces some deep structural flaws.
Taking the GCC alone, there are 101 fund management companies in the region managing $28.5 billion of assets between them, according to Lipper data. Those firms run a total of 337 funds with average assets under management at $84 million; taking a median figure to iron out the inflating effect of a few bigger funds that figure is just short of $20 million. To see a graphic showing AuM by asset class in the GCC, click here.
The six biggest funds in the region had cumulated assets of $10 billion and represented over a third of the market at the end of September. To see a graphic of the top funds, click here.
Absolutely Fabulous?
Among the side-effects of the financial crisis, the importance for European wealth managers and other intermediaries of both managing investors’ expectations and understanding fully what those expectations are, has been underlined.
This is not entirely new. The rise of absolute return products largely reflects intermediaries’ efforts to deal directly with client expectations that, for many, have taken a severe blow. It is worth looking back at the level of inflows to funds seeking absolute returns before and after 2008 (the nadir for the industry in terms of sales activity) to see how this has evolved.
To view the chart, click here.
The data not only show the relative level of in- and out-flows for absolute return funds in Europe since 2005, but serves as a means to illustrate how activity has shifted in Europe.
Up to the middle of 2007, investors in Italy, Switzerland and France were strong supporters of absolute return. However the failure of many of these funds through 2007-2008 sent investors running for the door. The best example of this is enhanced money market funds, primarily bought in France, where 31.6 billion euros of sales in 2005-2006 were followed by redemptions of 39 billion in 2007-2008 and essentially no activity since.
As the fund sales trends suggest, many investors were less than impressed with their funds’ performance as the effects of the credit crisis rippled through the financial markets. By early 2008 the banking ombudsman in Lausanne had already received complaints about absolute return products.
The previous year had seen the arrival of the Eligible Assets Directive (EAD), providing legally-binding guidance on which financial instruments could be included in cross-border Ucits funds, following the expansion of their investment capabilities with the implementation of Ucits III in 2003.
Envy, desire and basis points
I would like to tell you a story. It’s one about the tempestuous relationship between fund managers and their investors, a tale of envy, desire and basis point negotiations. You may have spotted by now that this is not the plot for this season’s latest blockbuster.
My story has recently gained a little extra spice with two old-fashioned heroes riding into view. One from the West – Omaha - and the other from the East - well, his father hailed from Russia – with both willing to make a little less money in order to help their fellow citizens. Warren Buffett and Stuart Rose are not alone; others in France and Germany are also saddling up. These horsemen seem to be heading in the opposite direction from those in the European funds industry.
There is one aspect that I’d like to look at to explore this: the fees generated by funds in relation to their assets. And in this case Europe and the US look pretty different.
One of the implicit benefits of investing in a mutual fund is that investors enjoy lower annual charges as a result of a fund’s success in increasing assets, in other words that costs fall as more investors join – economies of scale.
The following chart illustrates these economies of scale in action for funds sold across Europe. But although the disproportionately high expenses borne by the smallest funds does mean that average total expense ratios (TERs) fall as assets rise, crucially, such economies of scale do not continue through further asset rises among larger funds. View the chart by clicking here.
ECONOMIES OF SCALE
When comparing the UK to continental Europe there appears, at first, to be a different approach. But on closer scrutiny one can see that the apparent lack of economies of scale being passed on to investors largely reflect the fact that the smallest funds in the UK tend not to let expenses get out of control and create disproportionately high TERs.
Rude health, and a changing of the guard?
By Detlef Glow, Head of EMEA Research at Lipper. The views expressed are his own.
The European exchange-traded-fund (ETF) industry has shown some resilience in the face of questions about management practices raised by market observers like the Financial Stability Board (FSB) and regulatory bodies like the FSA in the UK.
The segment grew by 7.74 percent over the first seven month of 2011, with assets under management up by 17.20 billion euros to reach 239.37 billion.
This has come as some critics have characterised ETFs as a systemic risk for financial markets, due to the use of swaps to replicate the underlying index. Another risk that has been highlighted was the liquidity of some securities accepted as collateral to secure the positions in derivatives and for security lending strategies. Also raised was the outstanding short volume in some ETFs.
But as the ETF industry is fully regulated by market authorities and uses typical techniques for derivatives and securities-lending strategies, the risks highlighted are already known. In addition, the assets under management of the global ETF industry are still less than ten percent of the total, and the issues might be better raised with respect to all funds, instead of pointing the finger at one market segment.
Despite publicity surrounding these issues, and in contrast to the expectations of some market observers, the industry has shown a pretty normal growth pattern in terms of newly-launched funds, with 167 new products hitting the market during the first half of 2011. Most of those were equity funds (102), with commodity funds a significant minority (22).
Risk Management: Did fund managers learn their lesson?
By Detlef Glow, Head of EMEA Research at Lipper. The views expressed are his own.
In the last decade investors and fund managers faced two major crises in the stock markets, the popping of the technology bubble in 2001 and financial crisis starting in 2006.
Portfolio managers suffered average losses of about 50 percent in the wake of both crises, leading investors to question what their fund managers learned.
A Lipper and Avana Invest study on the maximum drawdown of actively managed funds found that those fund managers must have introduced new risk management tools after the bust of the technology bubble. Still, they failed to meet investor expectations on managing risk.
The changes led to smaller tracking errors, but the funds suffered nearly the same losses shown in their respective markets during the 2006-2010 financial crisis.
The study by Lipper and Avana, a German asset management boutique firm, found that portfolio managers started a risk management system that measured relative risk compared to their benchmarks instead of measuring absolute risk in terms of losses.
The new management guidelines did not meet the expectations of private investors and led to the following conclusions: Relative risk management systems are penalizing fund managers if their risk compared to the benchmark moved above a defined level. The study found that a fund manager was not allowed to hold a high percentage of his portfolio in cash or decrease the weighting of a specific industry to zero, as this would increase the risk of the portfolio relative to the benchmark.
A choice between risk and return?
By Dunny P. Moonesawmy. Head of Fund Research for Lipper in Western Europe/Middle East and Africa. The views expressed are his own.
Hedge funds have delivered decent risk-return results over the past ten years. And as transparency and liquidity increased post-credit crisis, they have regained their appeal as providers of absolute return opportunities for investors. In addition, an increasing lack of market visibility globally has played to hedge funds’ supposed strengths, with total industry assets under management now exceeding the $2 trillion, according to Hedge Fund Research.
There is a divide, however, with the industry split between single hedge funds — totaling more than 11,000 in the Lipper database — and some 867 funds of hedge funds (FoHFs). The general perception is that single-manager hedge funds are the more risky investment and to cushion that risk, some investors prefer to diversify their portfolio by investing in FoHFs instead. But is it worth it?
An analysis of single hedge funds and FoHFs during the past ten years shows interesting results in terms of performance and risk. Indeed, whether on a cumulative basis over 3-, 5- or 10-years or accounting for calendar years in 2008, 2009 and 2010, single manager hedge funds performed significantly better on average than FoHFs.
For details of performance, click on this link.
Outperformance of single-manager hedge funds is clear during these periods but since the beginning of the year both single managers and multi-managers have performed poorly, in euro terms, with a little advantage for multi-manager funds.
On a risk level, we have an opposite situation. Funds of hedge funds demonstrated better resistance to the downturn, with a maximum drawdown over 3 years of -19.42 percent against -24.55 percent for single hedge funds. If we take their volatility into account, we have similar results, with FoHFs showing smoother performance pattern over 3, 5 and 10 years. We have here the mirror image of the performance factor, with FoHFs demonstrating strong risk-management compared to single hedge funds.
Knowing me, knowing you..
For a fund company expanding out of its home market, a crucial question is whether a distribution strategy that works well locally will also work in other countries. You might call it the Abba Dilemma: Knowing me, knowing you?
The Swedish popsters’ 1977 hit single went on to suggest “there is nothing we can do”, but new research from Lipper hopes to shed some light on this issue.
The first step is to appreciate the importance of product development. At the end of 2001 the European mutual funds industry stood at 3 trillion euros ($4.2 trillion) in assets under management. By the end of the first quarter of 2011 this had grown to nearly 5.5 trillion. Of this latest total, 43 percent (2.4 trillion euros) of assets are now managed in funds that have been launched in the past nine years. In other words, 97 percent of industry growth since the end of 2001 has come from product development.
This is not just a quirk of the statistics over a longer time period. In 2010, for example, most local fund markets in Europe saw funds which were launched in previous years (referred to as ‘backlist’ funds) suffering redemptions while funds launches in 2010 enjoyed inflows.
You can see a chart showing these findings by clicking here
But this is not a uniform pattern. The most successful local market in 2010 (in terms of fund sales) was the UK. And in this market the vast majority of flows were into backlist funds, accounting for 81 percent of net sales.
This market stands out in Europe for the importance of Independent Financial Advisers (IFAs) as a distribution channel. Historical data reinforces just how important this has been. The weighting of flows into funds with a track record ranges from 40 percent (2007) or 50 percent (2004) to around 90 percent (2003 and Q1-2011), but the UK industry has achieved positive net sales in every year analysed – unlike most of the rest of Europe.
