Funds in flux: are investors getting a better deal?
By David Oakley. This article originally appeared on the Financial Times website, FT.com on August 1st, 2014
When Edward Bonham Carter first joined the City of London in 1982, starched collars, expensive silk ties and lace-up leather shoes were mandatory attire for fund managers. Some even wore a bowler hat. Today starched collars are no more, ties are optional and slip-on shoes are commonplace, while the vice-chairman of Jupiter Fund Management is possibly the only financier left in the City who still owns a bowler hat.
The transformation in the asset management industry has not been restricted to dress code since Mr Bonham Carter started his career at Schroders, Europe’s second-biggest-listed investment group, more than 30 years ago. Indeed, one area where arguably changes have been most keenly felt is among savers.
This year, in particular, has been a turning point for the retail investment business as passive funds have grown, putting pressure on the business models of active fund rivals, while new regulations and reforms in the pension industry are changing the way investment managers deal with their clients and develop products.
Mr Bonham Carter, who stepped down as chief executive of Jupiter in March, says: “Thirty years ago, the world and industry was less complicated. Fund management was about buying equities and bonds but it is not just the assets and products that have changed, it is much more fundamental than that. The next five to 10 years are likely to see more change than the previous 30 years in terms of product choices for the individual investor, the role of technology and the rising challenge of meeting retirement needs.”
Alasdair Macdonald, head of advisory portfolio management at consultants Towers Watson, adds: “There are a number of different trends – the move from defined benefit to defined contribution pension schemes and the end of compulsion over buying an annuity – that mean the consumer has more choice over their investment decisions. In a sense, the consumer has been empowered.”
Perhaps the key question for savers is a simple one: are they getting a better deal today than they did five, 10 or even 30 years ago?
A more discerning customer
To address this, it is important to look at the profile of the savers themselves, as they are to a large degree forcing the changes in the asset management business. For a start, people are living longer. In the UK, life expectancy has increased 10 years to 85 for men and eight years to 89 for women over the past 50 years. Many will spend as much as 30 years of their life as a pensioner, which means planning for retirement is even more important today than it was 50 years ago.
Savers are also more discerning and demanding as they have more freedom and control over their pensions. Not only are more pensions likely to be defined contribution schemes, putting more responsibility on the individual to save, but government reforms that make buying an annuity voluntary mean people can use their pension cash for anything they like, from buying a souped-up sports car to investing in an equity income fund.
This gives the saver more options but also provides opportunities for asset managers. In April, Robert Kapito, BlackRock’s president, told investors that up to $25bn of UK pensions savings annually was now “money in motion”, thanks to the government’s decision to remove the requirement for pensioners to buy an annuity. In other words, the billions that flow annually into annuities, which go largely into bonds, could flow elsewhere, such as equity or other kinds of funds controlled by asset managers, which offer better returns and better value.
Although these changes provide asset managers with opportunities, they also bring potential problems as savers have become far more sceptical about the performance of investment companies. In particular, this has put pressure on active managers and explains one of the most significant asset allocation trends this year: the switch into passive equity funds, which track the market and have cut their fees to the bone.
In the first half of the year, global inflows into passive equity mutual funds far outstripped those into active. According to data from Goldman Sachs Asset Management and Morningstar, two-thirds of the $222.9bn of inflows into equities in the first half of this year went into passive funds, boosting the profits of groups such as Vanguard, which specialise in these products.
Jeff Mollitor, chief investment officer in Europe at Vanguard, says: “Active managers very rarely beat the market, largely because they charge so much for their services. This is one of the main reasons why more people are using passive products.”
Fees under pressure
Fees, therefore, have become a hot-button issue and an area of focus for regulators. In the UK, the City watchdog has been at the forefront of reforms, making asset management fees more transparent while cracking down on how firms charge customers for broking services.
This has pushed fees lower. Standard charges of 0.75 per cent have fallen to about 0.60 per cent and, in some cases, lower. According to analysis by McKinsey, the consultancy, fee levels for retail funds fell 13 per cent in the UK last year as a result of the Retail Distribution Review, which barred distributors from receiving commission payments from asset managers. McKinsey expects levels to fall much further as the UK moves in line with the US. Retail fees are still 42 per cent higher in the UK than in the US, the consultancy says.
New rules are also in the pipeline that will force asset managers to pay for broking research rather than passing the costs on to clients, many of whom were largely unaware they faced these “hidden” commission charges. At an estimated £3bn a year, this is a large chunk of money that the customer will no longer have to foot.
While these reforms clearly benefit customers, asset managers worry that the pressure on the industry will force some groups to go under. Fees are falling just as the regulatory costs of new compliance and reporting rules are rising, hitting profit margins hard.
Anne Richards, chief investment officer at Aberdeen Asset Management, says: “There are two ways to go. If you are big, you need to diversify and offer products across the board, which is what we are doing at Aberdeen. If you are smaller, then you need to become an expert in your field. The ‘squeezed’ middle is a difficult place to be.”
Many active managers have responded to the increasing competition from passive funds and growing demands from clients with new products and strategies. These are designed to respond to changes in demography and an economic environment where historically low interest rates have made it harder for savers to build a big enough pension pot for their retirement.
Since the financial crisis, multi-asset or investment solution products, which offer clients a “solution” or “outcome” in line with their needs, have become one of the fastest-growing asset categories. In the past four years, BlackRock’s multi-asset products have grown more than 150 per cent, far outstripping the expansion in equities and bonds. It is a similar story at other big houses, such as JPMorgan Asset Management and Aberdeen.
These products are similar to old-fashioned balanced funds, which were prevalent in the 1970s and 1980s and offered a customer a combination of equities and bonds in one portfolio, typically 60 per cent stock and 40 per cent fixed income. However, today’s multi-asset version is far more complex and diversified, with a combination of equities from a variety of geographical regions and bonds from safe government securities to more risky high-yield debt.
The idea behind these products is to produce a relatively safe investment, which guarantees a specific yield or income as a “solution” to a particular customer’s needs. This is more important than ever as yields of government bonds are too low to meet the income requirements of most pensioners. For example, a sprinkling of dividend-yielding equity in a primarily safe bond portfolio is considered an ideal way to boost income without exposing the customer to too much risk.
Alex Hoctor-Duncan, head of BlackRock’s retail business in Europe, says: “There are two clear trends. Consumers are seeking products with a defined outcome, which complements an increased adoption of lower cost index products. This is resulting in more focus on overall portfolio construction and the understanding of how different asset classes work with each other.”
Mr Macdonald of Towers Watson adds: “The asset management industry is adapting like other industries. In the old days, an asset manager would offer an investor building blocks, an equity portfolio and a fixed income fund. Now they are offering the complete solution in one portfolio. You can see a similar thing happening in the car industry, where the dealer sells you a car, offers a manufacturer’s guarantee and roadside assistance as a complete package.”
Active managers are trying to raise their game in other ways, too. They are adapting the way they use data as well as using behavioural finance and psychology to boost performance. In the 1980s, a long lunch might have been a useful way to get the inside track on a company or product, but managers now turn first to the internet or a Bloomberg terminal.
Peter Harrison, head of investment at Schroders, says: “It is very different today compared with 20 or 30 years ago. Then, it was hard to get data. Now, we have too much of it. It is vital to be able to distinguish meaningful and important data from the noise, which is why we are looking at new ways of gathering information and making sense of it.”
Schroders has also employed Shane Sutton, Britain’s head cycling coach, to help some of its top fund managers improve their performance by analysing what they do well and badly. For example, some fund managers have a talent for picking a winning company but might lack the courage or discipline to sell when the performance of a stock turns sour. Mr Sutton uses his expertise as a cycling coach to help fund managers find their strengths and weaknesses.
Other asset managers, such as Man Group, have used technology that systemically analyses a fund manager’s trades to single out the best from the worst. In this way, they hope to help their fund managers repeat their successful trades and avoid their failures.
Mr Bonham Carter feels the industry is entering an exciting period, both for asset managers and savers. Although the industry needs further reform to give consumers even greater choice, increased transparency over fees and the growth of products have gone a long way to give savers more options.
Mr Bonham Carter’s bowler hat, which still hangs on his office coat-stand, is symbolic of a simpler era. The world and the industry may have become more complex, but at least the saver is more empowered to deal with the changing times.
Sidebar: Now we can all become our own financial advisers
More than anything else, the web has empowered individual savers, making it the single most important factor in reshaping the investment industry, writes David Oakley.
Online investment supermarkets have sprung up, most notably that of Hargreaves Lansdown, which enables people to log on and search for stocks and funds to invest in. It also offers investment guidance.
Other groups such as Fidelity Worldwide Investment have developed consumer-friendly websites, which offer step-by-step guides to a range of investments from ISAs to SIPPs.
Last week, Fidelity also launched a full retirement service for individuals, advisers and employers in response to changes in pension rules that no longer force people to buy an annuity.
Individuals can gain access to the retirement service on the web or over the telephone. It provides guidance on how to build a retirement income plan, how to budget and manage expenses and income needs.
James Burton, UK managing director at Fidelity, says: “The ageing population is the biggest trend in the industrialised world and people need help to decide what to do with their savings.”
Although the web, investment supermarkets and initiatives such as Fidelity’s retirement service offer consumers more choice, critics say customers can still be left confused over how to invest.
For example, online platforms offer so many different types of share class, rebates and tiered and stepped fee structures that it can make it difficult for customers to work out what they are paying for.
In theory, choosing investments should be as easy as going to the grocery store to buy a loaf of bread, with goods clearly labelled and prices on display with no hidden charges. Unfortunately, say some financial practitioners, it isn’t, and therefore more reforms are needed to make investing easier and more accessible.
David Oakley is the FT’s Investment Correspondent
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