A challenging road ahead

26 January 2015
By Tiziano Giannotti

By Fiona Maciver

For many, the start of the New Year goes hand in hand with fresh personal and business objectives for the next 12 months. While hitting such targets is often down to dogged resilience, external factors can throw a spanner in the works. The fund industry is undergoing a radical period of change and, whether manufacturer, fund buyer, commentator or regulator, all participants will grapple with challenges old and new over the coming year.

  • Distributors anticipate regulation and pricing pressures to be the main drivers of industry change over the next three years.
  • Low interest rates and inflationary concerns weigh on asset allocation and product selection decisions.
  • Asset managers and distributors need to work together to build trust with retail investors.
Game changers

Fund Buyer Focus regularly seeks the thoughts of distributors on the future of the industry and the challenges they face. Selectors are asked: ‘What do you consider to be the most important drivers of change in the fund market over the next 3 years?’ and ‘What is the biggest challenge that you are facing at the moment?’ Responses come in the form of open comments, which are then categorised for analysis.

Naturally, distributors face many different challenges, from basic survival to adapting to the macroeconomic environment. Responses reflect business models and each respondent’s specific role in a firm, with many emerging themes similar and intertwined. Before examining the top distributor challenges in greater depth, the following quote from a French IFA sets the scene, encapsulating many of the difficulties faced by fund selectors and manufacturers alike:

‘Regulation represents almost mortal danger from the European Commission, which is proposing a move from a system based on commissions to fee-based advice. For us, working over the internet, the risk is lethal, because we do not know if even 10% of our customer base is willing to pay. People came to us because it was free. ‘ ‘Apart from that, my challenge is to try to help customers understand that it is in their interest to take some risk, explaining that they cannot remain passive, watching falling interest rates and the decline in yields. The French investor is extremely cautious; as soon as you mention an equity fund to a client or prospect he will tell you that he has already lost on the stock market. Today it is a market for experienced investors and market professionals.’

With the tidal wave of regulation that has engulfed the industry in recent years, it is not surprising to see regulation and legislation as distributors’ key driver of change and major challenge for business models, in the chart above. Concerns are shared across channels, ranging from the additional reporting and record- keeping burden to the fundamental income issues for advisory businesses, currently operating on a non-fee basis.

Comparing responses with the same six-month period in 2013, there have been some notable changes in the top four drivers. At an aggregated level, regulation and legislation have remained in pole position, but moving up into second position is pricing and costs. With RDR in the UK and the Netherlands generating a greater focus on price, low-cost investing via passive strategies gathered significant momentum in 2014.

torte_drive of change2

Industry architecture registered a marginal fall into third place. However, the most notable move was linked to interest rates and inflation, leaping from ninth position in 2013 to fourth for the same period in 2014. The qualitative comments confirm that this weighs heavily on distributors’ minds. The current low-interest-rate and low-growth environment makes it difficult to achieve returns, particularly for clients reluctant to move away from traditional fixed income products. This is problematic for fund buyers in relation to both asset allocation and product selection, as they endeavour to generate positive returns for their clients. A recent comment from a French discretionary portfolio manager sums this up:

We need to make money for our clients, but the client doesn’t want to take any risk. We try to educate, to reduce overall risk aversion.’ The recent ECB announcement on deflation provides further angst for advisers and investors. Interest rates and inflation concerns will remain a significant challenge in the year ahead across geographies and distribution channels. With variances in the timescales of local and international regulatory initiatives, some differences are apparent in challenges cited at country level. This is most notable in the Netherlands, where pricing and cost pressures are rated as the most important factor, closely followed by regulation. Of course, the Netherlands, like the UK, has implemented a retrocession ban that has focused attention on fees more than elsewhere. Following implementation, both markets have witnessed a significant growth in passive fund sales, one consequence of which has been for passive-specialist Vanguard, a relatively new entrant in the European arena, to quickly build significant market share in both countries. This trend is expected to spread to the rest of Europe when Mifid 2 is finally implemented in 2017.

Elsewhere, Austrian and Spanish distributors highlight interest rates and inflation as their main challenge, with particular concerns about product suitability and the need to encourage investors to move out of assets offering little, or no, return. Rallying to the challenge There should be few surprises among asset managers about the major challenges confronting distributors – after all, manufacturers face similar issues, particularly in the areas of regulation and pricing pressures. Fund groups have a raft of regulatory initiatives to contend with over the next few years, requiring the devotion of significant resources, but they must not neglect to understand and support the requirements of their distribution partners during this time. While regulatory change requires more prescriptive solutions, addressing distributors’ concerns over the low interest rate and low growth environment is arguably more complex. The solution is not simply product driven. There are much wider issues to resolve, particularly with retail investors’ lack of trust in the industry and the need for more investor education. Manufacturers and distributors need to work closely together to educate investors on the risk and benefits of different types of long-term funds, whether passive or active investments.

The focus on cost and transparency should move on to value and outcomes for the end-client. Passive strategies stole the spotlight in 2014, capturing considerably more press coverage dedicated to their merits than their active counterparts. Will the active community start fighting back in 2015? So far, active managers have been conspicuously absent in mounting a defence. While there is no excuse for closet trackers charging active fees, there are still many active fund managers with a good story to tell. It is perplexing why PR machines have not been put to work to promote the success stories and shift the focus to a more balanced debate on cost and value for money.

Active-bashing and a constant focus on the cost of investing is only further dampening efforts made on investor engagement and damaging the reputation of the industry, at a time when it should be working tirelessly to build trust. Combined with the other hurdles, 2015 is set to be another interesting year, riddled with challenges and requiring more resilience.