Trends in Asset Management in Europe via Five Questions

Before answering that question it is probably wise to draw the attention to two little known facts that will help to understand what we’re actually talking about:

1. The European asset management market is dominated by institutional investors: roughly 75% of all assets are controlled by institutional investors. Insurers and pension funds and together control 42% and 33% is owned by other institutions. In order to win an institutional mandate one does not necessarily have to open another branch in another country, in any case institutional assets are stable and follow a strict governance.

2. The European asset management market is mainly a market of UK (36%), France (20%) and Germany (10%). All the rest is much smaller: the three followers up are: The Netherlands, Italy and Belgium with resp. 4, 4 and 2% of the assets. There are of course historic reasons that go back to the industrial revolution that started in the UK and conquered Europe via France, The Netherlands and Belgium. These early adapters had an important early starter advantage in cumulating wealth and are roughly 200 years later still among those nations that accumulated the most wealth.

These two facts combined means that the large players cover easily 90% of the market with 5 to ten locations (which they already have most probably). The new investments are only marginally contributing to the bottom line and are mainly investing in the future growth of certain regions. What one sees is that there is more and more competition of the large USA houses (the Blackrocks and State Streets of this world).

As argued before, distribution is key and the highest entry barrier. The cost of creating an asset manager is a containable cost, distribution might not at all be possible. The following approaches are used:

1. Creating an asset manger and its processes as well as hiring some key people is not so difficult: it’s a process that is containable and will typically cost you 10 country-average year salaries. Expect to need a team of 3 to 4 very experienced people to set up the thing and get the licence in Europe. Then you need of course to step up. These costs are containable and if distribution is working out then it is easily and fast earned back. The key in this approach is to set up a viable distribution. Therefore this approach is typically used if one owns distribution (insurance network, bank, etc.)

2. Buy an existing company. This is an attractive approach as it will ensure that you [a] ave a licence, [b] have some good people with local knowledge on board and [c] that there is some distribution in place. Also you can expect to have some assets and in many cases they appear to be rather sticky. In any case you will buy only if you believe that you have something to offer to the investors.

3. More and more since UCITS IV it becomes realistic to distribute products without having an asset manager in place. In most cases the local distributor will expect a local contact person or organization, but this can be your (small) sales wrap. This is more and more an attractive approach if you don’t want to become the unique choice of the mass market. Indeed in most countries becoming the choice of reference will require to have products that offer a local bias.

The answer to that question seems surprisingly stable. UK managers for the last decades tend to indicate that they pefer more exposure to hedge funds. Of course the reason is the search for alpha and diversification, both rational arguments to look at hedge funds.

However there are loads of “irrational arguments” that make people afraid. Many have tried to blame hedge funds for the crisis but all those attempts have failed. For some it would have been convenient if an industry that is weakly or not organized could be blamed so the attention on them would fade, and for others it was their insatiable hunger for controlling all into the greatest detail that drove them to try to blame hedge funds. Despite the fact that no evidence was found that hedge funds could be to blame, they got more than a fair share of regulation. This of course fuelled the anti-hedge fund climate and slowed down plans of institutional investors.

Another equally true explanation is that it is not so easy to invest in hedge funds. It takes a decade of errors and dedication to build up the capacity to invest in hedge funds. That’s the price that the Instutional Investors of the UK ar paying because of their choice to avoid funds of hedge funds and invest directly. One can therefore expect that investing more into hedge funds will remain high on the agenda of institutional investors for the next years to come.

If an asset manger wants to be successful, then there are three crucial things: distribution, distribution and distribution. Asset management products are sold based on confidence. Confidence is not something that can be gained via computers and electronic media. People need to “look someone in the eyes” to know if he/she is reliable. Further confidence is not build up fast: it takes time. This means that the local branch of a bank that served your father and that financed your baptising party has an enormous advantage over other channels. People tend to trust advisers when deciding about investment products. This is not only true for the the small investor who gathers 20K over his/her lifetime, this also holds for private banking. The private banking client might be much more knowledgeable about investments and money, still trust will be the basis and cornerstone of the relation.

So, if you don’t have your own distribution channel you’re simply one of the sharks in the “Red Sea”: you have a product that has no real differentiators, you cannot guarantee anything (not even that you can replicate past performance), … and to make things even worse statistically you’re bound to destroy value for your customer.

If you want to break through without a distribution channel then you must have an extraordinary product. However typically these extraordinary products are simply one bet on one trend. For example the fastest growing asset manger in Poland –Arka– in the period 2000 till 2007 had one strong focus: small cap companies. Every year they had the best performance of the whole market and his sales was the best … till the crash of the small cap companies when they showed a more than fifty percent loss to many customers. For half a decade they have set the trend and were the top-selling asset manager, all based on one lucky bet.

In summary, asset management is a business with seemingly low entry barriers, low capital requirements and can be set up with reasonable investment costs and lead time. However, it is very hard to create strong and sustainable distribution.

Part of this question could refer to companies and the other part to products. First the companies: it has simply been a dull place in Europe without major changes.

However, the asset management market is a very lively place and there are always companies doing good. For example we have a few strong hedge funds doing good business and for example Jabre Capital (Swiss based) is world leader in contingent Convertible Bonds (CoCo Bonds).

Coco bonds are a relatively new and exciting asset class. They are supposed to be part of a bank’s contingency plan. The idea is that these bonds would be a buffer between equity and capital. The idea is that if a bank gets liquidity problems that then those bonds are automatically (at least not at the decision of the investor) converted to equity or even considered as lost. That could be enough so that that bank should not rely on the state for a bailout. The legislation is still in its infancy as is the product itself. That means that there is a wide variety of different terms and conditions.

My personal guess would be that this asset class would grow fast and steadily. The logic behind is solid and the benefits are huge: a state would be able to ensure basic banking service without having to risk taxpayers money by investing into banks or granting them loans while no-one else does provide liquidity any more. The deeper –and more important– potential of this approach is that in the long run one can hope that this will spark a wave of de-regulation. That in its turn should

1. reduce the operational costs for banks and hence spark their role in re-allocating liquidity;

2. re-educate banks in the sense that they take their responsibility serious and not just depend on states to help them if anything goes wrong (one of those things to do is to use coherent risk measures and stop using the flawed Value-at-Risk that accompanied banks to their graves only a few years ago;

3. re-educate investors in thinking where to allocate money (ie. demand a higher risk premium from banks with worse numbers). This is essential in creating a healthy free-market climate. This disease –in its non-cured form– is the same bacteria that pushed countries like Greece, Spain, Portugal and Ireland towards taking more risk on board without significant interest rate hikes to compensate those risks (and warn the governments of the risks associated to their policies).

Of course in these times where the call for more government intervention is out of control and where law-makers and controlling authorities compete for journalists and public favour by adding truck-loads of detailed laws and rules it will take a while before the bank system will be allowed to cure after its grave illness. First we will have to see trough a period of ill advised over-regulation that both slows down economy and make the banks even more sick.