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Traditional fund management groups are facing increased threats from purveyors of alternative investment vehicles, a development that should sound a "warning bell" for the industry, according to one consultancy.
For the first time since their creation, launches of mutual funds in the US were outstripped by those of alternative vehicles such as exchange traded funds, closed ended funds and variable annuities in 2007, according to Cerulli Associates, while sales of structured products nearly doubled to $114 billion (Dh418.73 billion).
Old school asset managers are also coming under siege in Europe amid surging demand for structured products and bank deposits, as well as ETFs, which attracted net inflows of 22.8 billion euros (Dh130.59 billion) in the first four months of 2008 even as actively managed funds suffered outflows of 164 billion euros (Dh939.36 billion), according to data from Lipper Feri.
"This sounds a warning bell of sorts for mutual fund managers," said Cindy Zarker, director of US asset management at Cerulli. "While mutual funds aren't headed for extinction in the foreseeable future, the cumulative impact of alternative vehicles poses a significant threat."
The pace of innovation appears to be accelerating. Pan Asset Capital Management, recently established by John Redwood, a Conservative MP, and Robert Brown, former CEO of Sarasin Chiswell, claims to be the first UK firm to construct clients' portfolios entirely out of ETFs.
Meanwhile Lombard Odier Darier Hentsch & Cie, the venerable Swiss private bank, has launched a fund of structured products compatible with the popular Ucits III funds regime.
All but one of the 25 largest mutual fund managers in the US saw assets under management decline in the first quarter of 2008, according to Financial Research Corporation and industry estimates, and Cerulli found signs that traditional managers are being forced to adapt to the rapidly changing investment landscape.
Two-thirds of the houses it surveyed planned to develop alternative investment products or vehicles that blend the old with the new, such as allowing limited shorting in previously long-only portfolios.
"There is an evolution in portfolio construction with an emphasis on alternative vehicles that investors might use instead of mutual funds, whether it's an ETF or a structured product," said Zarker.
"The game has completely changed. For the big groups that tend to rely on long-only mutual funds, unless they are one of the top few performers they do feel there are some significant threats.
"More and more companies are taking their established funds and pushing the limits on them to be able to diversify more, whether through shorting, commodities or private equity," she added, citing the example of Vantage, which is promoting a multi-asset "endowment" approach, seeking to replicate the stellar returns of universities such as Harvard and Yale.
Cerulli said the growth of structured products in the US was partially driven by ageing baby boomers starting to switch from accumulation to decumulation.
Big opportunity
"Structured products can be engineered around a very precise outcome. There is a big opportunity in the retirement income market because you can engineer a structured product that says, over the term of the product, we are going to deliver you X per cent," said Zarker.
Sales of structured products to retail investors rose to 263 billion euros (Dh1,507.98 billion) in Europe in 2007, from 190 billion euros (Dh1,098.05 billion) a year earlier, and from $61 billion (Dh224.36 billion) to $94 billion (Dh345.73 billion) in North America and $78 billion (Dh286.88 billion) to $116 billion (Dh426.65 billion) in Asia, according to Blue Sky Asset Management, a London-based structured products specialist.
"Investors are clearly and actively demonstrating that they want and require alternative investments to traditional mutual funds or, at the very least, complements to their existing investments," said Chris Taylor, CEO of Blue Sky. "They want increased risk control in the face of economic and investment headwinds."
Diana Mackay, managing director of Lipper Feri, said fund outflows in countries such as Italy and Spain were being driven by a switch into bank deposits, a process encouraged by banks' desire to shore up their balance sheets. Across the euro zone, the volume of bank deposits jumped 8.9 per cent to 5,120 billion euros (Dh29,599.74 billion) in the eight months to April, according to the European Central Bank.
- Financial Times
By Peter Guest
Administrators are struggling to keep up with the demands of the fund management industry as it continues to embrace new strategies and new instruments, according to participants in an FT Mandate roundtable.
"Performance continues to be the primary objective of every asset manager," says Bernard Hanratty, head of fund services EMEA in Citi's global transaction services business. "As such, we are seeing the blurring of hedge and traditional long strategies. This change has had a significant impact on the infrastructure investment managers have in place to support those diverging strategies. The volumes of OTCs [over the counter derivatives] generated over the last 18-24 months, particularly in the traditional long space, have created significant issues, both for the industry and the ability of the managers to cope with it."
The burden for resolving these issues has fallen on the administrators, Hanratty says, and they have had to develop systems, procedures and controls of their own to deal with their clients' evolution. "This is the most significant challenge: the endless search for alpha."
Progress has been made in processing plain vanilla OTC transactions, but more complex instruments still remain sorely underserved. "This [work] has only been done with the rate swaps and CDS [credit default swaps], and that is about it," says Russell Hart, chief operating officer of PCE Investors. "It is a case of resorting to sending faxes of all your confirmations to the administrators so that they can handle them."
It is an issue that looks likely to remain current, according to David Wright, director of investment administration solutions at DST International, which provides technology to fund administrators and their clients. "The fund managers are always leading the way," Wright says. "The administrators are trying to catch up with what they are doing. We are trying to catch up with what the administrators are doing. Progress has been made over the last few years. Credit default swaps were an exotic instrument a few years ago. Many of those problems have now been solved, but ... people have moved on and there are now other OTCs, more sophisticated one-offs, and so on. We are making progress, but those up in front keep moving ahead. We are always playing a chasing game."
Sunil Chadda, principal consultant at Carne Global, agrees, and believes the problem is only going to be exacerbated by continuing innovation.
"OTC derivatives still have structural issues, operationally and in terms of the systems," says Chadda "The asset class we are seeing coming in now is that of term loans. There are a number of hedge funds out there wanting to trade term loans," he says. "If you look at the bank loans market, whether it is term loans or evolving loans, there is a complete lack of structure. It is like a sell-side Wild West," he says. "Trades do not settle on time. There is a lack of market convention. This is the next challenge."
Dependent on the complexity of the asset class in question, software and service providers typically lag between six months and two years behind the demands of their clients, Chadda estimates. There is expertise in the sell-side of investment banks, but this knowledge is yet to permeate into the administrators.
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