Yuri Bender: Many banks, fund houses and insurance companies
have reached the conclusion it is no longer necessary to manufacture
every product or strategy internally. But how should they choose an
outsourcing partner or sub-adviser? We have gathered an eminent panel
of senior representatives of banks and asset management companies from
Germany, Switzerland and the UK to address this question. We hope you
will share your experiences of both internal management and outsourcing
with fellow panel members and with PWM readers.
Abbey National’s outsourcing of £30bn (e45bn) in unit trusts and
insurance products to external managers has led to the most excitement
which the investment management community has seen in many years. What
was the toughest part of the decision to outsource, made against the
background of inevitable redundancies and accusations that Abbey has
thrown in the towel as far as asset management is concerned?
James Bevan: Abbey has been considering what it is doing across
every business with an open mind and a cultural imperative to consider
change. We had to decide whether the needs of both customers and
shareholders were best-served through investing in in-house operations.
But the £30bn we managed internally was a non-core activity for Abbey,
so we could serve a customer better through using sub-advisers.
It was hard logic and very straightforward. There was substantial pain
at a human level for those previously employed by the company but they
would not have security of tenure in any case if the needs of customers
are not being met. Our industry can be judged clinically by numbers.
Unless you start from the premise that you can be an outstanding
manager in all markets, you need to go down the outsourcing route.
No-one here can hold up their hand and say they are outstanding in all
asset classes.
Yuri Bender: Why did you opt for the multi-manager route rather
than the over-the-counter external funds promised by your rival bank
HSBC for next year?
James Bevan: The HSBC model involves three-year contracts with
managers of external products. We are not signing three-year contracts
with anybody. We can cancel our contracts with sub-advisers at any
time, as we have a fiduciary responsibility to our clients.
If one of our customers buys a product and the sub-adviser does not
deliver, we can pass the assets to a third party. But with HSBC, if a
customer buys a product managed by Threadneedle and HSBC then decides
this is not the best product, the logistics and implications of going
back to a customer and telling them to switch products can be very
painful and expensive.
‘No-one here can hold up their hand and say they are outstanding in all asset classes’
James Bevan, Abbey National
Yuri Bender:Other investment houses, such as BNP Paribas, have
decided to outsource particular asset classes to sub-advisers. Why not
develop internal expertise in these classes instead?
Josef Altmann: We have been using sub-advisers such as Neuberger
Berman for 10 years. BNP Paribas believes there is no asset manager who
can manage each asset class and style the best. Of the E15bn in our
Parvest Sicav, E1.5bn is sub-advisory. For some asset classes, we are
not the right manager, as we have a “growth at a reasonable price”
style.
For instance, we gave a Japan small cap sub-advisory mandate to
Sumitomo Mitsui, one of the biggest asset managers in Japan. For other
specialities such as US high yield we use T Rowe Price as sub-adviser.
So we have open architecture not only in front of distribution
partners, but also in our own product range. You can only compete if
you have a good product in each asset class.
As a growth house, we can’t switch to a value approach internally every
time this style comes into favour, so what some consider a core
competence may actually be sub-advised.
Hansjoerg Borutta:But if we make a mistake in choosing a manager
who does not provide alpha for some period of time, for whatever
reason, it is we who have to explain, so we cannot really hide. Imagine
what we would look like if we said “it was him, not us!”. When you make
your choice and do your due diligence, you always need to be thinking
whether what these people are doing is transparent, and whether you can
stand up and explain it.
Unfortunately, you need to make decisions. You may find an extremely
bright manager who you think is good, but does not reveal what they are
doing at all. You might be happy with them for many years as long as
they provide double-digit returns, but once it turns sour, people ask
questions.
If, at that point in time, you are unable to explain what they did, you
will be asked why you ever let them in. People never question things
when they are going well, but this is a reputational risk that you run,
and you assume the responsibility of having selected people you trust
in and give your name to their decision.
James Bevan:Can we explore the issue of relative cost, because
there is a danger of a customer paying twice for an outsourced product.
In our model, we have a single charge to the customer, and we then pay
a sub-adviser out of what we take, just as if we were discharging a
cheque to our in-house team. The issue is whether we want a set of
people sitting in an office outside our organisation, who are paid a
fee, or whether we want them directly as a fixed cost on our schedule.
No customer pays twice in my world.
Moz Afzal:We are a private bank and do not have as many assets as
you, but it is quite an interesting situation, in that we have a single
fee and that we do our own manager selection work, and we can charge 10
basis points, for example, keeping five basis points for making that
decision. The margins are actually very wafer-thin.
We have studied the big players in this market, such as Russell or SEI,
and their inability to move quickly is very apparent. If, for an
example, a manager who has underperformed for one or two years needs to
be dismissed, there is a question around the timing of that decision in
terms of moving assets.
Also, the big trend over the last two or three years is the emergence
of boutiques, very focused on a particular area due to management
style, who do not want mandates as big as E5-10bn and really only want
smaller amounts. During our selection process, especially over the last
four to five years, we found that, within our portfolios that were once
managed by Fidelity or Schroders, we now have a Thames River or a
Cazenove. They are more performance-orientated, and our performance has
improved as a result.
Josef Altmann:The sub-advisory choice is not only about alpha
generation. The selected sub-adviser must share the same culture. For
example, we deliver to our clients all stocks in the portfolio within
10 days after the end of the month. It is completely transparent. A
sub-adviser must deliver these figures to us in the same way.
Secondly, we come from the institutional business, and our aim is to be
fully invested. We may have one or two per cent in cash, but no more.
The sub-advisory manager must have the same process, and not have rules
which allow him to drift up to 10-15 per cent. There are many points
during due diligence which must match with your own goals.
‘The sub-advisory choice is not only about alpha generation. The selected sub-adviser must share the same culture’
Josef Altmann, BNP Paribas
James Bevan: We spend a huge amount of time setting up a
relationship with sub-advisers such as Goldman Sachs, “lifting the
bonnet”, understanding exactly how you take your decisions and how they
are implemented, then simulating what we think your returns should be,
relative to what they are, and seeing how tight that fit is. If it is
tight, we know you are doing what you say you do.
I do not think there are many in-house managers who would do that,
which is a real problem for the industry, because understanding talent
and identifying it is as much of a problem for an in-house as an
outsourced operation.
Yuri Bender: I have had several discussions with senior
strategists at UBS, many of whom remain very uncomfortable with the
notion of outsourcing. Some of them really cannot comprehend that an
organisation of UBS’ stature and size does not have the best product in
every asset class in-house, and that some may need to be outsourced.
How do you win this internal battle?
Hansjoerg Borutta:It is almost too good a question to be spoilt by
an answer. It is clear for us that we have to evaluate and assess
outside opportunities. It is not about finding another product we can
put on the shelf. We are client-centric, and we think about what the
best solution is that we can offer for a client, and then try to find
the right building blocks to actually produce that kind of solution. If
we find an absolutely satisfying economic solution internally, we are
happy. There is really no point in outsourcing everything we do to
somebody else. We have a core offering that we do not want to
jeopardise, in terms of our programmes and capabilities.
We are not forced to outsource, but clearly not all opportunities lie in-house.
Therefore, we added a capability of selecting managers who can add additional value to our offering. It is a healthy process.
James Bevan:There are two slightly different models at work: one
where there is an expectation that it is best to outsource all of the
implementation, which is our model, and the other model, where a
profound in-house competence already exists and which you are seeking
to complement. Where you have a house style that delivers absolutely
what it says, were you to attempt to do other things in other ways, you
would threaten the culture that creates the excellence you can
currently provide.
Yuri Bender: I would like to bring Michael in here. From a
sub-adviser’s point of view, I am sure you would very much prefer a
deal like the one you have with Skandia, where you sub-advise for them
provided you can also sell your funds through their platform. Would
that be typically how a sub-adviser works?
Michael Klimek: That would be the ideal scenario, without a
doubt. In Germany, we are in a transition phase, or probably in a
structural crisis. One of the reasons is that the big six distributors
own the big six manufacturers, so there is the potential to gain some
further mandates from their manufacturers, at the same time
distributing own-label
funds through the distributor. The reality is that the
distributor/manufacturer takes some time to check the quality of your
own-label product, sold through their network. As a matter of fact, it
is probably the most prominent market entry strategy in Germany. After
some time, you talk about sub-advisory opportunities.
In Germany, there is also a trend from more open architecture toward
more guided architecture. In the case of the big six, there is a trend
toward a preferred partnership system, involving the distribution of
mutual funds, plus sub-advising of some of the mutual funds of the
manufacturer from that big six.
Yuri Bender: Is there a €1bn minimum within a sub-advisory relationship?
Michael Klimek: Again, that would be an ideal scenario. Germany,
per se, is probably an underdeveloped country with regard to
sub-advisory or outsourcing. The willingness to outsource does not yet
exist, in contrast to markets such as Austria. There is a psychological
barrier.
There is a pricing problem too, especially on the institutional side.
There is also a problem around the fact that many investment processes
need to be restructured to provide more quality. However, none of these
internal discussions has been finalised. It will take some time before
we have developed into a market such as the UK, but we have big
potential.
‘Germany, per se, is probably an underdeveloped country with regard to sub-advisory or outsourcing’
Michael Klimek, Goldman Sachs
Yuri Bender: Germany has had several attempts at outsourcing. We
had the Dachfonds, but what has happened with those? They did not
really achieve their expected success – was that due to costs, or was
it through poor choice of external managers leading to poor performance?
Paul Burik:I cannot speak broadly about what was expected, since I
only know about our experience. We have several Dachfonds, and they
attracted substantial assets in the early part of this decade. Their
performance has been quite good, and it is not a performance issue.
However, in the press, the cost issue that was brought up earlier,
specifically around the layers of fees, has arisen, and even if you
have good performance, if there is a lot of attention given to the
expense base, you can lose assets, which has been the case for us. We
have been losing funds from Dachfond products, despite good peer group
rankings, which is counterintuitive, but it has been happening.
On sub-advising generally, if you look at the United States, it is
actually not all that common. If we think of sophisticated markets, the
one that is usually held up as the most sophisticated does not have a
great deal of sub-advising in it. Guided architecture is common, but
sub-advising is not.
In our particular case, Michael talked about a bifurcation between the
factory and the distribution, and there is certainly a split. Our
retail side is very committed to guided architecture, and is probably
the most committed of the big six. We have guided architecture with six
or seven firms, which are known brand names, and our retail group
focuses on working with known partners.
The factory side’s attitude is somewhat different. For us to bring
value to the table, we need to bring someone that the distribution
side, or institutional customers, would not find on their own,
otherwise we are not contributing value-added.
Our situation is analogous to what one finds in private banking. The
more sophisticated customers do not give you credit if you bring in the
capital group. They expect you to bring a boutique, whom they have
never heard of before, that is just as good, if not better than the
capital group. Therefore we are looking for very high levels of quality
or performance and service, but put less weight on brand recognition.
‘The more sophisticated customers do not give you credit if you
bring in the capital group. They expect you to bring a boutique, whom
they have never heard of before’
Paul Burik, Commerzbank
Yuri Bender:Heinrich, can private banking clients compare the
performance of the funds – of say five separate sub-advisory managers –
through a global custody system? If so, if Pictet is underperforming,
will they see that immediately, and might you have to sack yourselves?
Heinrich Adami: Pictet is primarily a European private bank, and
secondly an asset manager. This occasionally leads to a
misunderstanding when clients who we would love to have tell us that it
is “too bad” we are only a global custodian.
That is not true – we manage close to SFr225bn (E146bn). But global
custody has helped us to attract very important fortunes, particularly
from clients who sold their companies and who are now in a position to
ask for help in organising their fortune and looking at the roughly
100kg per month of reports.
The global custody system we developed is extremely good at
streamlining that and coming up with two or three pages at the
beginning, where you receive a very good impression of what your 10
managers do around the world.
However, this alone is starting to become a commodity. What we do are
the add-on services. A group in Geneva specialises in taking all these
numbers, which is very easy, once you have everything in-house. We have
a lot of information from which we can make an analysis, and question
why, for example, a certain manager always underperforms in fixed
income, yet still has a balanced mandate.
All these added services are very interesting to the client, and
perhaps more interesting than just receiving a nice report explaining
what their money is doing. I think global custody is moving towards
making reallocation proposals based on analysis.
On the second point, if we, for example, are managing European
equities, underperforming another manager, we would see this
immediately, and the group doing this analysis has to be very honest,
otherwise we would lose our credibility.
‘It would sometimes be easier for us to farm out to excellent
managers, but we would lose clients, because we are perceived as a
relationship bank’
Heinrich Adami, Pictet
James Bevan: I think the sophisticated client will expect you to
underperform from time to time. If we go back to first principles, it
must be that you are selecting external managers who have low
correlation with your own house, on the very expectation, from time to
time, you will have a difficult period, as a house provider, which is
exactly why you have other managers to ensure your overall customer
proposition is not damaged. That is why I do not think that a
sophisticated client has a problem with periodic underperformance from
a manager within a multi-manager or multi-asset framework.
Yuri Bender: Is there still a very strong emphasis within Pictet, and other private banks, in manufacturing products for internal clients?
Heinrich Adami: There is a nuance there, because we are
responding to what clients want. For instance, nobody would expect us
to be the best US equity manager. We are a European bank, so it is
perfectly acceptable that we are not the best in US equities, for
instance. However, if we could not show a decent product, we would lose
clients. It would sometimes be easier for us to farm out to excellent
managers, but we would lose clients, because we are perceived as a
relationship bank. It is not because we would make more money and we
want to push our own products, but rather it is really responding to
the client. That does not mean that we would not farm out in areas
where we cannot prove to be among the better performers.
Yuri Bender: You have several external relationships, Moz,
representing over $1bn (e825m), I would have thought, in assets farmed
out, one of them being with GAM. I have heard voices, within your
group, saying that GAM have performed so well for so long that they
will have to be sacked eventually, because they cannot continue being
so good. Is there a limit to the period of time over which you would be
loyal to a relationship with a partnership such as GAM?
James Bevan: I would say no, rather than yes.
Moz Afzal: Absolutely. The reason why we selected GAM was really
for our clients to have a very good alternative to an in-house
proposition, and because their performance was very good. However, it
was not just the performance aspect that was important, but their
transparency, and the technology they had invested in, in terms of
offering internal and external clients excellent evaluations, internet
reporting, and all the things that internal sales managers could obtain
from an external basis.
We found that performance was important, but so were the other pieces
that accompany it. Therefore, a client coming to EFG now has two
choices: they can decide on an internal solution, or on a standard GAM
product, where they can pick out three or four different GAM strategies
on a platform that is co-branded. For example, the client will receive
a co-branded valuation and a co-branded website. It is integral to the
whole process.
In answer to the question around how long we would remain with GAM, we
are actively monitoring their performance. We follow up with quarterly
meetings and have regular meetings with GAM management. It is “joined
at the hip” in some respects, but performance is not the overriding
aspect. If it starts to deteriorate, then clearly we have a fiduciary
responsibility to offer an alternative.
Interestingly, and going back to a point made earlier, there is a
question as to why we do not farm everything out externally. However,
the key point is that clients expect you to know the markets and to run
your own money. They expect you to offer them ideas and solutions that
you have formulated yourself, rather than from farmed out processes.
Therefore, managing money internally is just as important as offering
an external product.
The high net worth clients are sophisticated enough to know an
underperforming in-house product, but they equally want you to
understand the markets and to have the experience and knowledge base to
offer internal products as well as external products.
‘Clients expect you to know the markets and to run your own money.
They expect you to offer them ideas and solutions that you have
formulated yourself’
Moz Afzal, EFG
Yuri Bender:How much marketing are manufacturers expected to do
within a sub-advisory relationship? Are they right there in the
prospectus, or is their name buried somewhere? Do they receive full
credit for what they do? How much involvement is there, typically?
Hansjoerg Borutta: We certainly would give credit to the
managers who have helped us to perform. We are always clear that this
is part of the offering. If, for instance, Goldman Sachs has
significantly contributed, it would be mentioned in the report, and we
would explain how the performance came about.
However, we do not appreciate seeing external sales forces being able
to go anywhere within the organisation and make their own pitches,
since it would fly in the face of the whole concept of offering
investment solutions for our clients. That is also why we developed
packaged offerings, which is something which “sits on the shelf” and
can be used for wrapping up and being part of an individual solution.
If people want to have the third party experience, it would be foolish
of us to withhold that information, because that is part of what people
have paid for as a private investor. However, there is a distinction
between an open shelf and open distribution.
‘Clients expect you to know the markets and to run your own money.
They expect you to offer them ideas and solutions that you have
formulated yourself’
Moz Afzal, EFG
