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The Big Squeeze
European mutual fund managers scramble to cut costs and launch new products.
Pity the poor European mutual fund manager. The credit crisis has unleashed a wave of investor jitters and sent stock markets around the world tumbling. But although mutual funds in the U.S., where the crisis actually began, have suffered relatively little fallout, European managers are experiencing unprecedented outflows of investor funds.
The industry in Europe has been caught in a perfect storm: Theres stiff competition from structured products sold by banks; European retail investors, less experienced in the equity markets than their U.S. counterparts, have low tolerance for shaky market conditions; and compared to U.S. employees with their bulky 401(k) plans, Europeans have much smaller pools of retirement savings, depriving the funds of regular inflows. One of these factors alone could lead to a surge in redemptions, but the triple whammy is wreaking havoc.
Now European fund companies are fighting back. Money managers are rolling out new strategies from betting on specialist products such as funds that invest in emerging markets to boosting sales of alternative investments such as hedge funds to cutting costs in a bid to attract investors and maintain profit margins. In this environment you have to be more innovative, says Jean-Baptiste de Franssu, vice president of the European Fund and Asset Management Association and chief executive of Invescos continental European business. Samir Shah, a financial products analyst at Landsbanki Securities (UK), contends that funds need a strong marketing edge to attract investors. The winners will be specialist and alternatives managers with good track records, he says.
Given the current state of the industry, a good track record is indeed a rare thing. European fund companies suffered record outflows from retail funds, excluding money market funds, of 47 billion ($74.8 billion) in 2007, according to Lipper Feri, a London firm that tracks fund sales. In sharp contrast, the U.S. mutual fund industry enjoyed inflows of $226.6 billion last year, also excluding money market funds, in spite of the subprime meltdown. The downturn has intensified so far this year, with Europe experiencing outflows of 100.2 billion as of the end of February, the latest period for which figures are available, and U.S. funds seeing a sharp slowdown in inflows, to just $5.6 billion.
In Europe, experts say, the pain runs far deeper than it did during the bear market in 2002, when investors dumped equity funds because of the sharp decline in European stock markets. Then investors simply shifted money into other products, such as money market and bond funds. This time around the problems are affecting all asset classes, and retail investors are simply moving back to deposit accounts while institutions are sitting in money market funds, says Diana Mackay, co-CEO of Lipper Feri. Bond funds saw outflows of 17.1 billion in the 12 months through February, compared with outflows of 62.9 billion for stock funds, the firm reports.
The malaise may be most visible in the U.K., but it has spread across Europe. Undertakings in collective investments in transferable securities, or UCITS, the main type of European mutual fund, had net outflows of 101 billion in the second half of 2007, according to figures from EFAMA. For the full year net sales fell by more than half, to 170 billion from 452 billion in 2006, but even those figures understate the weakness of the European market. Asia, which traditionally accounts for less than one quarter of UCITS sales, generated more than 50 percent of net sales last year, de Franssu notes. As far as European investors are concerned, he adds, the falls in assets were dramatic.
In the U.K., Europes biggest savings market, funds suffered retail withdrawals in December 2007 for the first time in 15 years, with net outflows of £858 million ($1.7 billion) compared with inflows of £1.9 billion in December 2006, according to the Investment Management Association, an industry group. Thats a pretty damning statistic, says Landsbankis Shah. Theres a high degree of uncertainty. The industry recorded an additional £721 million of net withdrawals in January before recovering to post net sales of £811 million in February.
Funds investing in U.K. commercial property suffered especially strong outflows, forcing firms like Axa Investment Managers in Paris and Dutch insurer Aegon to freeze withdrawals from their U.K. property funds to prevent liquidity problems.
The Italian fund market has experienced even bigger outflows, and its not hard to see why. A shocking 90 percent of the fund industry in Italy has a five-year average return below the 2.34 percent yield on Italian Treasury bills, says Pietro Giuliani, chairman and CEO of Milans Azimut Group, which has 15 billion under management. In the past four years, shares have done well while bond markets have underperformed and destroyed value for the client. Yet even at the best of times, only 25 percent of asset management clients portfolios were invested in equities, he says. It is inevitable that there should be such a high level of dissatisfaction.
Italian funds suffered outflows of 65 billion in 2007, compared with outflows of 48 billion in 2006. In January they lost an additional 19 billion in assets, mostly in equity funds, according to Italian industry association Assogestioni. Outflows slowed to 7.3 billion in February, with bond funds taking the biggest hit. January was a disaster, says Attilio Ferrari, CEO of Milan-based Arca, Italys fourth-largest fund manager, with 22 billion in assets under management. The industry has never seen a month like it. It may again, however. Azimuts Giuliani predicts that assets under management in Italy could contract a further 30 percent in the next 12 months. The industry is in serious difficulty, he says.
European fund managers are employing a number of strategies in an effort to reverse the tide. Turning to specialist sector funds, or funds that invest in one niche segment, such as luxury goods, green technology, agriculture or even water, may not be a bad bet. The $6 billion Schroders Alternative Solutions Agriculture Fund, a retail fund launched in October 2006, closed to new investors in February after raising an impressive $5.3 billion. The Luxembourg-based fund invests in such commodities as wheat, corn and livestock and has returned an annualized 26.26 percent to the end of March on the back of the commodities boom.
Some so-called themed funds have launched more recently, however. The Julius Baer Luxury Brands fund, which invests in brands like Cartier, Hermès and Bulgari, had raised just 30 million in the first two months since it was launched in January. Investors like the idea of the fund, but they are scared to invest right now, says Scilla Huang Sun, manager of the fund. But she remains confident, noting that top luxury companies have strong brands and pricing power.
Other managers are betting on emerging markets to tempt investors hungry for returns. In February, Jupiter Asset Management launched its India fund, notwithstanding an 18.7 percent drop in the Indian stock market since the beginning of the year. Jupiter touts the fund as a way to gain exposure to the countrys high economic growth potential. This has been aimed at retail investors, so there is clearly appetite for risk, says Edward Bonham Carter, the CEO of London-based Jupiter; he declines to specify how much the fund has raised. Over the past month Jupiter has also seen more interest in bombed out sectors such as financials, notably from investors with a taste for risk, he adds.
Managers also have been marketing more funds that offer guaranteed returns in an effort to compete with some of the banks popular structured products that promise specified returns or guarantee that investors wont lose their initial capital. Italys Arca, for example, started selling guaranteed balanced funds for the first time in March and is going after high-net-worth investors as well. It plans to launch a fund of hedge funds later this year.
Azimut is seeking to do the same thing. The firm recently entered a joint venture with investment bank Tamburi Investment Partners that will sell funds to high-net-worth individuals and family offices. Despite outflows from its stock and bond funds in January, Azimut bucked the trend in Italy with overall positive net inflows, thanks to 708,000 in sales of its hedge fund, Aliseo, which returned an attractive 12.5 percent, after fees, in 2007. At the beginning of February, Azimut launched Aliseosei, a fund of hedge funds that invests in equity long-short funds.
In addition to diversifying their products, many funds are increasingly looking for new clients outside Europe. Consider Jupiter, which today is a predominantly U.K. retail fund business. The firm signed a distribution agreement in January with Taishin Bank, a Taipei-based financial holding company, under which Taishin will sell five of Jupiters unit trusts in Taiwan through its banking network. Jupiter hopes to further diversify by reaching similar arrangements in other markets, Bonham Carter says.
Notwithstanding their efforts to generate fresh sales, many money managers realize that new products may not be enough to shore up the bottom line. Cost cutting is a daily exercise in a difficult environment, says Arcas Ferrari. Europes money management industry has been saddled with high costs since the boom times of 2006, when profits hit a record 16 billion. That heyday saw fund managers salaries and marketing budgets climb. Management consulting firm McKinsey & Co. says the combination of higher costs, depressed equity markets and weak inflows could sink the profitability of European asset managers by as much as 30 percent. The belt-tightening is widespread. London-based Henderson Global Investors, which manages £59.2 billion in assets, has cut 44 jobs in sales, marketing and human resources, saving about £20 million on its cost base of £234 million, says Richard Acworth, a spokesman for the group. Variable staff expenses, such as the portion of fund managers pay linked to performance fees, will also go down should returns fall, notes Acworth.
Fund managers will certainly have to find new ways to adapt their business after some very good years. Its like going from a hot and comfortable bath to a colder one, says Bonham Carter. Its a bit of a shock.