Pesky start-ups, higher costs and weaker markets have left bulked-up money managers searching for growth opportunities.
By David Lanchner
November 2000
Institutional Investor Magazine
For the complete Euro 100 ranking results, please go to the rankings section of this site.
So much for the logic of consolidation.
After several years of poor performance in its value-oriented portfolios of stocks and bonds, Swiss money manager UBS saw new money inflows fall and profits decline by 26 percent in 1999. Europe's largest investment firm has also had to contend with wrenching change as it tries to bring London-based Phillips & Drew and Chicago-based Brinson Partners under its own brand. Tony Dye, who headed Phillips & Drew, and Gary Brinson, founder and head of Chicago-based Brinson Partners, resigned under pressure in March, leaving chief executive Peter Wuffli to integrate the UBS subsidiaries.
"We suffered from some short-term performance issues last year," says Wuffli. "Even though our value portfolios are now doing well, we decided to strengthen our global research platform and expand the range of our investment products. Now we can offer clients nearly any kind of portfolio they want."
Like many of its global counterparts, UBS finds itself in a bind. As it spends freely to create a unified brand name and deliver the products and services demanded by a diverse, worldwide customer base, the money management firm is also competing in a slower-growth, fee-conscious marketplace. And a new generation of index funds, private equity investors and hedge players are all vying to claim their own piece of turf. Then there is talent. Keeping star portfolio managers and their teams together is increasingly expensive as opportunities open at rival firms and start-ups. In the background, the world's longest-
running bull market is quickly losing speed and threatening to turn the financial services marketplace into a war of attrition.
"Everyone wants a piece of the European market, largely because of future prospects for the introduction of pension funds," notes Stephen Wilshire, head of European research at pension consulting firm Frank Russell Co. in London. "But with the exception of the U.K., Holland and Switzerland, there are still no real pension funds to speak of in Europe. The pie is quite small, and the appetite of fund managers is quite large. Until these markets start diverting assets into funded pension schemes, competition will be a continuous downward force on fees."
The lack of major new growth opportunities is starting to manifest itself in the Euro 100, Institutional Investor's ranking of the largest money managers. While the minimum amount of assets needed to break into Europe's top five rose sharply last year, to E649 billion ($545 billion), the growth rate isn't quite what it seems. (II has, for the first time, used the euro, rather than the U.S. dollar, as the basis for the ranking. Because of the decline in the euro and ongoing shifts in the currency makeup of managers' portfolios, only generalized year-to-year comparisons here and elsewhere in this article are possible.) Without fifth-ranked Deutsche Asset Management's absorption of Bankers Trust Corp.'s investment unit, the minimum to join this elite group last year would have risen much more modestly. Aside from UBS (E1.09 trillion) at the No. 1 spot and Deutsche Bank in fifth (E649 billion), the top tier includes Axa Group (E781 billion), Barclays Global Investors (E779 billion) and Credit Suisse Group (E735 billion) in the second, third and fourth spots, respectively.
And the asset level required to make it onto the Euro 100 list actually hasn't changed much in the past few years. The minimum this year is E17 billion, roughly the same level it was at the end of 1997, given changes in the currency during its two-year history. "Along with poor growth at industry leaders like UBS, this is further evidence of increasing competition from upstart specialist players," says an executive at a U.S. money management firm. In his view, the contraction at the very top of the list, together with little or no movement at the bottom, is a sign that the industry is fragmenting into more firms managing smaller amounts rather than consolidating into fewer players handling more. It wasn't supposed to work this way.
What are the major players planning to do while waiting for serious local pension fund initiatives to get under way? UBS and its nearest rivals are directly challenging these smaller upstarts by launching new products, trying to maneuver around them by utilizing their global heft and marketing power and, at times, working with them to provide services that boutiques simply can't afford to offer. As always, firms are also buying each other to grow.
Transatlantic relationships have been among the most ardent in the past year. In addition to seeking a foothold in the world's largest money management market, European firms crave U.S. expertise in credit analysis, 401(k) plan administration and emerging-markets and growth funds -- areas where the Europeans have considerably less experience. As growth slows in U.S. asset management, U.S. firms are eager to get access to promising European pension and retail fund markets. Recent examples of the transatlantic trend include Munich-based Allianz's October agreement to buy San Diegobased Nicholas-Applegate Capital Management for a minimum of $1.08 billion (although that could rise to as high as $2.68 billion, depending on how fast the U.S. firm grows), as well as Milan-based UniCredito Italiano's purchase of Boston's Pioneer Group for $1.2 billion in May. Nationwide Mutual Insurance Co. in Ohio purchased London's Gartmore Investment Management for $1.6 billion in March.
Certainly, there is no shortage of new participants stepping up to take the places of the acquired. Among the more successful, according to European pension fund consultants, is Och-Ziff Capital Management, a U.S.-based hedge fund manager that has set up shop in London. The firm now has about $3.2 billion under management in the U.S. and Europe. Two other hedge funds gaining investor attention are Citadel Investments, which specializes in low-risk arbitrage, and Pendragon Capital Management, both based in London.
And it's not just hedge funds nipping at the global giants. "Traditional products that are easily mimicked by passive investment are seeing their profits squeezed," says David Salisbury, chief executive of 13th-ranked Schroders.
U.S.-style index funds, which generate about one quarter of the fees that actively managed funds do, are catching on in the world. Non-U.S. index funds grew by $40 billion (not including market appreciation) in the first half of 2000, representing their biggest six-month gain ever, according to one recent survey. And there appears to be much room for growth, since, at $400 billion, the non-U.S. index market is still only one fifth the size of the $2 trillion U.S. index market. "European institutional clients and even some retail investors are increasingly moving to a strategy of holding index funds, complemented with higher-return, higher-risk specialist funds," says James Goulding, CEO of Deutsche Asset Management Europe.
The larger firms are responding to the changing marketplace with products -- particularly in the alternative-assets area -- where fees are much higher. Axa Group, Credit Suisse Group, Deutsche Asset Management, Merrill Lynch Investment Managers and UBS have all launched private equity or hedge funds in the past year or so. "If you go back five years ago, only about 5 percent of new money going to asset managers in the U.S. was earmarked for hedge funds and the like," says Phillip Colebatch, chief executive of Credit Suisse Asset Management. "Today 15 percent of new money going to U.S. asset managers is going to alternative investments. In Europe, where much less than 5 percent goes to alternative investments, we expect to see the same evolution over the next three to five years." One by-product of more-esoteric funds is the fees. Many of these funds can charge 20 percent in performance-based fees, potentially much more lucrative than the 1 percent or less in flat fees charged for stock and bond funds.
Although operating in a different marketplace, Barclays Global Investors, which has quadrupled its assets in the past five years in part because of its powerful position in index funds, is no less concerned about the ability of new competitors to cut into already low fees, says chief executive Lindsey Tomlinson. In addition to moving into higher-fee products, BGI has focused on items it can offer without absorbing huge maintenance costs. In the retail market, for example, the creation of "exchange traded" portfolios allows the firm to avoid the labor-intensive maintenance of a share registry, since the funds are bought and sold on stock exchanges.
Going beyond product, some are also attempting to leverage their substantial equity research departments to get into new areas. UBS is trying to extend its traditional equity expertise at Brinson and Phillips & Drew to credit analysis so it can expand in the growing market for euro-denominated corporate and high-yield bonds. Axa Group has already had a huge success with Concerto 1, the company's first European high-yield bond fund. Targeted at only E350 million, the fund, which was opened and closed to investors in September, raised E450 million.
Joint ventures are another means of fending off competition and generating fees. "We are also looking to partner with local managers who don't have the expertise or manpower to construct a global portfolio," says UBS's Wuffli. One recent example is a partnership with Mitsubishi Corp. of Japan. UBS is setting up global real estate investment trusts that Mitsubishi will sell to institutional clients in Japan.
Within the past year UBS has reconfigured its research teams at Phillips & Drew and Brinson along sectoral rather than geographic lines and is embarking on a major campaign to enlist multinational clients that have pension assets around the world. Smaller competitors simply can't offer that kind of comprehensive coverage. The global corporations and their employees can choose from a full stable of global and domestic stock and bond portfolios, as well as from the rapidly expanding menu of alternative-investment items like hedge funds, private equity and leveraged real estate portfolios. "We can provide them with pension products and integrated reporting throughout the world as well as core global portfolios supplemented by specialist funds that cut across asset classes and countries," says Wuffli.
Others don't share Wuffli's enthusiasm about the industry's ability to sell a truly universal investment product. "Just trying to create a pan-European equity or fixed-income product is a nightmare, let alone trying to create a global one," says BGI's Tomlinson. "You've got more than a dozen different tax and regulatory systems in the European Union. Clients want global and pan-European expertise, but the products must be sold and taxed differently in every country." He doesn't see that situation changing anytime soon.
In the meantime, the world's stock markets continue to sag, which means the clock is ticking for all the competitors. In an increasingly crowded field, "most money managers have been bailed out by rising equity markets," says Deutsche Asset Management's Goulding. That may not be the case a year from now.