The 2002 Euro 100: Culture shock

European retail investors didn’t embrace equities until the middle of the past decade. Which is to say that they enjoyed just a few sweet years before all hell broke loose, leaving them frustrated, embittered and wary of getting burned again.

Click here to view the entire The Euro 100 results available in the Research and Rankings section of this site.

Unlike their American counterparts, who began loading up on stocks through mutual funds in the 1980s, European retail investors didn’t embrace equities until the middle of the past decade. Which is to say that they enjoyed just a few sweet years before all hell broke loose, leaving them frustrated, embittered and wary of getting burned again.

The toll is shocking. Despite a surge last month, the Dow Jones Euro Stoxx index is still down 50 percent from its 2000 high -- it fell 40 percent in the 12 months through October -- and with European bourses experiencing intense volatility, it’s no wonder that European mutual fund inflows have slowed to a trickle. The Deutsche Börse’s announcement in September that it would close the Neuer Markt, its venue for trading fledgling stocks, many from the technology sector, officially closed an era of easy money that began with high hopes and ended with crushed dreams and empty billfolds.

All of this portends increasingly sour times for a money management industry that has been wallowing in gloom for the past two years. Unless recent market gains can stick, the fallout is plain: slowing asset growth, lower revenues from management fees, shrinking profit margins.

“The confidence of the retail investor has been shaken,” says Donald Brydon, chairman of Axa Investment Managers, who worries that mom-and-pop investors won’t return to stocks for a long time. “These investors have lost a considerable amount of their savings. An important engine of growth for the European asset managers has stalled.”

Between 1996 and 2000, assets in European mutual funds almost doubled, to $3.7 trillion. By the end of August 2002, the total had fallen slightly, to $3.65 trillion. Demand for equity mutual funds has averaged E4.5 billion ($4.4 billion) a month for the past year, more than 97 percent below the October 2000 peak of E184 billion. The little money that is flowing into firms is heading toward bonds, where fees are far lower than on equities.

Nor is the damage limited to the retail business. Pension funds and other institutional accounts are also growing more cautious. British retailer Boots and, ironically, the London Stock Exchange have moved pension fund assets out of equities into bonds.

Further dimming prospects for the industry: Pension reform efforts have slowed throughout the Continent. For years industry executives saw the drive to shift retirement burdens away from governments and into the hands of workers as the next big pot of gold. But recently, analysts have cut their estimates of the size of the market. Oliver, Wyman & Co., the London-based management consulting firm, now expects pension reform to produce a total of just E384 billion in new inflows to managers between 2001 and 2006, a paltry sum compared with the E15 trillion in total assets managed in Europe.

Few money managers have escaped the sting. Overall, the Euro 100 firms saw their total assets rise 5.5 percent, to E16.1 trillion. (This total excludes the assets for J.P. Morgan Fleming Asset Management, Nextra Investment Management and Sal. Oppenheim Jr. & Cie., because these firms did not report comparable assets for year-end 2000). The top ten money managers, led once again by UBS, which has finished first for nine out of the past ten years, fared even better, with a 7.6 percent gain. But these numbers mask fundamental problems. Fully 52 companies in the top 100 showed declines in assets. The bulk of the increase in the top ten, which account for 49 percent of all assets, came from acquisitions, not organic growth: Allianz Group, for example, soared by E472 billion in assets to second place, from sixth, thanks to its purchase of Dresdner Bank and Nicholas-Applegate Capital Management.

Further down the ranks, State Street Global Advisors showed one of the strongest gains, from E129.1 billion to E193.8 billion, as the Boston-based firm added Gartmore Investment Management’s passive business, in addition to new business wins. State Street jumped from 32nd to 18th on our list. Schroder Investment Management, meanwhile, dipped from 16th to 20th as assets fell from E210.2 billion to E180.3 billion.

All of this adds up to some unattractive performance numbers for the industry. Anticipating slower growth from retail investors and no significant pickup in institutional demand, a September 2002 Oliver Wyman survey estimates that European money managers will see revenues increase 7 percent per year between 2001 and 2006, down from about 15 percent a year between 1995 and 2000.

“Firms that have built a business model dependent on rapid growth will have to rethink,” says Davide Taliente, managing director of Oliver Wyman.

By some measures, Oliver Wyman’s numbers seem rosy. PricewaterhouseCoopers’ 2002 money management survey estimates that individual firm revenues fell by 8 percent in 2001, the last full year for which it has numbers. And 2002, by any estimate, is a much tougher year for the industry.

Softening revenues demand belt-tightening and prefigure additional consolidation. In recent months Merrill Lynch Investment Managers and Citigroup Asset Management announced layoffs; Schroder Investment Management is cutting about 8 percent of its workforce. More firms are outsourcing their back-office operations. Last year Scottish Widows Investment Partnership closed an outsourcing deal with State Street. Merging funds is another popular tactic. For example, Frankfurt-based DWS recently merged nine small funds into five.

Such efforts notwithstanding, the industry has not done a very good job controlling costs. According to the PricewaterhouseCoopers survey, average industry costs grew 6 percent between 2001 and 2002. That’s pretty good compared with the average annual increase of 18 percent recorded between 1998 and 2000. Back then, however, revenues were soaring in keeping with bull-market-levitated assets. Letting costs grow while revenues are sinking by 8 percent doesn’t do much good. “It feels a little bit like the moment in cartoons when the character runs off the edge of a cliff but the legs keep going,” says Lindsay Tomlinson, chief executive officer of Barclays Global Investors (Europe).

Except this cartoon character won’t have a happy landing. PricewaterhouseCoopers calculates that the average operating margin for European money managers fell to 23 percent in 2001, from 28.1 percent in 2000 and 29.2 percent in 1999.

“Our view is that at least one third of the industry is not making profits,” says Pars Purewal, head of the U.K. investment management practice at PricewaterhouseCoopers. It’s clear to some analysts that more drastic measures need to be taken. Among them: a sharper look at compensation. “Paying someone £200,000 to turn up to work and lose clients’ money is not sensible,” notes Norman Riddell, who runs an eponymous investment bank and is the former CEO of Amvescap in Europe.

If top management can’t get the job done, it may be that new leadership is needed at some firms. Says BGI’s Tomlinson: “A lot of people in this industry who have had a pretty pleasant time over the last decade might decide that the outlook is rather more gloomy. Many will choose to hang up their boots before things get really bloody.”

One hopeful sign: many industry executives report strong institutional client interest in alternative assets that tend not to correlate with listed equities -- private equity, real estate, venture capital, hedge funds and funds-of-hedge-funds. Oliver Wyman predicts that alternative assets under management will grow from E175 billion to E676 billion in Europe between 2001 and 2006.

The alternative sector, moreover, generally carries the highest fees, which is why mainstream fund managers have been keen to buy alternatives expertise. In May, for example, Dublin-based Pioneer Investments paid E117 million for London-based Momentum Asset Management, with E1.6 billion in assets.

At Credit Suisse Asset Management, reports deputy chairman Robert Parker, developing alternative products is the No. 1 priority. CSAM already has roughly E6 billion in funds-of-hedge-funds, making it one of the largest players in Europe. “Our strategic push in 2003 and 2004 will be to diversify our product range and offer more in alternatives,” Parker says.

Increasingly, too, institutional investors across the Continent are demanding absolute return portfolio strategies that aim to protect their assets, however the market moves. As CSAM’s Parker says, “The days are gone when you could turn up at a meeting and say to a client, ‘The markets are down 10 percent, and we are down 8 percent; aren’t we clever?’”

Related