RETHINKING DISTRIBUTION

Rethinking Distribution Creating competitive advantage in a new fund distribution paradigm

J une 2011

Rethinkin g Distributi on

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Message from the authors

PwC Luxembourg

CACEIS Investor Services

For the third consecutive year we are proud to partner with CACEIS to examine the future of our industry within the context of the major trends which are currently asserting themselves. When our industry faces such a maelstrom of change, it is not enough to simply react. We must take the time to actively consider what our future may hold in store. We must exercise our imagination and combine it with our knowledge of the industry as it stands to make informed assumptions that will allow us to more effectively weigh the value of our longer term objectives. It is not an easy task. With such an array of forces affecting our industry – an industry which is itself complex and sophisticated – it would be tempting to adopt a ‘wait and see’approach. In this report we have tried to resist this temptation. Although nobody can predict the future of fund distribution, we do have broad trends that can guide us. Utilising these trends, we have defined a number of potential scenarios for the next five to ten years. Some will materialise, some will not. The value of each scenario lies in the critique that we can individually bring to it after considering the factors involved and weighing the arguments objectively. This will certainly help the reader to navigate through uncertain times. We trust you will find this report useful, informative and most of all, thought provoking. We hope that you will contribute to the debate at www.rethinkingdistribution.com and we look forward to discussing your views in the future.

With today’s increasingly globalised economy and the emergence of new economic and political powers, the long-term ramifications of any global crisis can only be more pronounced. However, despite the coordinated intervention of global institutions, which seem to be steering the financial industry on a more stable course, the true and enduring consequences of the crisis remain less than clear. CACEIS, in association with our long-term research partner, PwC Luxembourg, have undertaken to analyse the growing field of international fund distribution, identifying the drivers of change and speculating on the possible outcomes in this post-crisis environment. We sought to focus research efforts on a limited number of the most common scenarios faced by industry players. And for each scenario, we have determined the most probable direction of distribution developments and the best course of action to achieve a successful commercial venture. As a leading service provider in the global fund distribution arena, CACEIS cannot limit itself to simply performing an analysis of current market trends. We strongly believe that we have a responsibility to our clients, be they fund distributors, institutional investors or asset managers, to understand andmake preparations for the future environment in which they will do business. It is through these attempts to gain a deeper understanding of the intricacies of the markets in which our clients operate that we are able to remain a frontrunner, offering innovative services in an increasingly complex fund distribution environment.

We trust you will find this publication both enlightening and compelling.

Marc Saluzzi PwC Luxembourg, Financial Services Leader

François Marion CACEIS, Chief Executive Officer

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About this report

This report presents the findings of our research and analysis over the past six months, including in-depth interviews with several senior executives at asset management companies, banks and professional associations whom I would like to thank for their time commitment and in-depth insights of the industry. CACEIS and PwC Luxembourg jointly developed the hypotheses and analysis for this research and I would like to acknowledge all our colleagues and experts from CACEIS and PwC namely Arianna Arzeni, Xavier Balthazar, Olivier Carré, Mark Evans, Thierry Flamand, François Génaux, Claude Michaux, John Parkhouse, Christophe Pittie and Didier Prime for their contributions and support during this project. I would also like to thank GregoryWeber and Xavier Domalainwho provided essential research to this project.

Our goal is to provide leaders within the asset management industry with thoughtful insights and create a basis for discussion on the future of the industry. This research is independent and has not been sponsored or commissioned by any firm or institution.

Dariush Yazdani PwC Luxembourg, Director of Financial Services Research Unit

www.rethinkingdistrib

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Table of contents

Message from the authors

3

About this report

4

Executive Summary

6

Introduction

10

Key drivers of change • Increase in regulation

14

16

• Increased exposure to emerging markets • Change in investor trust and loyalty patterns

18

20

• Focus on pension and retirement products and solutions

22

• Increased separation of alpha and beta and competition from other financial products

24

• Increasing use of technology to reach investors

26

tion.com

Scenario Planning • Distribution Models

30

31

• Global Fund Distribution

35

• Pension and Insurance Markets

38

• Substitute Products

42

• e-Investors

46

Conclusion

52

Executive Summary

The key drivers of change we have observed in the past few years are far frombeing a temporary phenomenon.These trends are set to cause a significant shift within the asset management industry. Each of these trends and their effects are distinctive in nature but the implications for asset managers are to a certain extent similar. Our research anticipates the following developments with the industry in the future:

Agreement” allowing the distribution of European funds in selected emerging markets and vice versa. At minimum an inclusive process should be considered, where the views, needs and concerns of emerging market regulators find due consideration in developing new European fund regulations.

The risk of pension savings will not be fully transferred to the individual

SEGREGATION BETWEEN PURE DISTRIBUTION AND PURE ADVICE

European governments, particularly, will impose minimum return requirements on pension savings products. Asset managers will face challenges in endorsing these risks, or part of them, and therefore to provide such products independently. They will be forced to partner with insurance companies and other providers to bank on this opportunity.

We believe increased regulation at the point of sale and investor scrutiny will lead to a segregation between pure advice and pure distribution. The asset management industry, especially in Anglo-Saxon countries, will move towards a new paradigm where, after receiving advice, the investor will execute an order via a trading platform or an intermediary. However, this evolutionmay be slow in Continental Europewhere distributors, as they keep their current commission charging structures, may be encouraged to further integrate in-house product manufacturing to better control costs and risks of distributing funds to a still captive clientele.

more than a Regulatory level playing field is needed to compete against substitute products

The regulatory level playing field which is set to partially materialise in the near future through PRIPs (Packeged Retail Investment Products) will not result in a significant increase of competitiveness of the asset management industry. The other ingredients required from the asset management industry are better time to market, an improved product fit in terms of investor needs (such as capital protection and outcome orientation) as well as increasing the attractiveness of mutual funds for banking and insurance distributors.

Reciprocity between Europe and SELECTED Emerging Markets key to long term growth

To avoid marginalisation and loss of opportunity in playing a significant role in emerging markets, the European asset management industry should push for a “Reciprocity

6

Faceattritionor increase interaction, information and transparency

• Put yourselves in each other’s shoes Asset managers should draw on their relationships with distributors, advisers and investors to develop new products, and move towards solution-based products. To deliver the required products, they may need to teamup with other financial solution providers. • Enhance value through quality The most successful distribution strategy cannot be successful if the product fails to deliver investors the expected performance, the value-for-money (the maximum client benefit in the most cost-effective manner) and the safety of a highly regulated vehicle. All in all, investors want a new experience from the asset management industry. The ability of the latter to deliver this new experience, or not, will dictate how succesful the industry will remain going forward.

With increasing use of social media and connectivity, investors will be better informed and will challenge their advisers. Advisers will need to ensure that their personal expertise and sophistication remains high in order to be able to respond to informed investors and engage in a fruitful dialogue. Asset managers and distributors will need to provide tools allowing investors to inform, compare and invest through internet and mobile solutions. Failure to do so would result in customers switching to the competition. To create a competitive advantage in such a new fund distribution paradigm, our research concludes that the key implications for asset managers are: • Invest in relationships Asset managers should invest in close relationships with distributors, investors andemergingmarket players toposition themselves as a privileged interlocutor and solution-provider. • Share and collaborate Assetmanagement firms shouldbeable to listen toandcapture client feedback, using social media for instance, to deliver successful products and services in a timely manner. They should also provide more information, educational materials and training to both investors and advisers to improve their financial capability.

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8

Introduction

Rethinking Distribution

9

The asset management (AM) industry inWestern countries has seen tremendous growth over the past thirty years driven by strong local and regional economic developments, expansion in emergingmarkets and the sometimes artificial appreciation of underlying assets. However, global trends point towards a shift in this status quo in the future. The majority of these global trends, including the shift of economic power to emergingmarkets, the ageing of industrial countries, higher regulation, new technology and social media, are well recognised. However, their impact is not always clear. What do these trends mean for European asset managers and how do they need to adapt their distribution models to be successful in an ever more competitive landscape? To enable decision makers to reflect on how best to create competitive advantages in distribution, as well as developing a framework for discussion, we have set out a series of potential scenarios and their plausible implications. Our analysis is based on six key drivers of change which have the potential to change the asset management industry: Introduction

1

Increase in regulation

2

Increased exposure to emerging markets

3

Change in investor trust and loyalty patterns

4

Focus on pension and retirement products and solutions

5

Increased separation of alpha and beta and competition from other financial products

6

Increasing use of technology to reach investors

10

We identified twenty different scenarios by combining these key drivers. Based on in-depth interviews with a number of industry players (asset managers and distributors) we then assessed the most likely scenarios that couldmaterialise in the coming five to ten years and their implications on distributionmodels within the asset management industry. During our consultations with industry players there was unanimous agreement on almost all key drivers of change (with the exception of technology) with slight differences on the most likely scenarios and speed of impact on the industry. This report concentrates on the longer term changes affecting European asset managers distributing UCITS and Non-UCITS mutual funds within and outside Europe to institutional and retail investors. A number of drivers are already at work, ranging from tighter regulation within the AM industry to the rise of emerging markets. Some asset managers have already positioned themselves to profit from these shifts. Understanding the drivers of change and defining a clear strategic positioning and response will be key to success. A failure to do so could lead to a loss of positioning andmarket share over the long run.

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12

Key Drivers of Change

Rethinking Distribution

13

Key Drivers of Change

Six key drivers of change will impact the future fund distribution paradigm:

• Increase in regulation • Increased exposure to emerging markets • Change in investor trust and loyalty patterns

• Focus on pension and retirement products and solutions • Increased separation of alpha and beta and competition from other financial products • Increasing use of technology to reach investors

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Figure 1

Multiple drivers of change are at work in the Asset Manangement (AM) industry

Increased separation of alpha and beta and competition from other financial products • Rise of outcome-oriented products* • ETF growth • Increased competition from substitute products

Focus on pension and retirement products and solutions • Ageing population in major markets • Increased pension liabilities & public expenditure • Limits of pay-as-you-go systems

Increased exposure to emerging markets

Change in investor trust & loyalty patterns • Trust deficit • Demand for higher transparency • Diminishing client loyalty • Less captive clientele

AM industry

• Shift in economic power • Performance of emerging market funds • Growing middle-class in emerging markets • Success of UCITS in emerging markets

Increasing use of technology to reach investors • The emergence of mobile technology • Growing impact of social media • Targeting a new generation of customers

Increase in regulation

• Stricter and more uniform regulation • Increased regulatory cost and burden • Increased focus at the point of sale with diverging rules at national level • Increased protectionism

* Outcome-oriented products include liability-driven investments, capital-protected, absolute return and income-oriented products

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1

Increase in regulation The increase in regulation will hit all financial services sectors. Within the AM industry, as former CESR Chairman Eddy Wymeersch stated, “like it or not, there is a real avalanche of regulation coming”. According to EFAMA there are over 25 European and US regulatory initiatives that the European fund market is being forced to deal with, including UCITS IV, AIFMD, MiFID II, Basel III, Solvency II, Dodd Frank and Fatca [1] . Regulation is therefore clearly one of themain challenges facing the industry (see figure 2). In the past, regulators weremore strongly focused on products which, while increasing costs for asset managers, also enhanced the development and growth of the industry. As an example, the UCITS Directive is often cited as one of the most successful EU initiatives and has been such a success that the UCITS brand is now recognised as the leading globally distributed investment product. With the recent financial crisis and increased political pressures, regulators have become more focused on investor protection at the point of sale. This may result in both higher costs for asset managers and distributors, as well as distortions within the financial services industry such as product arbitrage by distributors.

Stricter and more uniform regulation

Fund regulation will become much stricter and more uniform with the arrival of ESMA (European Securities and Markets Authority). While supervision will remain with national regulators, ESMA will be able to issue “regulatory technical standards”which will be legally binding and become national law across all EUMember States. This will contribute to further harmonisation of national regulations and help create a higher level playing field. UCITS IV and other directives are set to provide more stringent rules within the industry but also provide new opportunities for cross-border distributors and asset managers.

Figure 2

What is the biggest challenge you anticipate facing in 2011?

N/A; 3%

Market Volatility; 17%

Investor/Client Confidence; 37%

Regulations; 43%

Source : Linedata, Looking forward: State of the AM industry Survey 2011

[1] Ignites, Regulation avalanche a worry for Europe, 16 March 2011

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Increased regulatory costs and burden

greater ownership of asset growth. In Asia for instance, support is eroding for UCITS funds with the recent regulatory changes in Hong Kong, such as the requirement of investor characterisation before the sale of any product containing derivatives.

As an example of regulatory burden and costs, the European Commission estimated the implementation cost of UCITS IV at around EUR 1bn [2] . Regarding the impact of the AIFM Directive across Europe, Charles River Associates prepared a report for the FSA in which a one-off compliance cost of up to EUR 3.2bn with ongoing compliance costs of around EUR 311m were expected [3] . Since the introduction of MiFID in 2007, regulation has put more emphasis on distribution and on conflicts of interest. In the UK, the RDR (Retail Distribution Review) will fundamentally change the way the market for retail investments is structured and operates. One of the key objectives of RDR is to address the potential for adviser remuneration to distort customer outcomes. Other regulations like Basel III and Solvency II may also indirectly impact the distribution of investment products. Due to capital and liquidity requirements, large investors and distributors like banks and insurance companies could potentially reduce their exposure to certain higher-risk asset classes. Instead, they may favour the offering of “on-balance sheet” savings products to their clients. Increased focus at the point of sale Emerging markets may offer significant opportunities for European funds if they decide to adopt the UCITS brand to channel their savings into well-regulated vehicles. As UCITS funds have already been enjoying a growing success in Asia, Latin America and in the Middle-East for the last five to ten years, local and/or regional initiatives may emerge to take [2] Commission Staff Working Document, Impact Assessment related to implementation measures of UCITS IV, April 2010 [3] Charles River Associates, Impact of the proposed AIFM Directive across Europe, October 2009 Increased protectionism

Looking forward: can regulation disrupt the existing distribution model?

Increased regulation will have implications for both the asset managers and distributors. Indeed, it may further strengthen the power of the distributor, but it may also level the playing field among the investment products sold via the same distribution channels. Outside the EU, there are risks that higher barriers to entering emerging markets may prevent European players from tapping into this new source of growth. The question should be how the AM industry will be able to mitigate those risks.

Figure 3

Times are changing

Banking

Bank capital rules

Depositaries

Liquidity requirements

MiFID II

Consumer protection

AIFMD

PRIPs

IMD II

UCITSV

Corporate governance& executive remuneration

UCITS IV

Insurance

Solvency II

Asset Management

17

Figure 4

Net sales of European domiciled funds (EUR bn)

2

Increased exposure to emerging markets As GDP growth in emerging markets is expected to increase more rapidly than in OECD countries over the next decade, there will be a continued and inexorable shift of economic power fromOECD countries to SAAAME (South America, Africa, Asia, and Middle East). This will significantly impact the AM industry, both in terms of investment decisions and distribution strategies. PwC’s latest analysis anticipates that the GDP of the largest E7 emerging economies will overtake the current G7 economies by 2020, and Chinamay already have surpassed the US by the end of the decade [4] . Currently, China has a population of 1.3 billion and one of the highest savings rates in the world (53.6% in 2009). It will also have 12 million Chinese millionaire households by 2020 and its number of middle class urban households will have trebled [5] .

300

190.4

200

170.7

100.7

91.6

100

57.1

30.2

N.A.

0

2007

20 08

2009

2010

-100

-200

Investing in emerging markets Total

-300

-305

-400

N.A. No data available for net sales of emerging market funds in 2008

Source : Lipper datadigest

attractive fund distribution destinations

Asia is the second-largest market for UCITS products after Europe, accounting for 40% of net sales over the past three years [6] .While the penetration of European fundmanagers in the largest emergingmarkets remains low, significant opportunities may arise in the future. Asia accounts for 60%of the total world population but holds only 13% of AuM (see figure 5).

attractive investments

Driven by a low interest rate environment in Europe and a limited growth potential, investors appetite for emerging market products has grown. As an illustration of this, the net sales of emerging market funds increased by 76% in 2010 to reachmore than EUR 100bn, i.e. 59%of total net sales in Europe (see figure 4).

Figure 5

Amount of AuM compared to population (% of the world total)

70%

Population AuM

60%

60%

52%

50%

[4] PwC,TheWorld in2050-Theacceleratingshiftofglobaleconomicpower:challengesandopportunities [5] McKinsey Global Institute [6] PwC and FSC (Financial Services Council), Asia Region Fund Passport, The Future of the funds management industry in Asia, November 2010

40%

35%

30%

20%

13%

13%

10%

7%

0%

Asia

EU

Americas

Source : PwC

18

“Europe has created a global standard in Financial Services and has the opportunity to leverageon it especially after the financial crisis. Five years ago, when our global Asset Management teamwas meeting Asian regulators, a majority of the questions were posed to our US partners, now they are asked to our European team.”

Looking forward: Howwill EU domiciled funds be able to maintain their dominance in Global Fund Distribution? UCITS funds have already managed to successfully enter international markets but theymay face increased competition from emerging markets in the future. Therefore, the following questions may be raised: • It is natural to assume that, sooner or later, the domestic asset management industry of the emerging economies will either want to expand their operations or control their level of access to foreign investors, including those in the EU. However, can we really expect that European asset managers will have to compete with emergingmarket players in both emerging markets and in Europe? • Given the global desire for increased exposure to growth in emerging markets, can emerging market players develop a global rival to the UCITS brand, and if so, what is a realistic timeline for this to occur within, if at all? • As seen throughout economic history, emerging economies rely on protectionism to develop and strengthen their domestic industries before allowing foreign entrants. What options does the EU have to mitigate this risk? How should European funds maintain and develop their penetration in emerging markets?

Marc Saluzzi – PwC Luxembourg, Financial Services Leader

The success of the UCITS brand

Since its creation in December 1985, UCITS have managed to build an international brand recognition. According to PwC’s GFD Poster, as at end 2010, 13% of cross border registrations occur outside Europe, with 77% of these registrations being from Luxembourg domiciled funds. Market data suggest that between two-thirds and three-quarters of all existing offshore funds distributed in Asia are structured as UCITS and that 90% of all new offshore funds sold in the region are UCITS. Asian investors could account for 20% of total UCITS assets [7] .

[7] According to Terry Pan, Managing Director and Head of Hong Kong Business at JPMorgan Asset Management , in Global Investor Magazine, December 2010

19

3

Change in investor trust and loyalty patterns While investors are puttingmoney back into investment funds, the recent financial crisis has damaged distributor and adviser reputation. The loss of investors’ trust and loyalty stems from various factors. These include lack of transparency, performance and cost. Lack of transparency (e.g. risk disclosures) has been one of themajor causes now being addressed by the regulator, however the industry will need to work on consistent low performance and high costs for investors in order to regain their trust. In the post-Madoff environment, investors are still concerned about trustworthiness, which remains the most important factor in choosing an adviser. A PwC/UCL survey of retail investors in 2009 showed that only 20% of investors were satisfied with their financial advisers (see figure 6). Distributors and advisers are now spending more time with clients explaining their investment choices and showing them information about the funds. As distributors and advisers strive not to push products, some investors still perceive them as not much different from salesmen. However, a trust deficit does not necessarily lead to investors switching their providers, as shown by Eurobarometer [8] : “While only 13% of EU consumers switched their providers for savings and investment products, only 35% of the ones who did not switch believed their current bank was providing good value for money”.

Prime relationships

Today, fund distributors and advisers have a significant negotiation power towards fund managers. This is evidenced by the fact that fundmanagers have to give between 40% and 60%of their management fees to distributors and advisers due to their prime relationships with an often captive clientele. With increasing pressure from regulators and investors for transparency, especially on costs and conflicts of interest, the future of prime relationships will depend on how loyal investors will remain towards their distributor and adviser.

Figure 6

Trust deficit of financial advisers. Are you satisfied with your financial adviser(s)?

Strongly agree; 9%

Strongly disagree; 10%

Disagree; 14%

Neutral; 47%

Agree; 20%

[8] European Commission, Eurobarometer, Consumers’views on switching service providers, Analytical Report, January 2009

Source : PwC/UCL Retail Investor survey 2009

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Figure 7

Role of the intermediaries towards end-investors

Investment fund asset ownership (share in percent)

Fund distribution is mostly a B2B business for fund managers and there is a continuous trend in the fund industry towards further intermediation. The share of households ownership in investment fund assets has been decreasing over the last years while insurers, pension funds and other financial intermediaries have been continuously increasing their fund asset ownership on behalf of end-investors (see figure 7).With a potential shake- up of investor trust and loyalty, and regulatory changes, the distributionmodels may becomemore complex. This could lead to a clear distinction between the roles of pure distributors (e.g. Stock Exchanges) and pure advisers. On top of these two roles, we anticipate the emergence of new types of intermediaries which will help investors to make more informed investment decisions (e.g. social media). 22.5 2.5 24.7 2.8 25.4 2.9 26.4 3.2 28.6 3.4 32.0 3.4

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

22.5 2.5

24.7 2.8

General government Insurers & pension fun Other nancial interme MFIs Non- nancial corporati Households

25.4 2.9

3.2

3.4

3.4

26.4

28.6

32.0

11.6

13.4

15.6

17.0

15.6

9.8

15.8

9.1

9.6 9.5

9.2 8.7

10.8

9.0 8.8

7.8 8.6

10.1

42.8

39.9

37.0

35.5

34.6

32.4

2004

2005

2006

2007

2008

2009

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

General government Insurers & pension funds Other nancial intermediaries MFIs Non- nancial corporations Households

11.6

13.4

15.6

17.0

15.6

9.8

15.8

Looking forward: howwill the relations between fund managers and distributors/ advisers evolve? 9.1 10.8 10.1 9.6 9.5 9.2 8.7 9.0 8.8

7.8 8.6

42.8

39.9

37.0

35.5

34.6

32.4

With increasing investor and regulatory scrutiny on the distribution of investment funds, the question is how much the model of large distributors, generally vertically integrated groups in Continental Europe, will change. In Anglo-Saxon countries, with investors welcoming the end of product influence, how will advisers position themselves towards traditional distributors? 2004 2005 2006 2007 2008 2009

Source : EFAMA Factbook 2010

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4

Focus on pension and retirement products and solutions According to the United Nations figures [9] , the proportion of the world’s population aged over 65 is set tomore than double by 2050, to 16.2% from7.6% currently. By 2050, approximately 1 billion people will be over 65 years. More specifically in Europe, 50% of the population will be more than 55 years old by 2050 (see figure 8). Given that a largemajority of assets under management is held by the eldest part of the population, the fund industry bears significant risks of asset outflows due to decumulation (the conversion of assets accumulated during an employee’s working life into pension income at retirement age). On the other hand, as governments are increasingly moving away frompay-as-you-go systems and as decumulation also embodies a significant new risk (longevity risk) for the record number of future retirees, significant opportunities for fund managers may arise provided that they are able to offer adequate long-term pension and retirement solutions.

In the current context, the cost of caring for retired people will profoundly affect growth prospects and will increase the level of debts. Even a consolidation of 1% of GDP per year over 20 years may not fully bring back debt to the 60%GDP reference [11] .

Figure 8

Western Europe Population (millions)

350

300

123 38%

167 50%

250

Age 22-55 Age > 55

200

150

199 62%

166 50%

100

50

0

2010

2050

Increased public pension expenditure

Source :World Bank

By 2050, for every retiree in the EU, there will be only two workers, which represents a major deterioration from the current ratio of 1:4. The ageing of the population will also affect emergingmarkets like China which will have five workers for every retiree by 2020, compared to a ratio of 1:10 in 1990. As a consequence, public pension expenditure will grow to represent on average 12.4% of the GDP in 2050 in Europe (vs. 10.3% today [10] ) and up to 16% in Spain (see figure 9).

[9] United Nations,World Population Prospects, the 2010 revision [10] The 2009 Ageing report (European Commission, 2008) [11] European Commission – Sustainability report 2009

22

The move from pay-as-you-go systems will leave future pensioners to deal with critical investment decisions

so. Will the risks fall to the retirees, who must ensure that they set aside sufficient savings to draw down in the future, and if they fail to do so, end up suffering the consequences i.e. old age poverty? Or will the investment industry be bound to carry the risk, whereby if assets under management fail to produce the required returns needed for the steadily larger outflows of retiree income, the losses must be covered by the product manufacturer? In this case, what would be the impact on the competitiveness of the asset management industry, considering that today, the fund industry is not fully equipped to offer pension and retirement solutions?

The greying of Europe, coupled with the increased longevity of the population, will pose a problem to pay-as-you-go pension schemes. European governments are reacting to this issue by shifting the responsibility of retirement planning to the working-age individuals. This, however, creates a new challenge for individuals who now have tomake investment decisions for their own long-termfinancial well-being. These decisions need to take into account the savings required to meet the longer period of retirement due to the increase in life expectancy (longevity risk), as well as considering the risk of investment and inflation. The asset management industry has a critical role in supporting individuals by delivering products suited to their retirement needs. Products must be designed, not only to save for retirement, but also to allow steady income flow after the accumulation phase to safeguard the investor against insufficient cash flows in old age. Looking forward: how do AM distribution strategies need to adapt to tackle the risks and opportunities arising from the ageing population? As governments withdraw frompay-as-you-go systems, it raises the obvious question as to who will accept the future risks of providing for retiree income when the state will no longer do The challenge of the AM industry to propose pension and retirement solutions

Figure 9

Increase in public pension expenditure by 2050 (% expected GDP)

Current level (GDP pp) Additional expense (GDP pp)

20%

0.7%

15%

1.2%

2.3%

2.1%

1.5%

7.1%

3.6%

2.4%

2.6%

10%

8.2%

1.5%

4.0%

14.0%

13.0%

11.0%

10.9%

10.4%

10.3%

5%

6.8%

7.8%

8.4%

6.8%

6.5%

6.6%

4.0%

0%

PL 2.5%

ES

RO

IT

FR

HU

DE

LT

CZ

SK

UK

IE

Total

-5%

Source : European Commission

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5

Increased separation of alpha and beta and competition from other financial products The increased specialisation of investment funds, to better match investor’s constraints, and the competition from substitute products are two major drivers likely to reshape the investment fund industry in the coming years. On the one hand, the increased specialisation of investment funds has been driven by the growing need of investors to diversify their portfolio to comply with specific risk/returns constraints leading to further sophistication (such as LDI, etc.) of the industry. On the other hand, the competition from other financial products is caused by the development of savings products which can be packaged with the same content into different wrappers and be sold to the same investor, via the same distribution channels. As from 2006, the share of structured products and ETP relative to the European fund industry has steadily grown from 9% in 2006 to 13% in 2009 after a peak of 17% in 2008 (see figure10).

provide cheap beta, which results in pressure on fees of active managers not able to create alpha, or be able to provide alpha to demand a premium. However, core-satellite allocation strategies are bridging active and passive exposure to propose investment solutions to institutional investors. The strength of the core- satellite allocation is to provide institutional investors with an adequate level of transparency for performance attribution with the clear isolation between the alpha and the beta.

Figure 10

Evolution of mutual funds in Europe vs. substitute products (EUR bn)

The separation of alpha and beta

UCITS Assets Structured Products & ETP

7000

Over the past years, the AM industry has gradually split between products offering pure exposure to beta, like index funds or exchange-traded funds (ETFs), and products delivering alpha (see figure 11). This trend is leading asset managers to either

6159

5990

5956

6000

5315

5000

4543

4000

3000

2000

801

782

1000

764

704

558

0

2006

2007

2008

2009

2010

Source : PwC Analysis

24

Increased competition from SUBSTITUTE products

mutual funds which are pre-dominantly open ended and offer a regular revenue stream for asset managers and distributors over the holding period by the customer. Looking forward: Towhat extentwouldthe asset management industry be able to compete with substitute products? Investment funds protect investors through strict investment and diversification rules, efficient supervision of both the fund and themanagement company, the separation of management company and safekeeping of the assets. The European Commission aims to create a robust and coherent framework for PRIPs which will provide for consistent and effective investor protection and a level-playing field for distributors and originators. However, it is still uncertain how investment funds will be able to gainmarket share by competing in terms of product efficiency (e.g. capital protection, cost and tax efficiency…).

Financial innovation and the broader range of financial products is constantly giving investors alternative means to achieve their financial goals. In the past, money market funds substituted for bank deposits and equity funds substituted for direct holdings of equities. More recently structured products, notes and certificates intended for different investors have become close substitutes for investment funds. The threat for the fund industry is all the more important when the cost to switch to structured products and the perceived level of product differentiation are both very low. In addition, current regulation is creating distortions allowing for product and distribution channel arbitrage. Whilemost of the substitute savings products cannot deliver the same level of investor protection, as shown during the recent financial crisis, substitute products have proved tobe efficient from an investor point of view. Substitute products allow for a broad range of asset classes and investment strategies and can as well be developed and brought to themarket faster to satisfy newmarket developments and new trends. Substitute products developed by the insurance industry are often marketed with a focus on “tax optimisation”(e.g. investment life-insurance contracts). Substitute products not only provide investors with fast and targeted solutions but can also prove advantageous to distributors and issuers. With regulators demanding higher capital requirements, banking and insurance distributors are shifting their product focus tominimise the need for additional capital. In doing so, they might prefer to sell cash deposits (vs. money market funds). This could be a more difficult arbitrage going forward. Moreover, structured products are attractive to issuers and distributors who look for both quick revenue streams and churn in customer portfolio. Such products have high upfront fees and set maturities in contrast to

Figure 11

Comparative growth of funds, by investment strategies

2009 (% net sales/AuM)

2010 (% net sales/AuM)

Traditional strategies

Bond

+7.9%

+9.6%

+6.7%

+4.0%

Equity

+7.3%

+11.7%

Mixed

-3.8%

-10.2%

MM

Absolute returns ETFs

Alpha strategies

+11.9%

+19.4%

+20.2%

+15.3%

Beta strategies

Source : PwC Analysis based on Lipper FMI figures

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6

Increasing use of technology to reach investors

Growing impact of social media

The development of mobile technology and the emergence of social media offers individual investors innovative ways to access and scrutinise the investment fund industry. It also represents a new challenge for fund promoters who are now required to evolve their marketing strategy to be visible on these new communication channels.

Social networking has become a major trend for both personal and professional purposes. Social networks allowpeople to share information, opinions and even recommendations on all types of topics.While the phenomenon is already widespread inmany countries (see figure 13), is there really a strong impact on the fund management industry to be expected from social media?

The emergence of mobile technology

The greater use of mobile technology has spurred the development of applications tailored to the asset management business. As shown in figure 12, the number of active users of mobile banking and related services is expected tomultiply by 16 by 2015 (close to one billion people). Distributors on the front line have started providing their clients and prospects with real time accessible applications to track their fund performances and to carry out subscription and redemption operations. For instance, in the UK, one of the biggest fund distributors is already proposing an application on iPhone allowing their clients to get information regarding fund price, performance and management fee on a range of more than 1,000 funds. Clients also have the opportunity to invest through the fund platform.

Figure 12

Number of active users of mobile banking and related services, forecast (in millions)

1000

894

750

500

250

55

0

2009

2015

Source : fst

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“ We are told that RDR is the next big thing we need to be thinking about, but I think it pales in significance compared to the impact social media will have on our industry.”

• Will newmedia and newgenerations of investors and advisers behave in the same way as previously or will they adopt new behaviour? • Canwe expect tomorrow’s consumers of financial products to place as much trust in personal relationships and one-to-one advice as before, or will they become more remote and data guided in their investment decisions? • Will a pervasive internet coupled with the explosion of social media and new norms of communication have a significant effect on the client and adviser relationship? • Will the new applications and channels afford real competitive advantage to savvy firms, or can we expect to see limited innovation in terms of client relationship management?

Phil Calvert, IFA Life - The Social Network of IFAs and Financial Planners

Targeting a new generation of customers

Investors still favour their distributors and advisers to access investment products, although they are likely to use many channels to access both advice and products. In the future these prime relationships could be challenged by the new generation of students and young professionals, who may be more financially literate.

Figure 13

Share of social networking users, % (2010)

46%

US UK SouthKorea France Spain Germany Turkey

43%

40% 40% 36%

Looking forward: IS the emergence of new technology likely to disrupt the current distribution channels?

34%

31%

26%

24%

Japan China India

The status of social media is steadily evolving from a leisure activity to a strategic marketing tool for the industry. What will the future role of social media be within financial services?

23%

12%

0%

10%

20%

30%

40%

50%

Source : Pew, 2010

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Scenario Planning

Rethinking Distribution

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Scenario Planning

Based on the combination of key drivers of change we identified twenty different scenarios (four scenarios for each reasonable combination of two key drivers) around the following themes:

• Distribution Models • Global Fund Distribution • Pension and Insurance Markets • Substitute Products • e-Investors

We then assessed the most likely scenarios that could materialise in the coming five to ten years and their implications on distribution within the AM industry.

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1

Scenario Planning Distribution Models

Figure 14

Continental European model While investors remain sticky to their distributor, regulatory pressure at the point of sale and at national levels will result in higher liability for distributors who may favour selling their own products to better control increased costs and risks. This would lead to players increasingly concentrating asset management, distribution and advice activities within their own group rather than sourcing these from various players.

Anglo-Saxon model

With higher regulation at the point of sale and less captive clientele, distribution will become more complex with a segregation of advice, distribution and asset management. There will also be a growing number of gatekeepers between AM and distributors (wrap platform, distributors’fund selection unit…)

Regulation at the point of sale High Low

Increased competition

Business as usual

Current distribution models will prevail given that regulation at the point of sale will not increase and distributors will still benefit from a captive clientele.

Although there will be no increase in regulation at the point of sale, lower captive clientele will lead to investors increasingly evaluating and comparing products and advice offers to meet their needs. This will result in a higher competition between distributors, as well as AMs, to gain market share.

Captive clientele

Low

High

Regulation and changes in customer behaviour have the potential to disrupt current distributionmodels. While a trend towards open-architecture and the separation of manufacturing and distribution was announced several years ago, there are still different degrees of openness in Europe. Open-architecture means that the fund manufacturer and distributor belong to different groups but many large European banks are still debating the choice of selling their ownmanufactured products or those from third parties.

In fact, any move will depend highly upon a clear change in regulation at the point of sale and/or client captivity with their distributor or adviser. The axes for our scenario planning represent the degree of regulation at the point of sale versus the clientele captivity, where we attempt to chart the likely outcome of this fusion of established captive clientele and further liabilities on distributors (see figure 14).

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Where dowe stand?

vary. As long as clients remain captive to their distributors, the distribution models will not radically change. However, as investor scrutiny increases and financial education improves, investors will increasingly look for best of breed products and their respective providers. Looking forward, we believe that over the next five to ten years, the Anglo-Saxon and the Continental Europeanmodels may evolve differently and we anticipate an increasing gap between them. While in Continental Europe, investors will remain captive to their banks, consumers in the Anglo-Saxon countries will welcome the end of product influence and recognise the intrinsic value of advice. Increased regulation at the point of sale will further widen the gap between the two models. On the one hand, Anglo-Saxon regulators are trying to move the industry away from selling products towards true independent advice which will result in a clearer segregation of asset management, distribution and advice. Indeed one of the key plans of the FSA’s Retail Distribution Review in the UK for instance is the Adviser Charging regime. Under this regime, advisers will no longer be allowed to receive commission on the retail investment products they recommend. This model is likely to disrupt the way advisers operate as according to JP Morgan research [13] , while 60%of consumer approve Adviser Charging regime, only 8% of the population currently pay for or claim to be willing to pay for advice on their savings and investments.

The structure of the fund industry has changed relatively little over years. According to a speech of Mario Draghi [12] , the governor of the Bank of Italy, no less than 90% of Continental European retail management activity is carried out under the vertically integratedmodel compared with less than two thirds in the US and the UK. In Continental Europe, the major AM firms remain generally fully-owned subsidiaries of large banking and insurance groups but recent events may change this situation. During the latest financial crisis a few financial groups sold their AM arms to restore their capital strength, often because these subsidiaries are generally more autonomous and easier to sell than core banking activities like retail and investment banking units. In addition, small independent boutique-style asset management firms have recently managed to rank among the top European master groups in terms of net sales. While the integrated model still remains dominant, we believe that increasing regulatory scrutiny and/or weakening of the prime relationships between clients and distributors, have the potential to fundamentally impact the distribution marketplace.

What dowe expect in the long term?

With increased regulation at the point of sale, the asset management value chain will become more complex as pure advice will be segregated from pure distribution. This evolution will allow the AM industry to implement a clear difference between the buy- and sell-sides, and independent research and advice. However, the pace of evolution may

[12] Mario Draghi,Transformation in the European Financial Industry: Opportunities and Risks, Frankfurt, 22 November 2007 [13] J.P. Morgan Asset Management, Adviser Charging: putting a price on financial advice, May 2011

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