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In this article, we look at 4 broad trends: regulation, low yields, equity volatility and decreased country chauvinism and evaluate who the beneficiaries and losers may be.
There is seldom a perfect translation between what happens in the UK and Europe and what you can expect to happen in South Africa. But, South Africa does tend to follow, albeit quite loosely. A good example is the connection between the UK’s RDR and the SA FAIS rules which seem to be very similar. We should also note that South Africa, to a large extent, was protected from the credit crunch (by arbitrary reserve bank limits), which will likely cause the legislative backlash to be reduced relative to the developed markets.
What follows is a quick overview of some of the trends we see in asset management in the UK and Europe, with comments on how this same trend may impact investors in South Africa.
There seem to be four broad trends in the European and UK asset management industry:
- Steep spike in regulation as the regulators continue to respond to the credit crunch
- Low yields on fixed income securities and a rigged bond market.
- Equity volatility and investor caution
- Decreased country chauvinism
Lets address each individually and evaluate who the beneficiaries and losers may be. This, with an eye, on South African investors.
- Regulation: It is usually a guarantee that regulation will spike following a market crisis like that in 2007. Glass Steagall – the law that separated retail and investment banks – was repealed in 1999 and this is largely seen as the catalyst that drove us towards the financial cliff in 2007. Needless to say, we disagree with this, largely because the two major triggers of the financial crisis – the failures of Baire Sterns and Lehman Brothers – could equally have occurred if Glass Steagall was in tact. It also seems a non-sequitor that strict regulation of banks leads to growth and less regulation leads to collapse. Naturally, we are not saying regulation is a bad thing – just that poor regulation is a bad thing. The Basel rules governing bank’s balance sheets is a good example. They were modified in 1996 to allow banks to effectively set their own capital requirements based on their own internal credit/risk ratings. The credit agencies did not do their job and banks held assets that weren’t really that valuable. The US government also passed legislation that allowed for poor families to access significant mortgages (via government agencies like Fannie Mac/Mae). This fuelled house price growth which left those who entered in the late stages of the housing bull market with less equity than their mortgages. And so the list can go on of legislation that can be the blame, not the rescuer of the financial crisis. Our view is simple: markets are cyclical and legislation almost always follows a market crash. But that legislation almost always would not have prevented it, nor is it likely to prevent the next one. We can expect South African investors to see more and more legislation come into play over the coming years.
- Low Yields: We are deeply concerned about the high price (and low yield) of global bonds. It is important to note that the high prices and resultant low interest rates seem artificially maintained by governments and central banks because they save governments money. Low interest rates help keep repayments down. Equally, the central banks, buy back government bonds by issuing fresh currency (quantitative easing), which they hope will help kick start growth (by keeping rates down and by injecting liquidity). We are also noting that banks are now, via regulation, required to buy government bonds. All these aspects add up to one equation: there are far more buyers than sellers of government bonds at the moment. And that is bad for pensioners and others hoping to protect capital and live off interest. In the UK, the five year GILT (government bond) yield was under 1% at the time of writing. Another consequence of low yields is that credit comes into vogue – the higher yielding corporate and junk bonds are often the only place to find reasonable yields. This should worry investors.
- Equity Volatility: Equity price volatility is usually a sign of a market with little confidence. Interestingly, the first quarter of 2013 saw the lowest equity volatility since April 2007. Yet, building up to this point, we have seen some of the most volatile price movements in recorded history. This has been a reflection of jittery investors. We would argue that one quarter is too short a period to reflect any change in market risk appetite.
- Decreased country chauvinism. Historically, UK clients preferred to invest the bulk of their savings into UK equities and UK bonds. But this has changed over the past 15 years, where UK investments are now in the minority, relative to the rest of the world. This is interesting from a few perspectives. First, the clients remain loyal to asset managers who are nearby – so the location of the investment team remains important. And second, this has opened the door for asset managers to develop competencies outside their home geographies. We see this in South Africa too. We are also seeing a decrease in dependence on locally listed pooled funds – in the UK, for example, the percentage of pooled vehicles in UK domiciled funds is small.
- Solutions providers. The buzz word inside asset managers, these days, is “solutions”. The logic is as follows: we normally provide products and allow our clients to choose what suits them. But, rather than second guess their needs by selling products, we should be asking them what they want and we should build that. In short, the outcome is a solution. They then employ their multi asset teams to create various offerings based on a specific client needs (say inflation + 5 over 10 years). We are concerned that this is yet another trend and, also, that markets are inherently random over the short run. How do you create a degree of certainty within the boundaries of investments that are driven by so many complicated factors, many of which are not that knowable.
Beneficiaries, who are they?
- Asset managers have gained market share from banks – banks are tainted by the credit crunch and bank deposits are poor income generators.
- Big players benefit over small as they can envelop regulation better.
- Platforms and IFA aquirors have gained because they can take on some of the compliance burden (and reduce personal risk for the underlying adviser). The RDR, for example, has created a surge in sales of IFA practices into tied distribution models.
- UCITS funds – historically Lux and Dublin – are seen as greater safe havens in times of uncertainty. You could expect South Africans to start to redomicile away from Guernsey and Jersey, for example.
- Bonds, sadly, are a big beneficiary – there are too many buyers.
- Income funds of all shapes and sizes are in vogue (even, or especially, in equities!). Equity income, strategic income – you name it, the word income is involved in a funds name.
- Emerging and Frontier market offerings are in demand owning to the low yields in global developed markets and the secular growth story coming from the developing economies
- Low volatility trend. This results in a few notable beneficiaries. Firstly, the low volatility equity funds. Second, the absolute return oriented funds – like Cautious Managed and Absolute funds. There is also a move towards LDI – where asset managers can help match future liabilities by being creative with underlying structures. This is quite typical in defined benefit where they can sell their liability to a life company who can take the liability risk.
- We are also seeing a surge in structured products, where banks can compete with market linked offerings and retain the same level of exposure that they get from deposits, on their balance sheets.
- Banks: the trust is gone and so are the yields!
- Pensioners: there is very little income going around.
- Small to medium IFAs: how do they cope with increased legislation and the RDR? The short answer is that many don’t and they are close or sell into tied distribution.
- Small to medium Asset managers: the one saving grace of the boutique asset manager is that the service providers are all so scalable that their costs are very low. This means asset managers can survive for a lot longer than they used to (given similar asset levels). But we think the small manager is far more acutely aligned with a binary outcome: they will either become large and successful or they will go out of business. The middle ground that was created when boutiques were all the rage, has now gone.
- Hedge Funds and any “alternatives”: Again, a reflection on risk appetite. In South Africa, we saw an increase in the ability for clients to invest in hedge funds, yet there is very little movement on this. The unregulated status is also a concern during times like these. Clients are very risk averse.
- Local equities: as clients gain more comfort with investing outside their home country, local allocations will decrease. We see this in the flows to emerging markets which have increased by a factor of 6x over the last 10 years. But, the asset managers seem to be driving this trend. They are offering products which invest outside of their home country and their brand and client base is causing flows to be diverted into them. This self fulfils, positively.