NEW YORK ROUNDTABLE: Moving at a higher rate

Funds Europe spoke to a panel of asset managers in New York about the election of Donald Trump and, in addition, asked what the impact of higher interest rates on investors will be. Jan van Eck (CEO, VanEck)
Stephen Kaplan (head of US product strategy, JP Morgan Asset Management)
Marc Mayer (head of distribution, North America, Schroders)
Jeffrey Toussaint (former managing director, Ivy Global Investors)
Damian Zamudio (business development manager, international wealth management, Aberdeen Asset Management) Funds Europe: How will the outcome of the recent US election affect asset management in the United States? Stephen Kaplan, JPMAM: There is speculation on many things, such as what it means for the regulatory environment, and what investment opportunities might be created. Asset managers need to retain a long-term focus and not react to every little piece of news because the election has reshaped some valuations. The first half was challenging, with cheaper assets running relative to more expensive ones, but in the second half of the year there has been some dispersion – and this created really good opportunities for active managers. Jeffrey Toussaint, Ivy Global Investors : The election may mean fewer new regulations, though it remains to be seen whether we’ll see any repealing of old regulations. There is a great deal of sensationalism in the press these days. There was much less focus on who the appointees would be when Obama and Bush came in. There’s 4,000 appointees that
take place over time in various levels, but it seems like there’s so much more of a sensational focus on what Trump is doing, and I think that could have an effect on asset valuations and prices overall. We may see more volatility as a result from this than we’ve seen in past years. Marc Mayer, Schroders: The question about markets has a direct bearing on the demand for the services of asset managers. We all believe that the uncertainty is immense and this should generally depress asset prices. This was reflected in the futures market at 10pm on Tuesday, November 8 – but then US equities powered up! It looked like a definitive movement in capital markets, as though markets were saying, “It’s all right.” But protectionism is bad for emerging equities and debt; inflationary behaviour across the board is bad for US rates; yet the pro-business stance is good for US stocks. The implications for investors are very considerable and it feels like the uncertainty is not really reflected in the behaviour of asset prices, which are bifurcating. Jan van Eck, VanEck: To me, 80% of the regulatory agenda of 2017 was already baked before the election from a regulatory perspective, such as the Department of Labor (DOL) Fiduciary Rule and the liquidity rule which the SEC put in place shortly before the election. The liquidity rule is a massive new piece of thinking about our industry. It is kind of the equivalent of a risk framework that asset managers will have to put in place and once a liquidity statistic is published, I think investors will start talking about it. Damian Zamudio, Aberdeen: When it comes to trying to talk about a Trump presidency, one needs the big caveat of needing to wait and see. His proposed fiscal stimulus package should support US equities, but on the flipside, bond yields are likely to rise. There have also been noises about cutting red tape in the financial sector, which may be a positive for asset management companies. Funds Europe: Could the election of Donald Trump reverse any internationalisation of US pension fund investments? Mayer: Unlikely, as the globalisation of institutional portfolios in the US is in its fourth or fifth decade of evolution. Emerging equity and debt allocations have been rising consistently for institutions every year, despite some very choppy performance. Kaplan: From an individual investor perspective, it is a very different story. They are under-allocated and under-diversified to a pretty large degree and are still significantly underweight. Van Eck: Institutions have been unhappily diversified for five years, because the S&P has beaten everything on the planet. Although 2016 started badly, with only fixed income having a heartbeat in terms of inflows, Brexit had the seemingly irrational response of firing a starting gun for emerging markets, fixed income and equity. It’s possible that popularity might wane a little now. Toussaint: From the perspective of global financial institutions and wealth managers, there have been many more manager searches for US equity than European or global equity – so maybe that answers the question to a certain extent. But whether investors should be allocating that way is a different story. Mayer: There’s certainly plenty of this visible in the individual market, but in the institutional market there has been quite a bit of stasis over the last few years. Through and post-financial crisis, for US corporate plans, it has been focused on fixed income as they sought to defuse their obligations, and on the other side of the barbell were return-seeking illiquid assets. Funds Europe: How might Brexit affect your business strategy in the UK and Europe? Van Eck: We do not have a presence in London. Outside of our New York City headquarters, our offices are in Germany and Switzerland, so it really doesn’t affect us directly. Longer term, we would just look at which domiciles were going to be business-friendly, and I always like to point out that Ireland is the most business-friendly country in Europe. Kaplan: We go mainly through Luxembourg. Having extensive operations in Luxembourg is helpful in addition to having a broad range of Oeics [open-ended investment companies] as well as Sicav products that allows us to be prepared for what could be. Toussaint: As with Trump, there are a lot of unknowns with Brexit, but it comes down to how your business is structured. There are certain companies that are doing far more business than just traditional asset management and Brexit would obviously affect them greatly. But if you were a US asset manager and using a Luxembourg hub with just a representative office in London, it probably will not affect your business very much. Obviously, passporting is the biggest question. But let’s remember that the UK is the second-largest asset management market out there and I’ve known several asset managers who are pushing into the UK market at this moment in time. Brexit does not seem to affect people who want to expand their business. Zamudio: As a UK-headquartered asset manager, we’re certainly monitoring the Brexit situation closely. For a long time, our cross-border fund range has been domiciled in Luxembourg and we have operations in many European cities, so we believe we will be able to adapt. From a US manager perspective, Brexit is arguably less of a determining issue than MiFID II, as most US managers do not share the costs of their trading and research costs that they pass on to their clients, which could ultimately mean they have to inform their own US client base of these costs, which will cause concerns. Mayer: European countries, including Britain, were at war with each other rather consistently for a millennium and now there has been 70 years of relative peace. In that sense the European Union has been at least a major factor in something extremely important. And it has undeniably aided trade within Europe and between Europe and the rest of world. Now there is growing nationalism and protectionism, increasingly on a global scale, which does have real implications. This challenge to globalisation is a challenge to economic growth. It may not all go in reverse, it may just slow down, but globalisation plays a meaningful role in global economic growth, which translates into returns. Funds Europe: Do you feel the speculation that digital giants such as Google or Amazon will enter the asset management industry is overplayed? Kaplan: Probably there will be more digital entrants because there’s a lot of money out there, and there is interest. However, going direct to client – which is probably what one of these major firms would do – is challenging. Managing people through volatility and other emotional cycles has taught established players a lot and has led even to changes in business models. With capital market assumptions of lower returns over the next ten to 15 years and potentially more volatility, there will be more emotion and clients will need someone to help them. Digital alone cannot do that. Mayer: A fundamental question is whether these firms would embrace regulation and be willing to become fiduciaries. When you get sued, you don’t get sued for $10 million, you get sued for $15 billion! I’m a little sceptical they would want to enter this industry. Toussaint: Yes, asset management adds an element of reputational risk to their traditional product line. But there is definitely a huge risk of some other entity out there entering our business, one that can develop a digital platform and make things more efficient. Van Eck: What Google and Amazon represent is already impacting asset management in full force today. Amazon is a scale player; they’re trying to vertically integrate and compete with everyone on price to get market share. Amazon is already here, it just changed its name to Vanguard! What Google is brilliant at is repackaging huge amounts of data for consumers – such as the search engine or Waze, which consumes all the driving data in the United States so you can get somewhere faster. Data consumption on that kind of scale I don’t think is at present in our industry because the markets are split, asset class by asset class, and these tech firms may not have an appetite for doing that. The way the new type of data processing is manifesting itself is in specialist asset management firms which are becoming mini-Googles by consuming data and analysing it for use in their investment processes. When you look at the success of Renaissance and AQR and lots of people using quantitative strategies, then I would say that the Google approach is in many places. Kaplan: On the product side, I agree. But it’s different on the distribution side, where targeting audiences is important and using data to think about how to efficiently work with different intermediaries that you might sell through. It’s about intermediated business versus not intermediated – and again it’s a question about how to do that while managing emotion and giving people information so that they don’t make the wrong decisions. Mayer: Millennials are supposed to trust computers more than they trust humans, certainly in finance, and that’s the opportunity for digital advice advisers. Although there are a lot of millennials, they aren’t earning all that much money yet. No one has any real discretionary money until they’re in their 50s. That market segment is coming, but it’s coming fairly slowly. Vanguard’s success was because they had a big franchise with baby boomers who were used to dealing with Vanguard’s skilled humans on the other end of the line. It’s not surprising we don’t have a $100 billion robo-adviser yet, as that target audience will come into wealth, but slowly. Kaplan: Today, robo asset management in the way it’s being constructed is inexpensive and relatively simplistic. As people gain more wealth, it will become much more important to digitise financial planning and client relationships. Mayer: Right now the number of firms that are good at this are still very few, and remember that we have just gone through two moments in history where all the big data in the world came up with the wrong answer – Brexit and the US presidential election. There is now at least a momentary repudiation of the idea that all you need is data, powerful computers, and good people to figure out what’s going on. We still have some more work to do and we should always remember that investing is fundamentally very hard. It’s not that computers won’t accomplish feats that humans can’t – it’s been happening for decades and is accelerating. Bit no one should believe that investing is easy and arbitragible opportunities are collapsing faster in the digital era. Zamudio: The threat of disruption within the asset management industry is certainly not overplayed. Those chief executives and senior management teams who are ignoring the potential of new entrants and the challenges and opportunities posed by technology aren’t doing their job. In terms of Google and Amazon, one could imagine them distributing funds on their platforms but whether they would become manufacturers – that is, asset managers – is a different question.  They would need to weigh up the potential revenues versus the costs, for example establishing financial compliance, risk and legal departments. Funds Europe: Have US asset managers been more successful at asset raising in Europe than their European counterparts? Toussaint: Morningstar data for cross-border active funds shows there are a little over 600 managers in that space and that US firms are very prominent. Only about 15% of the total had net sales year-to-date through the third quarter of this year of $100 million or greater – so there are not many doing really well. Fifteen per cent is 96, and of those, only 16 were from the US. So, in terms of active asset management sales, European firms are actually doing much better. There were about $130 billion in net active flows through the third quarter of this year, and only $25 billion of that came from US asset managers. However, if you add passive funds, those numbers would change dramatically. Kaplan: In terms of global sales, US-based managers tend to float towards the top, but this is because the US marketplace is bigger. There are a number of ways you can cut the data and the data tends to show different stories at different points in time. For global strategies there are a number of important elements. Education is important for building a global brand. We produce a ‘Guide to Markets’ in which we tried to simplify market complexities in 13 different languages. Zamudio: Typically US asset managers have the experience, knowledge and financial muscle to enter markets and be successful. US asset managers are not classed as SIFIs so can seed funds more easily with capital, which helps distribute funds and get them on platforms quicker. The US market is very competitive, which is why European counterparts have struggled. That said, Aberdeen’s success in the US is in part because of our international product range, for emerging market equities and debt, which domestic managers don’t offer. Van Eck: What strikes me is how so few UK managers have created ETFs, yet many other countries in Europe have ETF companies: Switzerland, Germany, France, the Netherlands, for example. Mayer: The US is decades into the migration towards passive investing. In many parts of the world where there is an intermediary market, you still see fund prices well in excess of 2%. In the US, those days passed two decades ago. Market forces created some US firms that are very good at running high-scale, low-cost manufacturing models – and that’s turned out to be very exportable. Kaplan: What happens, I believe, is that in the mutual fund world, active and passive get used interchangeably. There are processes we’ve had in place that lend themselves to an ETF structure. We’ve a number of ETFs already, but we didn’t start with the multi-cap, weighted, low-cost approach. We started with products that were more strategic beta in nature. Funds Europe: What impact do you think higher interest rates would have on US investors, and how likely is it that rates will increase? Kaplan: On the one hand, there’s potentially the opportunity for higher yield and funds will reinvest in higher rates, which is positive. On the other hand, if rates move very quickly, there is the risk that clients who viewed fixed income as a conservative investment will see a negative return. A lot remains to be seen and the best thing that anybody can do is to diversify across fixed income. Van Eck: Rates have started moving up in the United States again, and the Trump election has accelerated that move. There are two views: rates will move to 5%-6%; and there is the more moderate view of a hike to 2.75% or 3%. There are a couple of reasons I think the move may not have a big impact on investors. Firstly, there has just been a remarkable shift down in equity appetite since the global financial crisis, which I think has to do with risk aversion. The second reason is demographics. As the population of the US ages, there should be higher demand for income. Investors can get that income by buying cheaper bonds if rates went up, so we could have rising rates and still avoid a massive outflow in fixed income. Mayer: We know that the Fed looks at what’s going on all around the world, because they always comment on financial conditions and how they create movements in the term structure beyond anything the Fed itself does. They can feel more or less compelled to act, whether or not the market is doing something for them. Financial repression has not been good for savers, while very rich people invested in equities, or younger people in equity-heavy target date funds in their DC plans, have had a wonderful time in the United States. Being able to get a reasonable real return in the fixed income markets is terribly important for an immense number of people globally, however. Kaplan: Many people have been sitting on cash earning nothing. As they worried about potential macro events, many investors have not participated in quite a long equity run. Zamudio: Investors are concerned about their exposure to rate sensitivity and duration. This has been a concern since 2013 when the Fed began to taper and the discussion opened up as to when rates would increase and at what pace. Views on rate increases are mixed. Some advisers have been looking towards areas of the market that will benefit from a pick-up in infrastructure spending and US growth, like US smaller companies and sector plays on infrastructure in the US. Overall, there’s caution on the implication for the market as there’s little clarity on details, and Trump’s tone since the election has also softened. Van Eck: Hopefully we have seen the end of negative rates in 2016. I’ve never known a policy from government officials that had all private sector economists saying, “What are you doing?” Everyone viewed negative rates as contractionary, not expansionary. Funds Europe: Risk factors affecting business decisions are expensive: rate rises and the end of stimulus measures, Brexit, and the Middle East. How impactful is global risk at present on asset management? Zamudio: Political uncertainty, ultra-low interest rates, anaemic growth levels, to name just three themes, are weighing on investor sentiment. It’s discouraging investment and having a long-term mindset. Unfortunately, some of these risks are likely to linger for the foreseeable future, but that doesn’t mean investment decisions should be put on hold. The focus still needs to be undertaking fundamental research and being patient once invested. Kaplan: The industry needs to help people focus on the long term, and teach them about staying invested. This is probably the one thing collectively that asset managers could do a better job at. More effort needs to be made to understand asset allocation and to know what the underlying investments are doing. Van Eck: How clients allocate is the biggest unsolved problem in our industry. But, to be fair, I don’t think that academia really has solved that problem either, or it says that it can’t be solved. Institutions have got their methodology around asset allocation for better or worse. Individuals are half the time trying to figure out whether to get in the market, and I think financial advisers are looking for advice on asset allocation and they’re not getting it. They want conviction in something. Kaplan: But the timing aspect is also going to be difficult, which is why the balance of asset allocation long-term with tactical areas of opportunity on the margin is important. Van Eck: A lot of people have blown themselves up trying to solve that problem! But it is a client need, ultimately, to have confidence that your assets are being allocated in a reasonable way and will react to risks without trading excessively and unsuccessfully. Mayer: One of the most powerful innovations in investments over the last couple of decades was target-date funds, which take a lot of the stress and emotion out of asset allocation. These have broadly served DC participants well through the financial crisis. The reason is because they did not sell. They had a huge drawdown in equity-heavy funds – but they also saw a strong recovery. These funds take a lot of the mystery out of investing and show that the secret is often to do little rather than more. It’s always been fascinating to me that financial advisers don’t use target-date funds more often in individual retirement plans like IRAs. Funds Europe: If there’s one thing about the asset management industry you’d like to change, what would it be? Mayer: It would be for our industry to collectively do a better job of delivering the outcomes clients need, which is, predominantly security in retirement, though not exclusively that. Kaplan: Similarly, to focus more on the outcomes and the explanation of the outcomes so that people understand what they’re investing in and remain invested. Toussaint: Education. The industry should be better at educating investors and potential investors so that they make better-informed decisions and understand some of the dynamics that take place. Van Eck: I would like to see less turmoil amongst our distributors from the Department of Labor’s fiduciary rule. I’ve never seen a client base so much in turmoil. I think there is great emotion about the risk of litigation. If that fear could be taken off the table, it would allow them to do what they think is right, rather than just what they think they should do to avoid litigation. ©2016 funds europe

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