Change of the old guard
The established UK asset management industry is facing challenges from the rise of indexation and specialist managers. Fennell Betson reports
At the heart of the UK's domestic asset management business is the £800bn ($1.3trn) mountain of pension fund assets financing the country's mainly defined benefit (DB) occupational schemes. The investment soul of this business has been the traditional balanced mandate through which some 75% of these assets have been invested.
As Anthony Simpson of Mercury Asset Management, which is reckoned to control 12% of DB assets, says categorically: There is clearly a renewed challenge to the balanced mandate business." He points in particular to the impact of the UK pensions legislation.
The Pensions Act has resulted in scheme trustees, who are responsible for the investment of their schemes, adopting asset allocation benchmarks that are customised to meet their liabilities. Under the typical balanced portfolio, asset allocation was left to the investment manager and the performance was measured against the peer group of what other funds were doing. William Babtie of Dresdner RCM in London observes: "Balanced infers everyone is following the same benchmark".
Reflecting this change is the increasing using of the US term 'multi-asset class'. It will perhaps take a decade for the full impact of the legislation to work through the system.
At Schroders, another of the dominant City managers in the balanced portfolio market, Julian Samways says: "We are seeing a small trend to benchmarked portfolios, but often these are not that different to pensions industry median distributions."
But this is not the only issue facing balanced portfolio management. As one manager puts it: "The question is that people feel that they have picked the wrong balanced manager and they were pushed by their consultants into the 'Big Four'."
The matter of the of the dominance of the 'Big Four' managers has been dogging the industry and came to the forefront earlier this year after the performance of these managers in 1997, which has been generally recognised as a difficult year for them. According to figures of performance measurement company CAPS - which is owned by three of the major consultants but run independently from Leeds - at the end of 1997, 80% of the pensions funds balanced discretionary business segregated portfolios were managed by just 16% of managers surveyed. While the actual number is not disclosed, this could be the biggest 10 managers or so.
The survey covers over £300bn in segregated pensions assets, reckoned to be half of this business in the UK. There has undoubtedly been a trend to concentration, as in 1990, 80% of the business was in the hands of 25% of managers.
The 'Big Four' discretionary managers at end 1997, Mercury, Schrod-ers, PDFM and Gartmore, were grouped together by CAPS and their combined median portfolio return in 1997 was 70 basis points below the discretionary portfolios median of 15.6% in the CAPS universe. Over five years to end 1997, this group marginally outperformed, 13.9% versus 13.8%, says CAPS.
With the well publicised bearish stance taken by PDFM on certain markets, the group's performance has been affected, though its client base is reportedly sticking with the manager through thinner times.Gartmore has had its well publicised problems on performance and some consequent loss of clients.
Mercury, with over 1,400 pension fund clients, objects strenuously to being put into the Big Four. "We do not like being grouped in this way," says Simpson. "We think we have clearly distinguished ourselves from our competition in terms of our business and investment philosophy and our long term performance."
On the performance front, he says that 1997 was a tough year for active managers across all markets. "Our clients have generally experienced out-performance over the longer term - typically three and five years. But we were very disappointed that a small number of funds underperformed compared with our median in 1997." He adds: "In one team we had greater dispersion than we would have liked, consequently over a year ago we introduced sector bands and reduced the degree of flexibility afforded to individual fund managers, so this team is now in line with the rest of the house and we have reduced the level of dispersion." And though Mercury has lost a few high profile clients, he says: "We are maintaining our style, as our performance in the long term has been very good."
Samways says the grouping of the big four together is an artificial basis as the firms are all different, except that they happen to be the largest four managers. "The simple CAPS' performance figure hid many different performance records among the four managers. Our segregated funds outperformed the CAPS' median in 1997 and we had upper quartile performance in the five years' to 1997."
There is no doubt that the bigger managers and not just the top four are facing fierce business pressures on the balanced side. In fact, CAPS' analysis shows that the 'Big Four's' share of new appointments peaked at 54% in 1993, falling to 38% last year. The presence of other managers, including those offering specialist and in-dexed mandates, is increasing, says CAPS.
For Alastair Ross Goobey of Hermes Investment Management, which runs the BT and part of the Post Office pension fund schemes, "the old order is unequivocally changing". "Trustees are now saying to traditional balanced managers: 'The onus is on you to prove that you can do better than a passive style and /or specialist'".
He adds: "Consultants have had something of a shock that their recommendations of the last three or four years had not turned out as hoped. The concept of 'one manager fitting all' is beginning to be questioned."
The structure Hermes runs for the BT and PO funds is core indexation with satellite active management around this. This where part of the market is definitely headed, but the question is to what extent. Simpson at Mercury puts indexation at 15% penetration of the market, while Barclays Global Investors (BGI) reckons it is around 20%. The National Association of Pension Funds' 1997 survey of pension funds found that 35% of private sector and 44% of public sector funds indexed part of their portfolios, with 25% of £1bn plus funds indexed, amounting to £30bn, and in the public sector 37% of £1bn funds had indexed assets of £12bn. The total amount on an indexation basis came to around £60bn, equivalent to over 16% of the funds surveyed.
As Ross Goobey of Hermes says: "The trend to indexation is unmistakable, but how pronounced it is, is a question of judgement."
BGI along with Legal & General is leading the indexation charge and both believe the market is coming their way, with much more to come. With over £40bn of pension assets under management at end 1997, BGI is now among the 'Big Four' though this is not an epithet it aspires to. Last year, it took £2bn in new UK business and this trend appears to be being maintained this year, with new wins. Clare Dobie of BGI says: "The UK market is very exciting for us, being very fluid between fund managers with a clear movement to indexation." She believes there is a fundamental change in trustee behaviour: "Trustees have been upset not just by underperformance but by the swings in performance."
Legal & General says it took on £5.5bn in passive new business last year, but in the first months of 1998, it had already taken in some £3bn in new mandates.
US group State Street Global Advisors (SSGA), which runs a total of £8bn from London, says it has added a substantial amount of indexation business in the UK amounting to £1.5bn. Kanesh Lakani of SSGA says: "We expect this business to grow strongly this year and next."
In relation to total pension assets of £800bn, these shifts might not seem too dramatic, but both Schroders and Mercury acknowledge to an extent the threat it poses to them as committed active managers. Samways refers to a "slight trend to passive management", which he attributes to the troubles of 1997 for active managers. "We would caution against using 1997 performance among active manager as the prime reason to move."
Simpson thinks it may have some way further to go, adding: "We think this is the precisely the wrong time of the cycle to go indexed."
While neither of these two are contemplating offering indexation, Gartmore has embraced the concept by launching a hybrid specialist balanced product, in the belief that though balanced funds will still be a mainstay for trustees, the move to specialist and core passive and active satellites will continue.
At Gartmore Anthea Nugent says: "The product combines a passive element for risk control and asset allocation and very active stock selection, in conviction portfolios where every stock has a story." She adds that it re-moves closet indexation often prevalent in active portfolios and encourages active managers to concentrate on their stock selection. "Our ap-proach is going down a storm and we are winning mandates," she claims.
But passive management is undergoing development within itself and BGI is winning business with its enhanced active product. "Trustees are interested in more systematic ap-proaches to investment," says Dobie. Hermes is now offering its indexed approach through an insurance product for both the DB and DC markets, which is being taken up. At Dresdner RCM, Babtie, who reckons that in-dexation is increasing its market share by about 1% per annum, expects in-creasing opportunities for the group's enhanced indexation product.
But indexation also increases the scope for specialist managers to run the satellite portfolios and Dresdner RCM is also benefiting from the widening range of managers being looked at for specialist briefs as consultants widen their searches away from the bigger groups, particularly as it has produced some very good performance figures. "Our requests for proposals figures are up strongly this year. These have been for global equity mandates, fixed interest mandates, and our MFR strategies which are basically protected or enhanced gilt strategies and US equity mandates, among others."
Anna Roads of US group Fidelity's UK DB operation, which runs £5bn in pensions assets, says the company is now finding its name in the bigger frame. "We are seeing a movement towards specialisation, particularly with larger funds adopting a core passive and we hope to gain the active portion. About 30% of our new business is now specialist mandates."
At SSGA, Lakhani says that the resistance to overseas managers has finally broken with growing interest in the group's specialist products. "Our style and systematic approach are coming into favour. We have pitched this year for active UK and other mandates. These even include market neutral strategies. and we have been surprised by the number of enquiries we are receiving about these."
Smaller managers such as Singer & Friedlander say that there are possibilities of gaining specialist mandates where it has good track records. Many of the specialist US groups such as Capital Management and Wellington that have for many years been using the UK as a base are finding that their time has come with these market changes. But the traditional managers are quick to point out their underlying specialist strengths.
Samways at Schroders points out that a third of the client base is benchmarked or specialist portfolios.
The ability to run specialist portfolios is still seen very much as the preserve of the larger funds, with at least £1bn of assets, which may be a limiting factor in its growth. There seems little appetite among pension funds to go through the same process as in the US where portfolios can be made up of rafts of specialist mandates.
But whatever the longer term implications of these changes traditional balanced mandates will remain the mainstay of the mass of DB schemes, particularly for the smaller ones. At Fidelity, Roads says: "The old order is changing and the manager choice is widening". One of the problems of the period of manager concentration is, in her view: "there are not so many obvious candidates, who are good at managing UK and international assets". A number of the US groups who have been long established in the marketplace, such as JP Morgan, Goldman Sachs, Morgan Stanley, as well as Fidelity are well positioned to pick up business, as are groups such as Morgan Grenfell, Hill Samuel, Hendersons, Flemings and Baillie Gifford, whether they are still UK-owned or not.
Invesco is one group which wants to be a major player in the balanced market. David Gillen says: "We intend to be successful here and have waited until we have had the necessary performance to re-enter the market."
This opening of the market has been fortuitous for the new UK asset management arm of Société Générale, under the leadership of Nicola Horlick, who after her stormy departure from Morgan Grenfell, has built up a team to take on the balanced and fund market. In its first year, the company has already picked up accounts, proving that it is possible to win business without necessarily having a track record, something that would have been unthinkable some years ago. When Horlick says she hopes to have £5bn under management in five years in pooled and segregated accounts, this is not dismissed as being beyond the realm of realism.
Singer & Friedlander (S&F) is also reporting that its bespoke service for smaller balanced accounts is attracting the attention of consultants. At S&F, Peter Dencik says the poor performance of pooled managed funds has meant more trustees are looking at tailoring their own balanced portfolios. "But the main reason for moving from pooled vehicles is the need to have a strategic benchmark for MFR purposes, which a pool cannot provide."
Another manager who believes that balanced is still the way the bulk of the market wants to go is Colin Mc-Latchie of the London office of US manager Panagora. He challenges the wisdom that sees salvation in the specialist route. "Trustees may need to acknowledge they may have instead a poor supplier situation." The company's new balanced product, which claims outperformance of the WM 2000 ex-property benchmark by 5.8% in 1997, builds on a stru ctured management style. The balanced ap-proach can deliver consistent performance with a risk controlled process, he maintains.
The arrival of DC business as a significant force has been accepted and the issue for managers is that of positioning themselves to participate in the market. The choice seems to be to use, as Schroders did, a pooled pension fund vehicle (PFPV) or set up a life company that most seem to do, with JP Morgan one of the latest to opt for this route with others in the pipeline.
The business here is measured in flows rather than stocks of assets, but there is no doubt that it will be substantial. Some estimates say as much as 50% of corporate pension assets will be DC by 2005. Due to disappointing performance on their DC pooled funds by some of the major providers, this market is now seen as being open to attack in a way it was not previously.
But the debate that is not happening in the UK between asset managers and their clients is that about the euro and the impact it will have on portfolios. The background briefing documents are beginning to flow, but the general attitude is well summed up by Babtie: "We do not see any immediate interest in Emu issues. The reason we think is this: 'If a trustee wants to appoint a specialist European manager do you tie them just to Emu, or do you include non-Emu European countries? In balanced mandates, their manager is going rebalance their portfolio'."
For the contrarians, Dencik says: "The issue needs to be discussed, as it is not prudent for trustees to continue as they have. It is unthinkable that you can change the monetary system in Europe and not think it will have an effect and implication.""