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Impact Investing

IPE special report May 2018

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Fewer certainties in the big new world

Irish fund managers showed their mettle in 1999 by producing returns on their balanced accounts for pension fund clients averaging around 20% . This was at a time when the mainstay of their performance in recent years, the domestic equity market, turned out to be Euroland’s worst performer, with a mere 2.2% rise in 1999, while Irish gilts shed 4.7%.
The figures, based on the pooled managed funds run by 19 managers, are seen as a good proxy for the performance of balanced segregated pensions assets, as many managers run both portfolios along similar lines.
But the point is moot whether the Irish market let fund managers down, or they let the market down. Last year was the year of the great euro transition. “All Irish pension fund managers have been trying to reduce their domestic exposures and this has had a huge impact on the market,” says Samantha McConnell of Dublin-based Ulster Bank Investment Managers (UBIM), one of the two Irish asset managers now up for sale.
With little interest in Irish equities coming from international investors and local institutions still in hold off or disposal mode, a cloud hangs over the market. Even the flotation of Eircom, the Irish telecoms privatisation, was caught up in the mood and after an initial burst of price activity has subsided into the surrounding gloom.
“Even before the advent of the euro, we said we would be reducing the domestic stock-specific risk, lowering our holdings from 30 to 25%,” she says. In fact, UBIM is now holding only around 20% in Irish equities.
“The transition to the euro affected the Irish market very significantly,” says Michael Phelan of ESB Fund Managers, the other Dublin-based asset manager on the block. “Most trustees now place a limit on what they have in Ireland, with the intention of reducing it. The dilemma facing Irish asset managers is that they cannot support the market on a weak day.”
At Irish Life, Gerry Keenan reckons that domestic weightings have fallen by about half a percentage point each month. “We have sold the market, but we do not think there will be any more aggressive selling at this level. It will be cashflow-dominated, as managers redirect their flows.”
The next dilemma facing managers is the market represents some attractive opportuities, with the fundamentals of the major companies making up the bulk of the market having changed little. “The Irish market is now very good value,” maintains Phelan of ESB.
The scenario changed very quickly from April last, but he maintains that Irish managers should have seen the lights flashing amber well before then and have reduced their domestic exposures. He agrees this would have been very hard to do when the Irish market was among the top performers. “The Bank of Ireland Asset Management had been selling Ireland since 1996, but lost out on this good Irish performance of the next three years. They moved in the right direction, but perhaps too early.”
But BIAM did succeed in doing what every other manager is trying to do in Ireland, which is to build up its overseas credentials. Phelan points to the ESB FM’s own situation. “The real problem is that in Ireland you have to have an overseas capability. Trustees are now looking at the depth of resources that Irish fund managers have.” Inevitably, more and more of the assets they are managing will move out to Euroland and elsewhere overseas. “That would mean taking on three or four people to have a credible presence, and that was a route our parent decided it did not want to travel. In fund management you can gear up, but it can take a long time for the money to flow in as a result of what you do.”
In UBIM’s case, the restructuring at its Belfast-based parent Ulster Bank, part of the NatWest group, resulted in the asset manager being put up for disposal at the end of 1999. The parent was obviously not willing to commit the resources needed to develop the business to the next stage to take it international and fulfil its other ambitions.
There has been some consolidation already in the market, with New Ireland’s asset management arm falling into the lap of BIAM, as a result of the move by its parent the Bank of Ireland to buy the insurance group that owned the manager. Irish Progressive has since become part of Irish Life and with the acquisition by the UK’s CGU insurance group of the stake in Hibernian it did not already own, questions are being asked about the future of its asset management arm.
Since many of the asset managers are subsidiaries of UK insurers they could well be facing similar situations longer term as to their raison d’etre. Standard Life, the £70bn (e115bn) Edinburgh-based mutual life office, has always run its investment operations in Ireland from Scotland. Pat Woods, who manages its Ir£2.5bn of Irish assets, says: “Up to a year ago, there might have been a case for a bigger presence on the investment side in Ireland, as then a typical pension fund client would have 50–60% of assets in domestic equities and bonds. However, as portfolios go from 50 to 30% in Irish assets in the space of a couple of years with the introduction of the euro, this tips the balance away from considering Ireland as a base.”
But for other UK groups with active asset management businesses in Ireland the crunch time may still be some way off. As one market player puts it: “Do you really need an investment presence here, perhaps all you need is a good marketing team. And what would be the rationale for having a separate investment team here, if Britain goes into the euro – it would go completely. That, I think is the main threat. So, in the meantime, what all the companies are doing is trying to build up their assets to justify their continued existence.”
Such a view may sound uncompromising, but it explains why the outcome of the sale of UBIM and ESB could be of vital importance, not just for the future destiny of their own operations, but as a signal to the future of Irish investment management – is anyone outside really interested?
Phelan expects the ESB FM’s operations to be absorbed by another local manager keen to build up assets, whether UK or Irish-owned. “We thought with our sale that a greater level of interest would be expressed by US groups interested in Ireland as a way into Euroland.” And at Standard, Wood says: “I do not see any benefit from a US manager’s viewpoint or from a UK group’s perspective. If you are not already in the market, why would you want to be in it?” He predicts that the consolidation still has some way to go: “These sales won’t be the last, as there is overcapacity in the Irish fund management market.”
In the UBIM sale, the management has to agree to the purchaser, but if no outside group is interested, it may be faced with a local deal. A deal with AIB or Irish Life for the asset management side, with Irish Life acquiring Ulster Bank’s banking operations in the Republic and Bank of Ireland getting the Northern Ireland operations, is one scenario mentioned in Dublin.
In the meantime, the name of the game is the race for business from the bulk of pensions assets in defined benefit schemes and largely run through balanced portfolio mandates. Track record and good performance statistics are what are needed here, as in any other race. Hence the importance of the results posted up in the managed funds table.
But there is another condition that determines whether or not business will change hands, according to one manager: “There needs to be a big player doing badly, for there to be free money coming into the market for management.”
In this respect, all eyes will be on Ireland’s largest manager, Bank of Ireland Asset Management (BIAM), which makes no bones about having under par results for some years for its Irish balanced clients, largely due to being underweight in Irish stocks compared with competitors. “We marginally underperformed in relative terms in calendar 1997, and still more so in 1998, but against a background of high absolute returns,” says Tom Finlay of BIAM. But the group has been fighting back to find its form, and moving back to average performance at least, though this seems to have eluded it once again, despite the narrowing of the gap.
The irony is that the New Ireland funds, also managed by BIAM, did much better. Finlay comments that at the time of acquisition, the New Ireland “put an inspired constraint on us” in that the asset allocation of its managed fund would never move from its median long-term position in terms of equity and property. “So when we at BIAM brought our portfolios down to 52% for equities in an unconstrained balanced fund at the start of 1999 – our stock picking basically held up – the New Ireland benefited from the constraint and their unitised funds are doing well in relative terms.”
With assets of Ir£37bn, most of which are for non-Irish clients, BIAM bestrides the Irish market like a colussus, but it has spent the past year, after increasing its clients servicing teams by 50% , closeted with clients “telling them how we manage money”, he says. This year could well be the year when clients tell whether they accepted the message or not.
BIAM’s strengths in global equity and other specialist products that have won it business outside Ireland have only limited scope in its domestic market. Finlay says: “The balanced to specialist is definitely a trend here, but we do not have mega funds, so only a few funds can consider core satellite structures.”
At Irish Life, Keenan is sure the market will develop in this direction, perhaps in eager anticipation that core portfolios will be managed on a consensus basis, a trend that has really gripped the market and where his group leads. A number of groups now run unitised consensus funds where the asset allocation is the average of the managed funds cohort and the assets are run passively in line with an appropriate index.
BIAM launched such a fund in September and by year-end had attracted Ir£135m, with the indexed element being run by Barclays Global Investors. “In Ireland it is the main form of passive management, though some of the bigger funds look at the more conventional matching of indices,” says Finlay. But BIAM did not see any conflict in going the passive route. “We are mainly active, but did not see it as sensible to absent ourselves from that part of the market.”
With consensus sweeping up much of new business in the defined contribution (DC) market, often as schemes’ perferred default option, players in the DC market have to think hard about missing out on the opportunity. By the end of 1999, five managers were operating in the market, with products of slightly different hues. Irish Life, which introduced the first fund, claims to have captured half the new DC market, in which its consensus product will have played a big part.
But consensus is not something that all managers are comfortable about. At UBIM, it is clearly causing heartsearching. As McConnell says: “The eternal dilemma is here. From a marketing point of view we would love to run a consensus fund, but we are an active house. There is this cultural aspect that has to be overcome.” At Friends First, Pramit Ghose regards offering strongly performing active and a consensus products as a commonsense issue of meeting clients’ requirements
Whatever about the future of the Irish equity market, one of the main casualties of the euro has been the Irish bond market. The authorities reorganised the government gilts in order to create a more a more liquid market, by buying back and issuing three or four new stocks. But Irish trustees are moving to a euro-related index (see page 45). “Irish bonds only comprise 2% of this index,” points out Phelan at ESB. “And the shift out of the Irish gilt scene is well under way.” Many of the dealers have reduced their bond teams in Dublin, because when fund managers move to continental issues they will deal with the big houses in London or on the continent to get better prices, he says.
On the corporate bond side, there are moves to recruit credit risk specialists, but Phelan is pessimistic about small teams in Ireland being able to match the resources of the much bigger operations in London and elsewhere. “Irish brokers cannot do the same level of research as a Merrill Lynch can on corporate issues.”
A sign of the changed times was Irish Life's launch of a specialist long bond fund targeted at pension funds’ deferred and maturing liabilities. “By going into Euro-zone issues we have been able to increase the duration by about 50%. This give a much better match for pension liabilities,” says Keenan. It seems to have hit a chord among funds with assets isolated for maturing and deferred liabilities, as the fund has taken in some Ir£70m since launch.
But, as one manager says, the changing of the bond portfolios to a euro scenario is the easy bit, whatever about the devastating impact on employment among Dublin’s gilt dealers. But riding the headlong downward sweep of the domestic equity roller coaster has been anything but easy. Ghose at Friends First acknowledges the past year has been a tough time for Irish investors and markets, acknowledging, “In retrospect, had you moved out of Ireland earlier, you might have missed the fall in the market.” He attributes the fall simply to the fact that Irish investors were not buyers, rather than being active sellers. He adds that there was some selling to make room for the Eircom float, so as not to increase exposures to the domestic market. “Now valuations look extraordinarily attractive, but you cannot go in. If you went in tactically, it would look rather strange.”
Rebutting the view often held by outsiders, he says the momentum within the Irish economy is not off course, though there are “pockets of problems”, such as property market. Finlay at BIAM echoes this view.
Friends First has reduced its balanced portfolios’ domestic equity content from 35% mid-1998 to around 22% at end-1999. At Standard Life, Woods reckons that average exposures are down from around the 30% mark at the time of joining the euro to around 20%. “About 15% seems to be the figure the industry is moving towards, so we may be two thirds of the way there, given the diversion of cash and the underperformance of the market from lack of buying.” But he is not sure that investors have a clear view of where they want their total Euroland exposure to be. “I would not be surprised if the Euroland equity proportion were betwen 30 and 40% in a couple of years”, though there has undoubtedly been some degree of substitution of non-domestic Euroland for domestic. BIAM has launched a Euroland fund with only 2% Irish equity, equivalent to the country’s market weighting in euro terms. “So if someone wants to go cold turkey, they can do so with this fund,” says Finlay.
Another manager blames the consultants for making a lot of comments about getting out of Ireland and going to Euroland. “This noise was played at a very loud level, if it had been played more low key, maybe people could have got out quietly.” In his view investors wanted Euroland holdings including Ireland at perhaps 25–30% of portfolios, but could not get out of Ireland that quickly. There was as a result considerable interest in increasing investment in the US and Far East, and in particular Japan.
So one challenge for Irish managers is to be able to meet this new demand for both increased Euroland and wider overseas exposure. Ghose reckons that Irish managers’ track record for overall international equity performance is very good. In an exercise to compare Irish with their UK counterparts, he looked at the Irish CPMS figures and UK WM figures for international equity performance, with the Irish managers very definitely out-performing their UK counterparts over one, three and five years (to end-December 1998), mainly due to the British penchant for the Far East and shunning of the US, because on a region-by-region basis, the performance was level pegging. He says: “In terms of stock selection in Irish markets, Irish fund managers are as good as their glamorous big UK competitors. In terms of strategy and asset allocation, Dublin has judged the global trends far more astutely.”
Friends First has been building up their international capability. “We have transferred the management of our continental European equities for Irish clients from our London colleagues. While we will liaise with London, operate the same philosphy and benefit from their research, we run the portfolios from here.” He believes other groups are building up teams.
In addition, to winning business in the home market, one way to prove your credentials is to go foraging in the wider world as BIAM has done so successfully, and others such as AIB IM and UBIM are determined to do as well. As Finlay says: “It is very hard to be defensive without being in the offensive as well.” At UBIM, this strategy is now in place and moves outside the domestic are high on the agenda. “Already some 22% of our funds are from the UK, but this would include the Ulster Bank pensions fund.” But this year, it started to win third-party business in the north of Ireland for the first time. This was not so much a matter of an Irish but more of a group peace dividend as a result of sorting out territorial issues with its sister investment company Gartmore, also part of the UK’s NatWest. “They saw us as a minor player with quite a different ethos and philosophy and so did not have an issue with us going head to head with them on cases – though much of the business of interest to us would be too small for Gartmore in any event.” But this initiative means travelling the long road of making contacts with the consultants in Belfast, Edinburgh and London, who run the business there. “To get them to include a Dublin-based asset manager on their books can be a difficult task. Because our performance was so good relative to the UK last year, the consultants thought we were taking huge risks, which we don’t.” The group already has a range of approved UK products, but knows the going will be slow, particularly until the ownership question is cleared up. “The UK and the US are the key markets, with continental Europe in third place. We believe our process is up to international speed and see our role as a satellite manager managing international or local equities.”
The Irish peace deal will be good for business overall, says McConnell, but points out that before it happened there was not an issue as far as business was concerned. For BIAM, any Northern Ireland business gained is automatically run from the UK office. Though wearing his hat as current chairman of the Irish Association of Pension Funds, Finlay says that good relations have been developed with the local committee of the NAPF in Belfast. “We discuss such issues as people moving between jurisdictions and schemes. Certainly, if sterling went into Emu, it would be easier to work on investment questions. But what has happened is very encouraging and has gone much further than expectations.”
Though the Irish market looks cosy from the outside, it is ferociously competitive, with fee levels below those in the UK and even more so than in the US. While this may protect the market to some degree from intrusion, one question is whether they are sufficient to provide the margins for the levels of service and research required in running international accounts. Finlay thinks there are difficulties in delivering specialist mandates where groups have only a few billion under management. So consolidation may be the only way that the industry will get control of its fee levels again.
Some 7% of pensions assets are said to be managed by non-domestic groups, mainly groups without a direct presence from abroad. As the market goes more specialist, it will inevitably attract more interest from outsiders. Edinburgh-based Baillie Gifford with top fund performance in 1999 says new investments have already come its way this year. It just pipped Montgomery Oppenheim, owned by Frankfurt-based Oppenheim group, which also expects to capitalise on its track record.
The industry is gearing up for the arrival of the Personal Retirement Savings Accounts, the all-purpose pensions saving vehicle at third-pillar level, which will bring business flows to the investment sector. But with the moves to allow the current self-employed pension vehicles to take benefits as cash, there are fears of the impact this could have on defined benefit pensions scheme, if retirees could take their lump sums. As Finlay notes: “DB is under significant threat, which could destabilise the existing situation. If those retiring can take the benefits as a lump sum, they will go against the experience of the scheme. We need to make changes to the regime in order to allow DB schemes to continue.”
On a more positive note, managers’ eyes and thoughts are firmly focused on the two new state funds being created to help meet future long-term social welfare needs and public sector pensions. With the interim legislation setting up the funds in place, managers are beginning to see the colour of the government’s money – albeit dimly at present. At UBIM, McConnell says: “We think these funds are very significant. It looks as if the National Treasury Management Authority will have the management role, but will outsource some of the funds to external managers.” How this is to be done is to be outlined in the pensions legislation due this year, which will set out the structure of the funds. At Irish Life, Keenan speculates as to whether, like operations in other countries, it would be required that the assets be invested outside the country. “Otherwise, there could be a question of nationalising the economy, if there was not such a rule.”
On all sides of investment management, there is a sense that the market is changing, perhaps much more than the players realised it would as result of the euro. The feeling is that everything is up for grabs, including even the two stalwart pillars of the Irish financial scene, the Bank of Ireland and Allied Irish Bank. The relative drop in the Irish market has brought home the realisation that that such a scenario is perhaps closer than might have been envisaged. There are fewer certainties in the big, harsh, new world of Euroland.

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