The market has openly embraced its new position in Euroland, but some national issues still exist, says Robert Marjolin at BNP
On January 1 1999, the 11 countries participating in EMU will convert their currencies to euro, thus eliminating all fluctuations in exchange rates. The world's second largest capital market will be born, drawing the attention of investors from both the continent and abroad.
In the fixed income area, convergence of interest rates is practically over and yield curve spreads have become extremely tight. It is widely expected that the sheer size of the market, with its economies of scale and cheaper financing, will generate a new supply of corporate debt which had been missing up to now. Yield curve plays had been the name of the game in unconnected markets dominated by government issues. Gradually, as the markets acquire greater depth, spread management will be key to good performance.
In the equity area, asset allocation was essentially focused on individual countries. It is now widely accepted that Europe-wide sectors will take precedence; the real issue is just how much more important. It should be kept in mind that Euroland will not, in the foreseeable future, come close to the degree of integration which prevails in the US. Taxation is still a national issue, economic cycles have not converged, most companies are either worldwide in focus or else have a strong domestic bias, etc. Actual convergence of economies and institutions will be a very long process, probably measured in decades. A critical factor will be the consolidation of existing national companies into genuine Euroland companies.
Even though such changes in capital markets may turn out to be a slow process, organisations need to be adapted to meet these new challenges. At BNP, these changes were made as early as 1996.
The changes in the fixed income area received top priority because the emergence of a unified bond market will happen first. The French team took responsibility for all of Euroland, so as to better coordinate the strategies. A credit analysis team was built up and a joint venture with an American group is under consideration to speed up the learning process.
At about the same time, in the equity area, the French and European teams merged and a new emphasis was put on sector analysis. Though managers remain primarily responsible for following one or several countries, they have received a secondary area of responsibility with one or several sectors to monitor, reporting findings to the group as a whole. Such a matrix organisation has greatly contributed to an integrated team.
Though these changes were undertaken to adapt to a perceived changing environment, one may want to reverse causality. It is precisely because management groups are getting organised to deal with the euro markets as an integrated capital market that integration will happen faster than economic analysis would warrant. This is another instance of self-fulfilling expectations.
Traditionally, French investors, whether individuals or institutions, have been heavily biased towards money market and bond funds as well as domestic investments more generally.
Since the beginning of 1996, the proportion invested in money market funds has diminished, due to low interest rates, whilst the share of equity funds has increased, due to buoyant markets. Some would like to believe this is a permanent change in behavior and put forward valid arguments like better performance over the long run, concerns about retirement, etc. This is possible, but one should wait for a bear market.
Far more meaningful is the fact that investors are increasingly considering Euroland as their domestic market. The change took less than one year and was the result of intense communication. BNP was the first to open fire mid 1997 by launching three funds which were the euro version of three of its major domestic funds. Because they were already familiar to the bank's clients, except with the geographical investment area, they met with great success : close to $1bn was collected in less than a year.
Now, euro funds have become a standard. No month goes by without several being launched. And there is a wide variety of products : actively managed funds, index funds on Dow Jones Euro Stoxx 50, guaranteed funds, etc. Even funds designed for the French PEA tax saving scheme (Plan d'Epargne en Actions), which are required to hold a minimum of 60% or 75% in French equities, are now increasingly investing the remainder in euro stocks outside France. BNP made the change for one of its funds : assets more than doubled in eight months, after having been flat for several years.
There is a clear break away from old culture, which is already showing up in industry statistics. The changes in patterns of investment were engineered by French investment management groups through strong marketing and the abundant supply of new products.
Entry into this market is difficult for newcomers since other forms of distribution, like IFAs and funds supermarkets, are still very marginal, and are expected to stay small. There is no lack of supply of equity funds where foreigners might believe they have a competitive advantage. In addition, the French market is not that attractive in terms of profitability for an outsider. Loads and fees are low because distribution through an existing branch network is highly cost efficient. Therefore, one should not expect prices and margins to go up.
As a result, foreign management groups have focused their strategy on either acquisitions for the purpose of buying market share or on supplying their expertise or products to existing manager-distributors. It is worth noting that major players, including BNP, have started offering funds of funds with outside managers to their own clients. The rationale is that investors will be increasingly reluctant to buy only one brand. Funds of funds is a way to meet this desire to go shopping whilst, at the same time, maintaining control of distribution.
The French government, fearful that the French industry will face increasing competition, has finally taken major steps to improve the competitiveness of the industry by authorising umbrella funds as well as master feeder funds.
Most important is the possibility to use the master feeder scheme. It will allow to rationalise and to reduce costs dramatically. By pooling the assets of different funds, it will improve stability of assets under management and therefore enhance performance, whilst allowing marketing differentiation. And because the French government will authorise, subject to reciprocity, the master and the feeders to be domiciled in different countries, the rationalisation can be far reaching.
Many French management groups are gearing up to supply their products or expertise to clients in other countries. Some already had experience with high net worth individuals. For instance, one quarter of BNP's business in this area is foreign based. However, selling to other distribution channels or to institutions is another matter.
Selling to institutions requires conformity to American standards in answering RFPs and in reporting to clients. Two years ago, French investment managers had very little experience in this domain. Since then, American and British consultants have advised a number of portfolio management groups. Changes have been dramatic, from design and implementation of investment processes to information technology. More needs to be done, but the momentum is there.
Third party distribution outside France is also fairly recent for French management groups. Clearly, building foreign distribution where local competitors are well entrenched is an arduous task requiring persistence and significant investments.
However, French banks have a competitive advantage over American and British management groups with their know-how of fund distribution through bank branch networks. It is not uncommon to offer such expertise together with the asset management capability.
Robert Marjolin is marketing director at BNP Gestions in Paris.