Investment management groups will have to adapt to international competition, says Carlos Albuquerque at AF Investments

The Portuguese investment fund market has experienced an average annual growth rate of about 38% since 1990. Itis generally admitted that the main growth drivers are related to the economic environment arising from the implementation of the Maastricht convergence criteria. In fact, decreasing inflation and decreasing interest rates have made investment funds very competitive as investment alternatives (See Fig 1).

During this period, the market mix has also changed. While in 1990 nearly 60% of the funds' assets were invested in money markets, by December 1997 that proportion had declined to 25%. Furthermore, the amount invested in equities has risen from less than PTE12bn in December 1990 to 482 PTE bn in December 1997. About 73% of this value - PTE351bn - were invested in domestic equities while the remaining 27% - PTE131bn - were invested in international markets.

Today, the majority of Portuguese mutual funds invest in domestic securities. Nevertheless, in December 1997 there were 15 in-ternational funds, 11 of which were equity funds.

The following mutual fund types exist: money market funds, fixed income funds, equity funds, funds of funds (investing in shares of other mutual funds), personal equity plans (PPA) and retirement investment plans (PPR), which are tax exempt funds with a similar investment policy to other investment funds'. The latter is also available within the insurance industry.

Funds constituted according to the EC Directive (harmonised funds) are generally sold as single entities, in spite of the possibility of joining them in a 'group of funds', established in the Portuguese regulations to work similarly to an umbrella fund. Due to the specific tax system applied to Portuguese investment funds - the fund itself being taxed and the NAV being calculated after tax - the concept of umbrella fund is not as useful in Portugal as in other countries.

The concept of 'funds of funds' enjoys an impressive success in the Portuguese market. Clearly, funds of funds have allowed the largest financial groups to offer their clients a basket of specialised funds boxed in an easily understood structure for the average investor. This success has led to the launch of a broad span of funds of funds, with different risk levels given by the weight of equity funds in their portfolio. Funds of funds have been, in 1996 and in 1997, the industry's flagship products, adding value both to investors and management companies, by simplifying decision making regarding investment strategy and by earning higher fees (See Fig 2).

The market structure has been subject to significant changes, motivated by the new economic environment. Investors are in-vesting for longer periods, adjusting their portfolio to the life-cycle stage in which they are. Between 1995 and 1997, investments in equity funds and funds of funds showed impressive growth rates, signalling a new cycle in the industry.

The market's major players are the largest Portuguese financial groups, through their asset management subsidiaries: AF Investimentos, the asset management holding of the BCP/Atlantico Group and Caixagest, which is the investment fund management company of the state owned bank Caixa Geral de Depositos, the largest bank in Portugal.

These two management companies account for more that 50% of the mutual fund market and, together, they have led the market for several years.

AF Investimentos is currently the leading Portuguese asset manager, with a 28% market share in mutual funds. It also has a Luxembourg-based operation, managing ap-proximately PTE194bn. While Caixagest manages only 15 mutual funds, AF Investimentos is responsible for more than twice that number. The main reason for that is the different distribution structure of both institutions. Caixagest distributes their funds through the branches of one single bank (Caixa Geral de Depositos), while AF Investimentos caters to two banks (Banco Comercial Portuguls and Banco Portuguls do Atlántico) and several segmented networks within them, focusing specific clients and offering specific products.

The top five management groups represent more than 80% of the market (See Fig 3). The remaining 20% are distributed by 12 management companies, all of them part of financial groups headed by banks.

There are environmental and industry-specific factors that suggest the market will continue to grow rapidly. Macroeconomic data (low interest rates and sustainable economic growth over the long run), demographic indicators (increasing seniority rates) and the social security reform (focusing on private retirement accounts), will motivate increasing investments in mutual funds and pension funds.

The implementation of the EMU and the euro will bring about deeper market integration, the loss of relevance of exchange risk as a decision factor in intra-euro investing and an increased transparency in pricing, performance and product structure. This will certainly imply increased competition across national frontiers, that will be specially relevant for wealthier customer segments.

The product mix should change to reflect the higher maturity of the market and the investors, with the increase of equity funds and, in the near future, funds of funds. In the medium term, life cycle funds (or a life cycle approach to individual investing) should be created in order to cater to changing investor requirements.

Furthermore, the euro should introduce the need to think up new ways of diversifying product supply, as geographical diversification loses importance within the EMU. This could be done through sector specialised mutual funds, thinner risk profile definition or the increased emphasis on extra-euro financial instruments.

Banks should remain as the main distribution channel, with an increasing role for personal investment advisory services as a competitive advantage for market-share gain. It is also possible that automatic channels such as ATMs will grow as distributors of investment funds, given their success and increasing versatility as multi-function bank teller substitutes. There is a growing trend among the largest financial institutions to establish alternative electronic interface channels, such as the internet.

This distribution framework constitutes a barrier to the entry of foreign competitors in the Portuguese market, making their growth very difficult unless they establish distribution agreements with local banks or other financial institutions. Their market potential should be limited to the wealthier, more sophisticated, private banking-type customers.

To conclude, we should expect the euro to allow continuing growth in the Portuguese investment funds market and also to facilitate an increase in market sophistication, resulting in higher shares of riskier funds in total managed assets.

Carlos Albuquerque is head of the marketing division at AF Investments in Lisbon