In the US, Northern Trust (NT) is a bank of two parts. The first is the corporate institutional services and the second by contrast the management of personal wealth through private banking type operations for mainly domestic clients. “The institutional business is a global custody driven business, with $1.5trn in assets in that segment on a worldwide basis”. (e1.7trn), says the group’s chairman Bill Osborn, at headquarters in Chicago.
The fastest growing region is Europe, particularly the UK.” He attributes the phenomenal growth NT is having to the withdrawal of other banks from this area, along with the jump in cross border investing. “These are huge factors driving the activity, ” he says. “Now there are just a handful of providers with the technology and the people.” The group has grown its institutional asset management business very effectively on this base in his view.
In the US, NT’s pension roots go back to the 1970s with the arrival of Erisa pensions business and the need for master trusts for domestic business and then the global custody business overseas, as the portfolios developed in the early 1980s, Osborn explains. “The question for investors was one of diversification and risk management in portfolios.” But despite the demand, there are just a limited number of players willing to put the resources into the custody business. And in fact those that did, realised pretty quickly that from a shareholders’ viewpoint they needed to provide more than just custodianship. “You have to have a mix of products to generate the returns required. Initially, this came from managing the short-term cash, by sweeping it automatically into vehicles.” Since then, some asset classes have become more commodity-like and amenable to indexation. “So investors looking at indexed portfolios, which are low cost and technology driven, these should be a natural for our custodian to do,” he says.
Similarly, in the case of fixed income assets, as these are “relatively low return”, they too are more commodity-orientated. “By this I mean if you are going to get value from your portfolios, you are not going to get as much of it on the fixed income side as you will on the equity or alternative investment side.” The challenge for the custodian was to be competitive in developing the area of service for certain clients. “In addition, we have had very good returns on the active equity side, which clients are always interested in. We attracted a team recently from Julius Baer in London with a strong track record on the equity side to expand this aspect to the European market.”
So when it comes to asset management, for example, he believes the group has established itself as a very serious player, which has proved timely considering the fast pace of consolidation in the business. “We have been able to layer that in.”
Northern Trust Global Investments, which looks after traditional investments has a total of $338bn under management, which grew by 29% in the first nine months of 2000, while assets under custody were up 20% plus. “What we are trying to do is grow assets under management faster than those under custody, because that means we are bringing more value to the client and to the shareholders.” The specialist manager of manager operations, now looks after some $16bn in assets, Osborn notes
He acknowledges some custodial clients will never accept the group as an asset manager as they see it as a conflict situation. “That does happen, but not everyone feels that way. Many will have groups who will evaluate us on our merits in the different areas. So they may say, you re our custodian, but if you have a good track record why not use you. If it is done at arm’s length, it can work out.”
Securities lending is a major product now, which he considers to be a quasi-investment service. “Foreign exchange has built up to be a very important factor in a revenue and value perspective to both our clients and to us.” These products cluster around the asset pools and if a custodian is very proficient in these areas they can add value, he maintains.
Osborn sums it up: “We have evolved our business around the issue of how do you add value to your clients? The value can come from acting as a custodian, as a manager, as a consultant, how you can understand risk, or even by helping to pick managers. We can really provide nearly anything they want. Though we understand that not everyone will want everything.”
The consolidation in the US has meant all custody players are picking up business, but the impetus coming from new DB pension plans has slowed down as more DC plans come on stream This growing market for NT is being serviced by the group retirement consulting operations, where Osborn says it ranks number 10 in US plan providers. “We are also finding that segments of this DC business feed into our private banking operations. As when people retire they continue to use us and we are getting some nice linkage. That has been part of our strategy to build around this.”
But while growth in the US continues, it is definitely not as fast as on the interntional side, where Europe has accelerated over the last five years. The arrival of the euro has added a further impetus, particularly the interest in using international funds, which is the reason for the acquisition of Ulster Bank’s fund administration business in Dublin. “Fund managers themselves are a major force for change in market. But their back office administration is not something we have gone after, as others have, due to the growth in our core business. “Our eye is always on the opportunity to sell as broad a range of product-mix as we can.”
The group’s pretax margin is 36 to 37%, coming down to 22 to 23% after tax, which compares well with some other competitors’ 22% pretax and 14% after tax, he maintains. “We have a 50% better margin and one reason is this product mix and the type of clients we have which give us the greatest opportunity to sell our products. We have not gone after the mutual fund industry, while for some custodians, 70% of their business is mutual funds. We just look at it all a bit differently.”
Osborn thinks there is a lot water to go under bridge before there can be talk of the custodians moving away from their core product of safekeeping and settlement and concentrating on the more profitable add-ons. “We have to get to T+1, straight-through-processing, make sure the depositaries are more efficient, and that the securities industry has a better settlement process. So in terms of the reality, such moves are a while off.” But should global custody disappear, he has no doubts that the group will have surrounded itself with an array of value-added products so see it continue to prosper.
He agrees that Europe looks like following a trajectory similar to that of the US, but with an even stronger trend to DC services requirements from the market, adding that in some respects Europe could end up leading the US. He points to the day when schemes in Europe will be able to pool their assets in some pensions vehicle which will reduce costs. “It needs political action, but it has to happen.” Tax differences will always add their own twist, he notes.
The consolidation in the UK, with players dropping out of the custody market is a trend he expects to see happen in all of Europe. “I think there are five or six global custodians in the market today, I don’t see that number growing. In Europe, many schemes are handled by local custodians and so on. All that is part of the opportunity we see. I don’t see that any of these local custodians getting into the global business. It is too hard, too much investment is needed.”
Could the global numbers shrink further? “Yes, you may have one fall out going forward. I think the major ones are in it for the long term.”
He shrugs off any suggestions that NT will not be able to make it on its own. “Five years ago, people were saying this. Just look at us today! Who has survived and who has delivered the returns! Because we are focused on just a few businesses and have invested heavily in these, I think we will continue to do well.”