On avoiding hostages to fortune
There is no disputing Northern Trust’s powerhouse status in global custody and asset servicing in Europe. In the UK alone, a big custody contract was renewed by the London Borough of Hillingdon’s pension scheme in 2012, and, along with several similar renewals, it added €19.5bn in custody assets for 13 new clients during 2011, including major names such as the Lothian Pension Fund, the Lancashire County Council Pension Scheme and the Superannuation Arrangements of the University of London (SAUL). Transition management mandates were won from the likes of the Northumberland County Council and Royal Borough of Kensington and Chelsea pension funds. Losses - such as the East Riding Pension Fund custody mandate that went to State Street - were rare exceptions in the effort to remain a go-to service provider.
But in investment management the dominance isn’t so clear. As CEO of international markets Wayne Bowers observes, with $716bn (€537.4bn) AUM - $123bn from clients outside the US - Northern Trust AM can stand alongside any firm in London. It makes 15th spot in IPE’s latest Top 400 Asset Managers survey.
“We’ve worked hard to build that,” Bowers says. “And we have done it by focusing on client segments where we have multiple capabilities in services they need - sovereign wealth funds, multinational corporates, superannuation schemes and large European pension funds.”
While other parts of the bank are tightening belts, investment management is putting on weight, completing an expansion programme in Hong Kong, including front-office index management and equity trading backed up by new risk and compliance functions. It has also made two key hires from BlackRock to help move client relations in Benelux from London to Amsterdam, and established a new presence in Stockholm.
And yet, plenty of asset managers outside IPE’s Top 15 enjoy a higher profile. Ironically, a recent major mandate perhaps exemplifies Northern Trust’s curious position. The €10bn Pensioenfonds Vervoer hired the firm to monitor its external mandates while it went hunting for a fiduciary manager. Robeco eventually got the nod - but it is interesting that Northern Trust should have held the interim position while not putting itself forward for the permanent one, particularly as this is the kind of full-service mandate that it appears to regard as its natural métier. “We are trying to position ourselves as a provider of solutions,” as Bowers puts it.
Of course, every institutional asset manager CEO says that. Bowers, however, is unusually candid in addressing the challenges of actually pulling it off in Europe, where the industry works in ways that can make it difficult, or limit the ambition to becoming a respected provider of efficient whole-portfolio ‘services’, instead.
“The ability to listen to and develop relationships with our clients is a central part of our culture,” he says. “That’s very different from being a product-pusher - a provider of a certain fund or style which has a certain visibility in that one capability for which they are always requested. But the buying mentality at European pension funds, involving rigorous selection processes for certain capabilities, is somewhat at odds with our business model. For that reason, our presence in Europe has been through single-mandate selections, rather than the solutions prospect that we prefer to describe when addressing the wider market.”
This might explain why the UK has been particularly hard to crack, despite the asset-servicing strength. Bowers points to the thought that went into making sure the firm’s Dublin Common Contractual Funds were scaleable for its global clientbase, benefiting from the worldwide success of the UCITS brand, while leaving the UK market a little cold. But building relationships with the consultant community is also tricky if you want direct engagement with clients, rather than a role as the specific peg that fits into a pre-determined asset-allocation hole.
Bowers describes how the core business strategy has been about identifying strong themes, and how the big one Northern Trust picked up on 5-7 years ago was core-satellite, alpha-beta separation and a general move towards asset allocation versus manager selection.
“You have large asset owners trying to improve the adherence of their asset and risk management to regulation, at a cheaper cost, and that’s where we come in,” he says. “Our ability to manage any pool of assets against a customised index is extremely strong. We see ESG and regulatory change affecting what asset owners can have exposure to, for instance - which means they won’t be able to manage against plain-vanilla indices. Our index capability has been utilised in that context, obviously, but so has our cash-management capability where clients using derivative overlays no longer want to hold collateral with investment banks.”
Bowers points to the success of a recently-launched MSCI ACWI IMI ex-Japan strategy, packaged as a Japanese trust, as an example of a passive solution deliberately tailored for one group of institutional investors. However, it is tough to sell the full benefit of this customised-beta potential when asset allocation decisions are being outsourced to intermediaries, who then favour the cheapest and simplest market solutions with incumbent, volume-driven players.
“We are seeing governance structures changing - for example, around responsibility for things like asset allocation in the Dutch and UK markets,” says Bowers. “But it is part of our challenge to be seen, not as a competitor, but as a partner with the consultant community that currently deals with those functions. We’ve had more progress through direct client relationships - through direct approaches or the RFP process.”
The obvious thing would be to develop the manager oversight capability that Vervoer used into a full fiduciary management solution. But again, Bowers eschews the easy soundbite and maps out the dangers - specifically, the peril of leaving expensive hostages to regulatory fortune.
“We have had a significant presence in the US delivering the investment programme solution,” he says. “The wealth business has driven the incorporation of asset allocation into that service, and institutional clients are taking it up. But outside the US we see significant, ongoing change in the regulatory landscape around risk and asset management, and our challenge there is to make sure we offer services that will still be relevant in a few years’ time. In the Netherlands, we had the trend towards the full outsource, but now the regulator is saying: ‘Hang on, you can’t do that’. If you focused on that game five years ago, you are suffering, now.”
And the regulatory uncertainty around fiduciary management is nothing to that around the trends in LDI, de-risking, recovery plans and ‘flight paths’, thanks to the revolutionary potential of the forthcoming IORP Directive.
“Seven years ago Dutch pension funds were assuring me that FTK wouldn’t happen, and that, if it did, all those years of good relations with the DNB would see that it didn’t have a big impact,” Bowers recalls. “Solvency II has been the same. We know that it will be deployed on pensions in some form or another, but these significant changes around how UK and Dutch schemes, in particular, are expected to report assets versus liabilities, are still being worked through, but also anticipated. We are looking for more clarity before we start working on solutions - fund-based or segregated - so we can be sure that they make sense for the pensions community.”
In the meantime, however Solvency II - or any other regulation - works out for pension funds, one thing is for sure: it will necessitate a re-think of investment strategy and turnover in portfolios. As Bowers observes, Northern Trust AM will be standing by with its formidable transition-management capability. While solutions await their true time, the firm will maintain its grip on the nuts and bolts and pipes of Europe’s pensions industry.