Italy is the wild child of Europe – a market that conjures up memories of high inflation, political instability and financial insecurity combined into a heady cocktail that was liberally laced with corruption. The child is now grown up but is the market as attractive a destination for investments as it is for holidays?
In the past 10 years, Italy’s profile in the investment market has changed dramatically. In 1991, the whole Italian mutual fund market registered some E35bn in assets. Today, Lipper data shows the largest Italian fund provider, San Paolo, ranking third behind the leading European supergroups, UBS and Deutsche Bank, with assets of over $90bn. Italian groups also occupy fourth and fifth positions in the table. In terms of market size, Italy has now overtaken France to become the largest market in Europe, with assets of E487bn at the end of February.
The evolution from ‘wild child’ to ‘young adult with prospects’ was not just dramatic. It was astonishing, and it revealed the power that the banking community exercised over their investors. Between 1991 and 1999 fund assets grew at a compound rate of 38.8%, according to Lipper, compared with a European and US average of around 19%. Growth over the more recent five-year period came close to topping 50%, following a doubling of asset size in both 1997 and 1998. The factors behind this change were complex, but essentially developed from the EMU and the economic pressures placed on prospective members. Growth has been hugely beneficial to Italian bank promoters who were able to engineer a wholesale move of their deposit-based clients into funds. Good business if you can get it, but this huge untapped internal potential has had the effect of inhibiting international growth.
Times are changing and Italian groups are now looking beyond their borders. Luxembourg and Dublin funds are attracting noticeable levels of investment and institutions wanting access to Italian bond and stock investment expertise can use these funds. Assessing the worth of domestic funds is much more problematic.
Italy suffers more than any other country from the difficulty of comparing the performance of their domestic funds with those from other countries. Currently, Italy is the only country that calculates performance net of tax. All taxes are paid by the fund – a positive advantage for the retail investor who does not need to be concerned about making additional declarations. However, it means that the only official NAV is net of tax and this seriously penalises Italian funds in any cross-border performance comparison. Not only are returns diminished by the immediate cost of taxes, but the effect is compounded over time. “Over a five-year period the amounts that are lost to tax have the effect of a regular dividend payment,” explains Fabio Galli of Italy’s mutual fund trade association, Assogestioni. “If these amounts were reinvested, there would be a significant cumulative effect, particularly in the bull markets we have experienced in recent years”. Assogestioni is working hard to resolve the problem. “We want to find a solution quickly and have it accepted by the Gips standards commission” says Galli. Until then, Italian fund management skills will not easily be spotted because institutional investors are not necessarily aware of the tax effect; and an assumption of underperformance is too easily made.
Tax has also proved to be a barrier in another way. Legislation taking effect in July 1998 introduced the current 12.5% “substitute tax” payable annually for gains accrued during the previous calendar year. However, although the legislation also provided for non-resident investors (if they reside in countries which do not appear on the Italian blacklist of tax havens and exchange information) to obtain a tax refund (15% of profit distributions and/or net capital gains on redemption), procedures to implement this were not immediately forthcoming. “In fact” says Vivian Donath, a specialist fund lawyer with Capurro, Michetti e Roj, “only in December 1999 did the tax authorities adopt these regulations which appeared in the Official Gazette on March 16, 2000!” Now Italy’s “substitute” tax can be reclaimed by non-residents – a benefit, but institutional investors must still bear the administrative costs of obtaining the refund (the documentation to be filed includes certification by the tax authorities of the investor’s state of residence).
Whether or not the 15% refund is sufficient to compensate for the effects of a 12.5% ‘substitute’ tax applied (and paid) annually to accrued gains will of course depend on the circumstances of individual investments.
Another point worth noting is that the legislation provides that non-residents’ refunds are to be paid by the relevant funds (they are to deduct amounts payable by way of refund from the substitute tax payable to the tax authorities) and not by the tax authorities. Obviously this will work well only if aggregate amounts payable by way of refund to non-residents do not exceed the substitute tax payable to the tax authorities.
In any event the legislation also contemplated the launch of funds dedicated to foreign residents (private individuals or institutions). No tax is payable by these funds so they are as tax-efficient as Luxembourg or Dublin funds (provided that ownership of units is not transferred to residents and no bearer shares are issued). However, once again the implementing rules (which list the documentation to be filed prior to subscription and redemption as well as providing that funds must forward the information contained in this documentation to the custodian bank before any distributions or redemptions are paid) were published in the Official Gazette in March.
Perhaps this is why only two such funds (according to Assogestioni) have been launched since the law was enacted. Nevertheless, the door is now open for foreign investors and procedural clarity will build with experience.
What then can Italian managers offer? “They recognise that they are coming from behind and that competition in the more mature markets is tough,” admits Galli. “However, they have a high level of expertise in managing bonds with foreign exchange risk and, of course, they understand their own stock market”.
The opportunity now exists for Italian fund managers to move away from home. The first signs of this happening can be seen in the recent announcement of Unicredito’s acquisition of US investment house Pioneer. This is a bold move and proof that the Italians are ready to play on the world stage.