Last December Ireland’s asset management industry was rocked by the sixth defection from Bank of Ireland Asset Management (BIAM) to Autralian financial services group Perpetual Trustees. BIAM was still reeling from the initial shock of the first four departures in October; now concerns regarding the bank’s ability to maintain its leading position in the Irish institutional market have intensified.
The departure of BIAM UK head David Boal follows that of former deputy Bank of Ireland CIOs Des Sullivan and John Nolan, senior portfolio managers Richard Kelly and John Forde, and portfolio manager Sarah Molloy.
Perpetual is expected to set up a Dublin-domiciled global equities business early next year.
It has been reported that since the first four departures in October BIAM has lost some E6bn in mandates. The losses have come predominantly in BIAM’s north American business where BIAM manages a number of EAFE mandates. But Tom Geraghty at Mercer suggests that the defections are only part of the story: “The money was pulled because the performance had been quite disappointing in this area,” he says. “The departures were the straw that broke the camel’s back.”
Opinion is divided regarding BIAM’s immediate prospects. One Dublin-based consultant notes: “When the first four left, BIAM reassured the market that that was the end of it, so it was a major blow when two more went. I don’t see how performance can’t be affected.”
David Kingston, chairman of Dublin-based consultancy Acuvest shares the sentiment. “They have a fundamental problem in that BIAM CIO Chris Riley, who has a great reputation and is a very capable manager is going to retire at some point. The perception of BIAM is that they are very reliant on him and the problem is that those that left were those most likely to take over. The continuity has gone. I would say that it will take two or three years to rebuild it.”
But at the other end of the spectrum is a weight of opinion that feels that BIAM will ride out the storm. Russell Irvine, actuarial consultant at Aon’s Dublin office is sanguine. “BIAM probably have the deepest and strongest of the management teams in Ireland.”
Tom Geraghty at Mercer Investment Consulting also takes a positive view: “There have been some good hires recently which should help to mitigate the problems caused by the departures.”
He adds: “BIAM have built up a huge loyalty over the last 20 years. A lot of pension plans have given BIAM the benefit of the doubt and some breathing space to make the appointments they need to make.”
Kingston argues that BIAM’s attitude will also be key: “The next couple of years are going to be critical and they will have to make some tough decisions. They will have to become much more flexible.”
The wobbles at the top of Ireland’s indigenous asset management industry are the last thing it needs at a time when global players have been coming onto the scene and taking significant market share.
The foreign influx has been supplying the growing demand for specialist management on the part of Ireland’s larger pension funds who are eager to take more control of their investment portfolios.
Balanced management suited the Irish managers very well because clients wanted a high allocation to Irish equities, particularly prior to the euro. But there is concern that the size of the local asset managers and their traditional business of balanced management make them ill-suited to providing the growing specialist mandate business.
One senior pensions industry source said: “the larger schemes are looking at the specialist services of the global players and not all of the local managers are considered to be on that stage. Global players have larger teams focused on the various markets all over the world, while the local managers claim to be global without having the team behind them.”
Resourcing is a key issue, and in this regard the local managers have their work cut out. “How can the Irish managers evolve as a force against the international players if their fees are lower?” the same source asks.
Gerry Keenan, director of investment development at Irish Life Investment Managers is unequivocal: “There is a rationalisation that is happening in the business at the moment. It looks as if only two players are standing shoulder to shoulder with the globalisation of the Irish market, and that is ourselves and the Bank of Ireland. That is a factual description of the position. Any pension fund consultant will tell you that.”
Cue Aon’s Irvine: “In 10 years there may be two Irish managers left: Bank of Ireland and Irish Life; the rest will be subsumed into something or the other.” He adds: “The influx of foreign competition is the main challenge facing local asset managers in 2005.”
Mercer, Ireland’s largest consultancy, has come in for criticism from many local managers for recommending foreign players. But as Geraghty points out: “Leveraging our global research capability we saw international managers who were, to be frank, more suited to some of our clients, especially as we moved more from the balanced to the specialist structure. This is particularly in relation to global equities where the potential of the international guys can add quite a bit above and beyond what some of the domestic players could offer.”
The growing demand for specialist management can be catered for by local managers in-house where the specialist teams and track records are in place. Where they are not, many are looking to outsourcing as a means to provide a full product portfolio.
“We see ourselves as an active house but realised that crucial to provide indexation where the crucial factor is scale,” says BIAM’s Lardner. “It was not credible for us to do indexation on our own so we set up an affiliation with State Street. We service their products.”
Irish Life has adopted a similar approach: “I believe that there will be a need for things like private equity, hedge funds, timber and global property,” says Keenan. “We are identifying overseas partners to work with in those areas.”
But while the moves being made by Ireland’s larger local managers provides reassurance that they will be a force for some years to come, the industry in general still has to bridge a confidence gap.
A senior figure at one of Ireland’s largest pension funds cites the recent call for tender it placed for a fixed income mandate, noting that the foreign manager “had an excellent grasp of the subject and their analytical tools which was way ahead of what the Irish had. The Irish managers tended to specialise in balanced mandates where fixed income is only one part”.
This is perhaps not so surprising, with pension funds in Ireland still largely equities-based and the pension funds of continental Europe much more focused on bonds.
While it is not a surprise, it is a concern, not least because of the impact that the new funding standard will have on the investment strategy of Irish pension funds.
The standard imposes strict solvency requirements on pension funds which, in the words of another senior source from the pensions industry “will force funds to have portfolios that are more bond-based because the need to match liabilities in the event of wind-up”.
So far there has not been much movement by funds towards a higher bond content. The source continues: “We have not seen much change in the 150 or so funds that we have scrutinised – and these are the ones that have funding problems.”
The lack of change is all the more interesting given the attitude towards the purchase of annuities. “Funds have not been buying annuities because the feeling was that they would get cheaper – which they didn’t”, says the same source. “But the investment profile wasn’t being changed to take account of the fact that pensions were being paid out directly out of the fund rather than by way of an annuity. They didn’t shift out of equities because they didn’t want to miss the rising tide. This is still the case today.”
The Dublin operation of Standard Life Investments is a case in point, as its investment director Jennifer Richards notes: “We think pension funds should invest in more long bonds but the decision is quite difficult because the average pension fund is up 10% this year, mainly because of Irish equities.”
While long bonds would seem to be the asset of choice from a matching point of view, many feel that they do not represent good value at the moment.
Keenan of Irish Life takes an opposing view. “In 2004 liabilities have risen in most cases by 14 to 15%, and funds which have maintained a heavy equity structure have seen a return of around 7-8 %,” he says. “So they have suffered a growth in the deficit or reduction in the surplus. The reality is that anybody has adopted a position of holding off going for long bonds has seen their funding position deteriorate over the last couple of years. Yes, bonds look relatively expensive but my advice is to average into a bond position.”
There is a feeling that part of the problem lies with the managers. A Dublin-based consultant notes that managers have focused on investment performance rather than risk and not tying in of assets and liabilities. “Managers need to look at absolute return; they have to recognise that they have to stop following the peer group and move on and do other things to make it work for the client. None of them are willing to take any kind of brave step that might be right for their client if it is wrong for their business risk.”
According to Keenan the problem is global. “It has manifested itself in that clients, asset managers and consultants sit separately and the quality of dialogue is very poor,” he says.
“Investment managers are not given information as to whether the fund is paying the pension via annuities or out of the fund. The trustees and consultants generally don’t share this information with the investment managers.”
The lack of movement in the asset allocation of pension funds can also be traced back to consultants. “A lot of the ALMs that have been done but haven’t taken as much account of the liabilities as you would expect,” says Kingston. “They were more asset maximisation models. The actuarial profession of which I am a member has to some extent closed its eyes and didn’t look at what was happening in terms of the shape of pension funds.”
Dan O’Donovan, managing director at Setanta Asset Management is scathing: “To be candid I don’t think the consultant is much of a custodian of investment knowledge as they might think they are. So perhaps they are better off stepping aside.”
The relatively high price of bonds has prompted some managers to create interim solutions.
BIAM advocates high-yield equities. Lardner: “The dividend yields that are available on some companies, sometimes more than 3%, don’t solve the matching problem but do provide a cushion against it.”
While funds may not be shifting their asset allocation as much as they might, asset managers are responding to the increasing importance of bonds. Ruth O’Briain, managing director at F&C’s Dublin office and chair of the Irish Association of Investment Managers notes: “Over the last two years more managers have launched long bond funds; they have also launched corporate bond funds and European index-linked bond funds. So we are trying to bring products through to ourselves the flexibility to match whatever our clients require as they move towards fixed income.”
One can understand – up to a point – the ongoing interest in equities and the reluctance to shift in the backdrop of the Irish stock market’s continuing outperformance relative to the rest of the Euro-zone. In 1999 the view was that Irish equities would account for between 2% and 5% of Irish pension funds by today. But the reality is that they still represent about 17%.
“We recently increased our allocation to Irish equities to 18%,” says Richards of Standard Life Investments. “But our selection is very stock specific; the companies we invest in are well managed and perform well. Our biggest stock weighting is about 3%.”
The consultants promulgated the view that when Ireland joined the euro funds shouldn’t have a big exposure to Irish equities because of stock specific risk. “Our view both then and now is that the Irish equity market is undervalued, so this has been bad advice,” says Acuvest’s Kingston.
He adds: “Most Irish pension funds have been reducing their exposure to Irish equities considerably; some are down to 1% or 2%. But their liabilities are largely in Ireland and it was wrong to say that European equities are a proxy for the Irish economy; maybe they will be once Ireland has been a member of the euro for 20 years. The Irish economy is growing much more rapidly than the rest of the Euro-zone and the prospects for Irish companies are better than for European companies, so if you can buy good Irish companies on lower P/Es and higher yields than their equivalents in Europe then frankly it is an academic argument. So by and large Irish pension funds have suffered very badly though reducing their allocations to Irish equities.”
The fact that allocations to equities among funds in Ireland are relatively high suggests a willingness to take risk. It is therefore interesting that alternative investments have been slow to develop. “One or two fund managers are providing hedge funds locally,” notes O’Briain. “One of the big issues is the learning curve that trustees have to climb in order to devote assets to those classes.”
The other area that pension funds are talking about is European real estate. “We have been suggesting that property weightings should be re-evaluated,” says Sean Hawkshaw, CEO, KBC Asset Management in Dublin. “From an Irish institutional investor point of view the cost of investing in Irish property is extremely high: there is 9% stamp duty, and all the charges on top can make it 12-13 % altogether. The market is strong but the cost of getting in is huge so investors looking overseas.”
Overall the asset allocation picture seems to lack sophistication. “Generally most asset managers have not diversified enough,” says a Dublin-based consultant who points out that the focus on equities has cost local managers dear. “They were betting on equities; some doubled their bets and got it twice as wrong. The fact is that the Irish managers have not performed well; for the year 2004 they are almost 200 basis points behind the indices.”
A good example of insufficient diversification can be found at KBCAM’s, where Hawkshaw is frank: “Traditionally we were a large cap manager with a larger equity weighting than most houses and had a growth bias in the portfolio. That was not the place to be for the last four years.”
KBC’s business has suffered accordingly. Another Dublin-based consultant notes: “Quite a few funds are moving away from KBC saying that they have stuck with them through thick and thin but have now had enough. They haven’t risen on the growth that there has been; they must be getting their stock selection incorrect.”
The major pension fund referred to earlier is closing its mandate with KBC. “Through the market downturn they were continually positioning themselves for a market recovery that never came,” says the fund’s senior executive.
But KBC is responding. “We are moving from being a one trick pony to a provider of multiple solutions,” says Hawkshaw. “We have a multi-manager product in partnership with Northern Trust.”
Manager underperformance and the experience that many funds have had of going from the frying pan into the fire has fuelled the development of the multi-manager business in Ireland.
“That is the primary driver,” says Derrick Dunne, co-CEO at MM Asset Management. He adds: “The large number of small to medium-sized funds makes the Irish market ideal.” It is the smaller funds who lack the resources to research managers, hire them and fire them, and the idea of delegating these functions to professionals is appealing.
The barrier is fees, more middlemen means more cost. O’Donovan notes: “Funds are paying through the nose for it. The client is getting hacked to bits by the charges. I am unimpressed – I can see it as a great way to earn fees but I am not too sure that will add value to the client. It might relieve clients of the burden of making a decision but so does an insurance premium.”
He adds: “And multimanagers do not know how to asset allocate.”
Education and confidence are also key, and this may give other options the edge, for now at least. “If the trustees are feeling unsteady about manager choice I think a lot of funds, especially the smaller ones, will go for passive mandates,” says Aon’s Irvine. “They understand the process of the passive fund better.”
The consultancy market in Ireland is dominated by Mercer; the feeling of many is that this is not healthy for the asset management industry in Ireland. “There is a huge distortion here,” says Irvine.
Kingston voices the frustration of many an asset manager in Ireland: “It must be a real problem if you are a local fund manager sitting on a lot of Irish business,” he says. “Typically Mercer are shifting the bigger funds into three or four managers who happen to be on their a list, which is probably decided in London or New York, not Dublin.”
Geraghty takes up the defence: “The accusation that we have this power and market dominance is something that is constantly thrown at us. The reality is we are competing in the marketplace with many others; why should we be apologetic that we continue to win business or indeed have fostered good and trusting relationships with our existing clients?”
But doesn’t too much concentration mean too narrow a recommendation of asset managers? “We hear this argument all the time,” says Geraghty. “We typically put several different managers in front of our clients, both domestic and international. I would argue that it is the competencies of the manager that sway decisions, not Mercer’s perceived blessings.” But Geraghty assures us that competition is