Working towards DC-day in Europe
Peter Marshall explains that the US may not necessarily be victorious in the European defined contribution stakes
Readers of IPE - including American fund managers - are well aware of the trends pointing to the explosive growth potential in defined contribution (DC) pension markets throughout Europe.
Most European observers assume that as DC markets evolve, they will prove an irresistible magnet for American investment management firms.
If one makes a simple linear extrapolation to Europe from the American DC market, there is justification for European firms to fear American competitors. In the 15 years that 401(K) plans - the most dynamic segment of the DC market - have existed, the DC market has grown from almost nothing to $1.3trn at year-end 1996. The top ten firms managing mutual funds for the DC market control over 25% of the market (Source: Pensions & Investments). None of these firms are commercial banks or insurance companies - the traditional providers in Europe.
Success in the 401(K) market requires a combination of the following capabilities: inexpensive, accurate, detailed and timely recordkeeping for individual participants high service quality for employers and employees brand name mutual funds
Each of these capabilities is a departure from a European - or British - model of success in fund management. US recordkeeping operates at a scale unknown in Europe, with firms spending tens of millions of dollars annually on technology to improve efficiency, raise service standards, and lower unit costs. Recordkeeping re-quires a 'service factory' environment, with manufacturing-type econ-omies of scale, and management skills that have had little opportunity to develop in Europe.
Customer service in the American DC market typically involves toll-free telephone access 24-hours a day, seven days a week. Response times for answering phones are measured and monitored, as are 'abandoned call' rates, mean time per inquiry, rate of inquiries solved on first call, and other statistical quality control measures. Customer service representatives have on-line access to all customer records, fund records, fund performance data, and even 'imaged' copies of customer correspondence. The technology investment to achieve this level of customer service is justified by higher customer-retention rates and greater ability to attract business from major companies.
American firms have also invested heavily in 'branding' their mu-tual funds - both at the company level and the individual fund level. No-where in Europe have fund groups developed similar skills - or results-from brand name promotion.
Based informally on what my colleagues and I have seen, most American firms, while aware of their advantages, remain cautious about their level of commitment to the European DC market, for a number of reasons. First, they have learned to be sceptical of Europe as a market for their services. In many parts of Europe, the purchase of pension services is driven by existing business relationships, not by investment performance or superior service. As a result, in the defined benefits pension markets, even those US firms that have made inroads in the UK, Netherlands and Switzerland, have begun by targeting European subsidiaries of their US multinational clients. Unless the buying behaviour of European investors moves toward the US performance-driven model, the prospects for American firms seem limited.
A second reason for caution is the political uncertainty reflecting the definition of these markets. At the EU level, there is no pensions directive, although a Green Paper has recently been published. At the national level, many countries are in flux. Italy, for example, passed its enabling legislation for DC plans in the summer of 1995, but final regulations remain to be written and the exact shape of regulation remains unclear. The details of regulation matter considerably. Will employers or employees choose the DC providers? Will employees have choices between investment portfolios? Will the portfolios be mutual funds or some other legal entity? These details impact both the definition of the competitive landscape, and the actual requirements for providing services to the marketplace.
The issue of service requirements is itself a third reason for caution on the part of the Americans. The presumed advantage that the US firms hold in terms of technology results from the large scale investments the Americans have made in recordkeeping systems and telephone 'call centres.' But can these technologies simply be exported to a different business environment and culture? We have seen repeated instances where subtle differences in accounting policies, tax reporting, or regulation render a US system inoperable in Europe without significant additional investment.
A final reason for caution is simply the uncertainty of timing and payback. Although the European DC market qualitatively looks attractive, at the current time it is next to impossible to establish accurate quantitative measures for when to invest, how much to invest, and the timing and level of returns on the investment. The result of all these cautionary factors is that many American firms are taking a 'wait and see' approach to the European markets.
If this article has portrayed reasonably accurately the viewpoints of major S fund managers, an American 'invasion' is not imminent, although competitive DC programmes from a few US firms will materialise. Rather, one should expect a significant number of joint efforts. These may come in at least two categories:
Hybrid firms: With the number of US money managers that have been purchased by European banks and insurance companies, a growing number of 'hybrids' can combine in one corporate entity the US skills in technology, customer service and investment performance with existing European relationships and distribution channels. European DC markets appear a natural next step for many hybrids.
Joint ventures: the same pooling of American skills with European relationships and market knowledge may happen via joint ventures rather than direct ownership.
Hybrids and joint ventures would appear to be strong contenders for market leadership, with the added benefit of reducing the risks and uncertainties for both Americans and Europeans.
Yet before conceding victory to hybrids and joint ventures, it is important to understand why in the US the banks and insurance companies have lost control of the DC market.
A focused DC business presents real challenges to the typical organisational structure of large financial institutions. The end purchaser for DC (the employer) is institutional, belonging to the 'wholesale' side of the business, while the products, technology, and customer service requirements are 'retail,' favouring the skill set on the consumer side of the business. In addition, portfolio managers often run the investment management business, and typically are not interested in retail products or service levels, or in spending the money for superior customer service. Hence in the US, most banks and insurance companies have not been able to reconcile the competitive requirements for this business line with their internal organisationalstructures.
These issues are not likely to be any easier to resolve in Europe, for very similar reasons. Thus European banks and insurers repeat the mistakes of their American counterparts. Despite the apparent advantages enjoyed in theory by the hybrids and joint ventures, real success in the European DC market will be enjoyed by those firms with single-minded organisational focus, aggressive investment in technology and customer service, superior marketing and good investment performance. Many of these firms are likely to be American.
Peter Marshall, a principal with Ernst & Young LLP in New York, is co-chair of Ernst & Young's Global Investment Management Committee.