Mixed messages at a time of crisis

While the asset management industry is opening to foreign investors and independence is increasingly valued, the general outlook is still conservative, finds Nina Röhrbein

Outflows of €52bn from Italian open-ended funds in 2007 followed by a further €40bn in the first quarter of 2008 have thrown the Italian asset management industry into a deep crisis. The outflows were driven both by the weakening global environment and the introduction of the markets in financial instruments directive (MiFID) regulations.

And although MiFID was limited to the retail side, this represents some 90% of Italy's total asset management business and so has had an impact across the whole industry.

However, the main victims of the outflows were domestic asset managers belonging to banks, while independent and foreign asset managers escaped most of the impact, says Lars Schickentanz, (pictured left) head of investment at Monte dei Paschi di Siena (MPS) Asset Management.

"In absolute and relative terms, Italy's mutual funds now have a 25-30% lower asset base compared to a year ago," notes Sandro Pierri, (pictured right) head of distribution Europe and Latin America and CEO at Pioneer Investment Management SGRpA. "This is also due to the large amount of fixed income portfolios that suffered when interest rates rose. All this has now forced the industry to rethink its offering." And competition is stiff as international asset managers have been flocking to Italy over the past decade to try to get a share of the growing institutional business.

"The general trend is an opening up of the industry which has so far been dominated by domestic players," says Vittorio Ambrogi, (pictured left) managing director at Morgan Stanley.

"The market offers enormous potential because of the strong saving habits of Italians," says Oreste Gallo, (pictured right) principal and head of southern Europe at Barclays Global Investors (BGI). "The percentage of assets under management managed by foreign asset managers has risen significantly and there is no bias against foreign asset managers."

"The low margins have, in some cases, started moving gradually towards European levels," says Marco Barbaro, (pictured left) country head of BNP Paribas Asset Management in Italy. "And we believe it is important to compete in the institutional as well as in the retail business to build visibility and increase our market share." Others have different motivations.

"We target niche business because becoming a major mainstream player would affect our brand of innovator and margins," says Giambattista Chiarelli, (pictured right) head of business development southern Europe at Pictet Asset Management.

For others, the move into the Italian institutional market has been mainly strategic in anticipation of a sharp growth triggered by pension reforms. "We are trying to convince investors who want to invest in actively managed products to pay the right price," says Filippo Battistini, head of institutional sales at AXA Investment Managers Italy. "But often pension funds want to benefit from the advantages offered by actively managed products without paying the difference between active and passive or semi-passive portfolio management."

Foreign asset managers are also attracted by certain characteristics of the Italian market.

"Most asset management companies in Italy belong to banks or insurers, which means that most of their assets are not independently managed," says Roberto Brasca, (pictured left) director at boutique asset manager Anima. "And this can easily lead to a bias."

In the wake of the current crisis, Bank of Italy governor Mario Draghi was reported to be recommending that banks separate from their asset management business in order to be able to compete better with asset managers in the rest of Europe.

"The idea is that a separation of banks and asset managers would stop conflicts of interest and favour a higher degree of open architecture in bank distribution, and thereby allow the development of more competitive domestic asset managers," says Schickentanz. "And this is the view that the Bank of Italy governor has expressed on several occasions to support the request of separation."

Schickentanz believes that a cycle of M&A activity is partly to blame for the crisis. "Mergers are part of the cause of the disease because there have been too many banking consolidations which do not necessarily lead to better asset management companies if they are not accompanied by a strong rationalisation process: cutting inefficiencies and costs is not enough to overcome the crisis," he says.

"In contrast, and unlike their independent and foreign competitors, domestic asset managers find it difficult to evolve towards more efficient and competitive companies, produce higher quality and internationalise. The solutions for the banks are to shut down or sell off their asset management business or, if they think there is value in the asset management business, create an independent joint venture able to compete in an open market."

MPS Asset Management is set to complete such a process. Around 60-70% of the company, which formerly belonged to Banca MPS, will be sold to a consortium consisting of a private equity group and an industrial non-domestic partner, leaving the bank with a minority shareholding.

"An asset manager that is viewed as being independent has a better chance of penetrating the non-captive market and playing on a par with foreign asset managers," says Schickentanz. "Furthermore, it has to invest in talent and develop suitable solutions for domestic investors."

But while more deals are foreseen not all players are expected to go down that route.

"While we anticipate medium-sized banks to cut their links with their asset management business and sell to private equity or international investors, big banks are not ready to do that yet," says Paolo Moia, who is in charge of pension funds at Eurizon Capital. "And they may even strengthen their asset management business in the meantime."

With no prevailing shareholders, Anima is one of the few independent Italian asset managers. It focuses on retail investment and acquired the mutual funds business of Deutsche Bank Italy (DWS) in 2007.

"Independent asset managers have shown a better performance and in the long run banks may even benefit from concentrating on their distribution business," says Brasca. "With banks managing both the manufacturing and distribution space there is confusion about what services the fees pay for."

"But the issue is independence of behaviour rather than shareholding because asset management companies need to have proper governance to do their job," says Pierri.

Morgan Stanley's asset management business in Italy is typically split into 80% retail or intermediaries and 20% institutional, including pension funds, banking foundations and insurers. However, Ambrogi is confident that the institutional market will expand, particularly if there were more choice of products. "If the institutional market remains exposed to the traditional asset classes eventually there will be fewer asset managers in the market," he says. "But if there is a shift towards alternatives more foreign players will be successful."

Like many other international asset managers, UBS is trying to regain investors' confidence through product innovation. "We have launched a speculative asset management company dedicated to hedge funds in order to meet client demand," says Antonio Chiarello, executive director and head of institutional and alternative business at UBS Global Asset Management.

"Alternatives are becoming more popular because institutional investors are looking for de-correlation from equities and bonds to lower their risk and because a change in legislation could give them a further boost. Last year, for example, the insurance regulator allowed insurance companies to invest up to 5% of their technical reserves in hedge funds, which was previously forbidden."

Current regulations - decree 703/96 - do not allow the open-ended, contractual and multi-employer pension funds established post-1993 to invest in alternatives or take up short positions. However, pre-existing pension funds, the ‘preesistenti', in other words schemes that were founded before 1993, and social security entities, the first pillar casse di previdenza dedicated to self-employed categories of workers, can make such investments. A debate about this issue is ongoing and many market players expect a change of the law in the near future.

"Draft reforms about the flexibility of investments for pension funds were supposed to come into force in June," says Pierri. "Now the chances are a new draft will be issued by December," says Pierri.

"These draft reforms would allow pension funds to use hedge funds and other alternatives by establishing a precise risk-budgeting framework that allows the optimisation of asset allocation as long as it is compliant with the risk budget."

But for now Italian institutional asset allocation remains conservative. According to Chiarello, 90% of pension funds still ask for traditional mandates, with only 10% being open for something new. "Monetary funds, bonds and balanced funds make up the main institutional business," he says.

"Alternative investments are growing as a concept, especially for institutional investors," says Schickentanz. "But Italian investors are particularly risk-averse and even if they have a long-term horizon they stick with a conservative portfolio."

"A typical bond-equities split is 80:20 or 70:30," adds Moia.

"We have seen a shift towards shorter products and a dramatic reduction of equities on the distribution side, as Italians are becoming even more prudent," says Cristiano Busnardo, CEO of Société Générale Asset Management (SGAM) Italy.

But he adds that use of hedge funds especially has been growing over the last seven years. "At the end of 2007, 7% of institutional portfolios was invested in hedge funds compared with zero per cent in 2000. We have 12% invested in flexible products that offer different levels  of equity split and which were, again, non-existent eight years ago."

"The major trend we observe with the big, pre-existing pension funds and some Italian social security entities is that they invest the core part of their fund in indexed products and the satellite part in alternatives, uncorrelated and absolute return products," says Battistini.

"The reason behind this is that most traditionally managed products failed to generate alpha. So now they prefer to invest in traditional passive products in order to get the beta and consider hedge funds, private equity, real estate investments and commodities as the real sources of alpha. "Smaller or less structured pension schemes without the resources for a core-satellite approach tend to adopt a traditional balanced approach."

"Alpha and beta separation is the trend we see particularly with the new pension funds," says Busnardo. "We now also propose index products to contractual pension funds because they are a diversification tool with low fees and a low tracking error. The first pillar social securities funds started using these some years ago."

Even the credit crunch has have failed to push more pension funds towards alternatives. "In the wake of the credit crunch risk reduction is the main driver," says Ambrogi. "Due to their conservative approach, institutional investors have been well protected from the subprime crisis and corporate problems," says Moia.

"But instead of relying more on a professional approach when it comes to asset allocation and diversification investors feel an additional fear of volatility and continue to diversify via European and international bonds and a whole range of equities including emerging markets. They are not ready to invest in alternatives yet although they do show interest."

But while Gallo agrees that it is too early for some alternative asset classes such as infrastructure, he has noticed demand for others such as hedge funds. "The preesistenti also have a large portion invested in physical real estate which they see as low risk," he adds. "The advantage the preesistenti have is that due to their size and economies of scale they are more efficient than the new pension funds, which tend to be smaller and incur higher fees."

Many institutional investors still keep an eye on the costs and lower fees are helped by the market's fierce competition. "Due to the difficulties in achieving alpha, interest has switched from active to passive, liquid investment management," says Gallo. "The high fee structure in Italy helped the cause and so the use of passive investment strategies such as ETFs, traditional pooled funds and segregated accounts has increased. Previously active management that was trying to add value prevailed in Italy."

But Busnardo disagrees. "While price was the key driver for clients a decade ago, the quality of the product is more important today," he says.

Liability-driven investment (LDI) and social responsible investment (SRI) still play a minor role in the Italian asset management industry, despite forecasts of growth. However, Gallo says that Italian defined benefit (DB) schemes are now showing interest in LDI for the first time.

SRI appears to be talked about more often than LDI but in 2007 only five out of 39 preesistenti pension funds had adopted SRI investment lines, says Chiarello.

Nevertheless, Battistini believes that SRI is becoming increasingly relevant to Italian pension funds. "This is due to three different factors: the decree 252 issued in 2005 that obliges pension schemes to declare in their annual reports whether they invest according to SRI criteria, the trade unions, which, as one of the sponsors of the new pension funds, are always more sensitive towards responsible investing, and the increasing familiarity of pension funds with the topic thanks to the groundwork undertaken by asset managers and advisers."

Pierri criticises the number of funds available, which leaves investors with too many choices. "The size of the funds is small because the number of funds is high," he says. "That is why we have gone back to basics with our offering and scaled down the number of products."

Last year's reform that strove to encourage employees to transfer their severance pay, the trattamento di fine rapporte (TFR), to a pension fund has only had a minor impact on institutional investors' requirements.

"As a one-off phenomenon we have seen inflows growing threefold following the TFR reform," says Pierri. "However, the tendency has been to go with the risk-averse guaranteed investment mandates, which is very much in line with the old TFR system."

"We had new requirements for the guaranteed lines following the TFR reform because their provision was a condition for the pension funds affected by the reform to receive the TFR-related funds," confirms Battistini.

"But these failed to attract large investments. Apart from this we did not encounter any new demand."

According to Chiarelli, new pension funds have a legal obligation to outsource all of their asset management, while the social security entities and preesistenti do not need to do that yet.

"But pension funds rely on their asset managers for coverage of the financial markets," says Moia. "They tend to use consultants for asset allocation and manager selection but consult their asset manager for a deeper analysis of the financial markets."

However, not everything is yet set for change in Italy. While foreign asset managers may come into the market with innovative products they tend to fail to set up domestic distribution operations, according to Schickentanz. "There is no independent distributor in Italy, as distribution is still tied to banks," he says.

"Foreign asset managers have brought a new quality of products to the Italian market," adds Ambrogi. "However, it is still mainly driven by distribution and so the challenge for international asset managers lies in finding new distributors."