Seeing with new eyes

In the final article on a new study, Amin Rajan and Neeraj Sahai conclude that there are no short-cuts to any place worth going

Marcel Proust said, “The real voyage of discovery comes not from seeking new lands but from seeing with new eyes.” In its current phase, globalisation is not just about developing new markets. It is also about understanding the opportunities and challenges for clients by creating investment products that are anchored in their lives.

There is little doubt that, after the bear market losses, clients are going back to basics: they want good consistent returns backed by a better alignment of interests.

As they venture outside their comfort-zone, asset managers are beginning to recognise that they have special ‘duty of care’ to their clients, otherwise they are open to unacceptable levels of reputational risks on a global basis, according to a new study sponsored by Citi*.

Alignment here involves external clients and internal stakeholders. In global businesses, the dominant trend has been to ignore the latter because of geographical distances, to the detriment of operating leverage, as we highlighted in our first article in this series (see IPE November 2007). But it has proved hard to ignore the former: powerful tail winds are building up behind factors that did not receive much attention in the earlier phases of globalisation in the 1990s.

Examples include business brand, talent development, infrastructure support, scalable investment strategies, client service teams, relationship with third party distributors and consultants, to name but a few. Their ascendancy is driven by the knock-on effects of the mutual fund excesses in the US at the start of this decade. As a chairman of a large global asset house put it to us, “In the retail market, what we did was akin to selling a bottle of milk and leaving the client to drink it alone, as if investment was a consumable product.”

Increased regulation inevitably followed with regulators in over 70 countries revising the old rules and introducing new ones: the amendments to Investment Company Act and Investment Advisers Act in the US are indicative of a worldwide trend. Under it, asset managers face two challenges: how to build an operating model that works in good times and bad; and how to ensure that the model is compliant in multiple jurisdictions.

At a time when final year pension plans were being closed and governments were promoting private pension plans, it was vital to regain investor confidence, which was severely dented in the US, and to a lesser extent in Japan, where the government was obliged to take over its part of the deficits of pension funds.

Investors, too, came to demand greater transparency in performance and charges, while wanting clear risk controls and enabling structures that ensured fair and acceptable business practices.

There were two other parallel developments reinforcing the importance of better governance: rising product complexity due to ever greater use of derivatives; and growing alliances in the front, middle and back office activities via joint ventures and outsourcing. Both of them were aided by globalisation.

A tipping point has occurred in the last three years, as governance crept up rapidly on the board agenda of asset managers, who have increasingly ventured abroad. Its principles have been increasingly directed at achieving three aims in all regions, according to our study (see figure):

Promoting and protecting client interests; Providing greater investment transparency; Adopting day-to-day business practices that meet obligations to clients. For example, in a number of asset houses, protecting client interests has led to the creation of a special committee with oversight responsibility for ensuring that client interests are put first or clients are sold products that they are perceived to need. Such committees typically report directly to the board.

To promote transparency in performance and charges, new processes are being implemented which provide explanations when performance deviates from the benchmark and offers alternative options. Disclosure of execution costs seeks to provide greater transparency.

Finally, to promote sound business practices, independent boards are being created for mutual funds and there is more transparency on compensation of investment professionals, especially in the US. These and other actions aim to minimise conflicts of interest, on the one hand, and promote better alignment of interest between investors and their managers, on the other.

In doing so, asset managers have begun to embrace the best practices that have long prevailed in some of the most admired partnership or independent houses in the global investment industry, who take a long term view when meeting client needs.

There are two other noteworthy points. First, these governance principles are helping senior executives to ‘set the tone at the top’ by emphasising what is important, why it is important and how it will be implemented.

Second, in North America, far more respondents expect these principles to influence their governance practices in the next three years compared to Europe or Asia Pacific. This reflects the fact that the improvement programme has been more ambitious in North America than elsewhere.

Globalisation has been a major catalyst of change in asset management. Neither the sub prime debacle nor the resulting jittery markets will halt the forces unleashed by it. The unintended painful side effects - as described in this series - are no more than the birth pangs of a new paradigm.

The winners so far are those who are smart enough to walk the tight-rope of accountability versus enterprise, efficiency versus creativity, collegiality versus autonomy.

*Globalisation of Funds: Challenges and Opportunities Available free from www.create-research.co.uk

Prof Rajan is CEO of CREATE-Research and Neeraj Sahai is global head of securities and Fund Services, at Citi

Case study: Japanese pension fund

Most of the top brands from the US and Europe are setting up shop in Asia to capitalise on the growth potential of countries like China, India, Indonesia and Malaysia. Distribution alliances are mushrooming in China and India; as are new manufacturing capabilities in Singapore and India. Some will doubtless succeed; others will not, on current reckoning.

Here in Asia, the local culture eschews hype: it is vital to match words with deeds. As a result of the bear market losses, local investors have lost faith in their asset managers. So, now people prefer to leave money in a zero interest bank account. Or, when they do invest, there’s a stampede at any whiff of a loss. They want a proper alignment of interests, in preference to the current situation where their agents - asset managers - carry little downside risks when things go pear-shaped.

Asia is the new frontier in asset management. Most of its fundamentals look great. But only those firms who have a clear value proposition and the business model to deliver it will survive. Many Japanese fund managers rushed headlong into the US and Europe as part of a grand globalisation strategy and paid a heavy price.

Their survival now depends upon understanding the client DNA: to create a win-win situation, they have to wrap ourselves around their clients, via better governance practice