Widening perspectives

French asset managers are in no doubt about what will be the most important event in institutional asset management in France this year – the eagerly-awaited award of mandates by the Fonds de Reserve Pour Les Retraites (FRR), the country’s new pension reserve fund.
The final selection of managers for the 27 mandates is expected by the beginning of the second quarter of the year with vesting by the end of the second quarter.
The award of an FRR mandate will confer considerable prestige on the winners. It will also expand institutional business significantly. The FRR currently has €17bn funds under management, some 10% of the total institutional assets under management in France.
Frank Goasguen, head of institutional business development at BNP Paribas Asset Management, probably speaks for most asset managers when he says: “The Fond Reserve pour les Retraites is the major opportunity in the French market for asset managers in 2004. Even though the fees will probably be low and the requirements are demanding, I don’t think there is a single player in the French market that isn’t interested.”
It may also influence the way asset managers do business in France. “It will act as a catalyst and a reference,” says Jérôme de Dax, managing director, global marketing at Société Générale Asset Management. “Look at the allocation of mandates. FRR has been considering all the key instruments that a long term institution should require in order to build a long-term performing portfolio. It the best example that the French market place could give regarding the very professional way of dealing with external asset management.”
The FRR is important, not only because it is providing an unusually large tranche of appels d’offres (RFPs) but also because it has arrived at a time when RFPs from the traditional source of institutional business have become scarcer. The Caisses de Retraite, (CDR) the government backed PAYG occupational pension schemes that are compulsory for employees in the private sector, have traditionally provided the bulk of RFPs.
Last year was a year of low activity in terms of RFPs from CDRs, says Goasguen: “There have been a few such as Organic and Parunion, but not as many as we have known in previous years. Whether 2004 will be more active or not is an open question. Our guess is that it will continue rather in the same trend as 2003, with a few big opportunities.”
To some extent, the fall in the number of RFPs was inevitable since CDRs issue them usually once every three years. Jean Pitois, director of institutional clients at AXA Investment Managers in Paris, points out that “most of the existing mandates were awarded between 2000 and 2002, so 2003 was never likely to be a very active year for RFPs.”
A process of consolidation among CDRs is also under way. “It’s difficult to predict what will happen but we think that some of the new groups which emerge from the consolidation will probably issue RFPs in the coming months,” says Pitois.
RFPs from CDRs depend largely on consultant activity. A wave of mandates in 1999 followed the arrival in France of international pension consultants Watson Wyatt and Mercer, who are currently handling the FRR manager selection.
Yet in France pensions consultancy is dominated by domestic players, principally Fixage and Finance Arbitrage. French consultants handle between 40% to 50% of French pension fund RFPs and their influence is growing.
Michel Piermay, president of Fixage, is doubtful about the extent of this growth. “It’s very difficult to measure the size of the consultancy market. The problem is how do you define a consultant? Some previous consultants are becoming managers and some managers are giving advice to investors. The boundaries are not very well defined.”
One CDR that has signalled its preparedness to issue a RFP is the CDR Groupe Vauban which insures the pensions of professionals. It currently has assets of around €2bn managed by 15 asset managers. It is considering adding to these managers two new RFPs for the management of its segregated funds. Christophe Cattoir, who is responsible for the financial management of Groupe Vauban, says it is considering the move not because it is dissatisfied with its current managers but because its funds have reached an optimal level which it does not want to exceed.
RFPs issued by CDRs are now more likely to be specialist, as the progressive move by French institutional investors away from balanced towards specialist mandates continues. Thierry Dissaux, chief executive officer, France, at CDC IXIS Asset Management sees a convergence between US and European asset management models of asset management: “In the US asset managers are specialised, which is more rational and more efficient for the customers. It’s very difficult to believe that an asset manager could be equally as good in active and passive products. The market, as always, will decide, and in our view will compel asset managers to make these choices.”
The FRR has given added impetus to the move towards specialised mandates, says Goasguen of BNP Paribas AM: “If the market needed a trend setter in that area, the FRR definitely confirmed the trend by making very clear choice in favour of specialist mandates.”
Yet others believe that there is more mileage in balanced management with a little fine tuning. Thierry Rigoulet, director of institutional business in France at Fortis Investments, suggests that institutional investors should not entirely abandon the balanced approach: “We are trying to convince clients not to give up definitively balanced mandates but look to diversify mandates with a large number of asset classes. Clients and their consultants should not be limited to equities and bonds but they should include alternative or hybrid asset classes like convertible bonds, emerging debt, credit, high yield and real estate.
“In this way they can either decrease the volatility of the portfolio or, with the same level of volatility, get a better level of return.”
The three year bear market in equities did not encourage institutional investors to switch from equities to bonds, says Dissaux of CDC IXIS AM. “There was a decrease in the assets under management for equity products, but this was solely linked to the decrease in the markets themselves There were no net outflows from equity products into bond products. French institutional investors believed, more or less, that the markets would rebound.”
However, allocation to equities is down and has remained down. Goasguen of BNP Paribas AM comments : “We saw little movement away from equities during the market’s bad period but we have seen very little, if no rebalancing of the portfolio to keep a constant weighting in equities. So the percentage allocated to equities is definitely lower than it was three years ago.”
Some investors moved into convertibles to take advantage of the expected rise in the markets. Convertibles were one of the success stories of 2003. Fortis Investments, for example, saw its convertible bond assets increase from €150m to €1bn during the year.
Others moved into the money markets. Currently there is massive liquidity in the market and investors are not fully invested Currently the average asset allocations are 15% in the money markets, 55% in bonds, 15% to 20% in equities and the remaining 10% to 15% in private equity and real estate.
Asset managers are doubtful whether this can continue far into 2004. Goasguens at BNP Paribas says: “People will not be happy with money market yields for long. The search for yield will become a necessity some time in 2004.
“Will there be a substantial return to equities? I don’t think so. Investors will try to find more diversification in higher yielding assets such as a little more equity, alternative investments , total returns, and other areas that could provide the same profile.”
Investors have become more wary of high volatility, says Nathalie Boullefort-Fulconis, global head of institutional business at AXA IM. “There has been a major revolution in investor sentiment. Investors act more and more in terms of risk allocation and less and less in terms of asset allocation. The rise in volatility in the fixed income market is very important factor here.
“Investors, other than long term investors like the reserve fund, often have a horizon of no more than three to five years, no more, and are focusing on an annual return of, for example, 5% or 7%. They build their asset allocation in such a way that it can achieve such a return with low volatility.”
Volatile equity markets and expensive bond markets a move away from benchmarked products in favour of absolute return products. Christine Moser, responsible for French institutional clients at Crédit Agricole Asset Management (CAAM) comments: “The equity weighting has decreased only slightly in reserves in spite of the fall of equity markets over the past three years, due to the effect of automatic allocation rebalancing. Investors remain therefore exposed and prudent faced with the current uncertainty over the rate of economic recovery. They logically prefer products that provide an absolute return, or at least a significant leeway vis-à-vis the benchmark.”
French asset managers are now devising strategies to satisfy this demand. These include long-short strategies to achieve total returns by relative value or arbitrage, and portfolio insurance. Portfolio insurance allows the investor to limit downside risk while allowing some participation in upside markets. This can be achieved through a mathematical process such as CPPI (Constant Proportion Portfolio Insurance) or through active asset allocation.
Institutional investor interest in total returns is likely to continue, even if there is a sustained recovery in the equity markets, says Dissaux of CDC IXIS AM. “Of course its an easy stance for investors to be in a benchmarked products when the market is running higher, but we think that even with more bullish markets the appetite that they began to feel for non-benchmarked products in general will stay and will even increase.”
There is also a growing interest among investors in products generating alpha, or manager performance. SGAM’s de Dax says the market is searching for alpha in both equities and fixed income. “Few investors are interested in having a benchmarked portfolio with a low tracking error. On the three main components of a portfolio – equities, fixed income and alternative investments – everyone is looking for alpha generation.
“In equities, should you decide to have active portfolio management, then you will look for alpha. In fixed income you are not going to stay with govvies-only portfolios. You will look at more sophisticated credit spread instruments to get the pick-up in yields you need to match your long term liabilities. And in alternative investments you are going to look for some non-correlated strategies. In this interest rate environment, alternatives are a good substitute for a short maturities bond portfolio.”
This splitting of risk will become an increasingly common feature of portfolios, he suggests. “My view is that institutions will more and more have specific needs on alpha generation which will be balanced by some indexed part of their portfolios and alternative investments.”
Future portfolios will balance one form of risk against another – for example, alpha against beta. For example, Fortis Investments has developed investment products with different levels of risk and returns. “We decided to distinguish between the alpha risk and the beta risk portfolio or market_risk,” Fortis’s Rigoulet explains. “So we are able to say to clients that we can deliver performance with a small level of beta risk. If you want a product that delivers 10% to 15% of performance it is necessary to accept some beta risk as well. But if you want Libor-plus product it is possible to deliver this kind of performance with only alpha risk.”
French pension funds are also in the market for products that are structured to enable them to match their liabilities. Boullefort-Fulconis of AXA IM says: “For institutional investors the capability of an asset manager to structure products is key. What we all learned from the equity crisis was that our institutional clients have an asset liability issue. So one service we can provide is to build the right solution for their asset liability equilibrium.”
Boullefort-Fulconis says an asset manager needs to have more than a basic expertise in equities and fixed income to build these solutions; in particular, an expertise in derivatives. “For example, a pension fund will have a duration which is usually very long, yet it cannot find very long find bonds of the right duration. It is only if you include derivatives in the management of the portfolio that you can really match the needs.”
The new appetite among institutional investors for diversified portfolios should have opened a path for multi-managers in France. However, they have made little headway so far. Jean-Louis Azoulay, president of SEI France, the French subsidiary of multi-manager SEI, comments: “The story of multi-management in France has been a story where there have been many players in the past few years. Not everybody has or will survive.”
Yet there is one business opportunity that seems particularly well-suited to multi-management, and that is the Loi Fillon, the law which has introduced a raft of tax advantaged third pillar pension plans – notably the PERP (Plan d’Epargne Retraite Populaire).
Azoulay says the plans are tailor-made for multi-managers. “The new long term savings are clearly an area where the multi-management solution is the natural solution for long-term, diversified asset management.”
There are still uncertainties about details, and no products have yet appeared. Yet this has not stopped asset managers talking to potential customers, says Azoulay. “It is very much the French way to say that you should book early to reserve your seat. We have taken the opportunity to talk to clients, so that when they and their advisers come to make a global pension diagnostic we will have a solution even though the solution will not be available for a few months.”
Jean-Yves Foucat, chief investment officer of SEI France, says the PERP will be attractive because it has better tax allowances than the current corporate DC plans – the so-called Article 83 plans. “One of the effects of the Loi Fillon is that the tax advantages are very clear. That means we could see a real development of the DC market in the next few years.”
Yet it is the FRR that promises the greatest opportunities for asset managers, both domestic and foreign. The size of mandates that the FRR is putting out for tender are large enough to tempt international houses to put in competitive offers. So will the FRR provide the way in to the French market that foreign managers have been sought?
Piermay of Fixage is sceptical: “For the moment the market is quite open. People selected after the first phases are coming from many countries and there are a lot of mandates. But the FRR will be a difficult client and the control will be strict. And the prestige of a mandate will be dangerous if the mandate is not very successful. There could be a problem of image.”
The traditional method of entry into the French market is through the side door rather than the front door, as third party providers. Last year Chicago-based Northern Trust Global Investments (NTGI) gained a third party agreement with Groupama Asset Management, the fund management arm of one of France’s largest insurers, to provide US equities advice on some $400m of assets in large and mid-cap US equity mandates.
Gordon Hogarth, head of European business development at NTGI, explains: “If you look at the way pension fund assets are managed, you’ll find that most of the managers are themselves French. It is very difficult for external, foreign non-French managers to get mandates. This is simply because of the historical strong bias of French institutional investors for domestic managers. Our agreement with Groupama has allowed us to effectively become a partner with the local player that has the local knowledge and the local contacts.”
Other US managers are now trying the front door. Merrill Lynch Investment Management, which been on the French market for three and a half years as a third party player, now plans to approach the institutional market directly. It has had some success, winning two mandates last year for European and US equities worth €30m and €100m.
The barriers to entry may be breaking down. CAAM’s Moser says points out that “clients now make less and less distinction between French and foreign firms but they rather distinguish between large and small asset management companies.”
The adoption of open architecture by French players could accelerate this process, says Hervé Guinamant, director of commercial development at CDC IXIS AM: “Open architecture was a dream two years ago, and a lot of European and Anglo Saxon players came and tried to be in the game. But the coming years will really be the years of open architecture. A lot of our competitors are asking ‘what kind of job I want to do – a producer, a distributor or what?
“Open architecture also means that foreign competitors will be much more present. So French asset managers will have to respond with added value products and services.”
Perhaps the real significance of the FRR is that it acts as a benchmark for the European market. SGAM’s De Dax points out that “The FRR is benchmarking itself with what some major reserve funds have been doing over the past years in Ireland, in Norway and in other countries.”
This reflects what is happening in the continental European market, he says. “Over the medium term the market will probably be less and less geographically based and more and more client-driven.
SGAM in France itself has just organised itself along three institutional business lines in continental Europe. One of them is pensions. “What is the difference between the needs of a pension fund on a large scale in the Netherlands, in France, in Germany and Switzerland? There are less and less differences.”