An in-depth conversation centred on active fund structure
Courtesy of Nick Burgess, Director/VP & Head of Product Strategy, EMEA, at AllianceBernstein.
Different firms have different terminology for ‘product. When I talk about ‘product’ I think about the structure of the fund while others think of ‘product’ as being the actual investment strategy. We as a firm have a core history in active equities and active fixed income. We also possess strength in multi-asset capability and over time, we’ve been adding in the alternatives space such as with alternative fixed income strategies within the private markets.
In creating these funds, what are the key factors you look at?
An institutional investor might approach an asset manager like AB (AllianceBernstein) and say, “I really like x strategy that you manage, here's £100 million. Go and invest on our behalf.” That is fantastic because with a £100 million a segregated account can be set up with significant economies of scale.
On the other end of the scale, you have retail investors. If you have an ISA in the UK for example and you want to invest £50 a month, you’re not going to be able to afford the costs associated with a segregated account. So, what we do as a house is we will create a pooled fund that provides economies of scale to all investors – big or small. Practically, we will pick a domicile such as the UK, Luxembourg or Ireland, and we’ll create a fund that’s going to invest in a specific asset class or region, following all the legalities of the fund structure. The advantage of that is that everyone can mingle together and create scale. Meaning, no matter whether you’re a £50 retail investor or £100 million institutional investor, you share those economies of scale.
When my team are looking at launching a fund, what we really need to think about is:
A. What is our competitive advantage? What do we think we can do really well?
B. Who are our clients and what are their needs? What are they looking for?
It’s of no value if you create a great strategy in such a small niche area that it isn’t going to generate any significant fund inflows. In the same manner, there’s no point identifying a client need if we don’t have the skills or the capability of meeting that need. As an active fund manager, we create strategies where we genuinely believe we can outperform the market or provide a solution through our active research and investment capability.
The third part to throw in there is around having the appropriate structure and positioning. We’ve recently launched funds domiciled in the UK. UK clients tend to invest in UK domiciled funds, as can be seen from flow stats from the UK. With Brexit, we don’t know what’s coming next so having a UK range is a good hedge in case there’s a divergence between the EU and the UK.
How much weight do you put on each factor when creating funds for different asset classes?
Each individual strategy will be treated quite differently. In large part that’s down to complexity. For example, we talk about private markets. Private markets require expertise in terms of management and capability. A lot of times alternative investments are mostly open to only high net worth or ultra-high net worth retail investors and institutions only.
In the public market space, with the creation of UCITS, it’s easier for retail investors now to partake in these economies of scale. Before UCITS, every country had come up with a similar solution to the same problem. The issue with that was they were all slightly different, and some countries used it as a protectionist strategy to block locals from investing in foreign funds and stop money leaving their country. What the EU did in response to that was to bring in UCITS. In short, as long as you meet the core requirements and are domiciled in an EU country, there are very limited restrictions on EU investors investing in funds in other EU countries. This enables consolidation of funds and further economies of scale. UCITS has become a brand that has been passported around the world including to Asian investors.
How has the global pandemic altered the way your team looks at factors when forming new fund products?
In some ways it has had a huge impact and in other ways it hasn’t had a massive impact. I guess I would say we are used to crises. My first day of work after university was the day Lehman Brothers went bust so that may have affected the way I have conducted my life from that point forward.
This is a new type of crisis, but our investment teams respond in the same way they do to all crises, ensure they fully understand the risks to ensure their portfolios are effectively positioned to manage those risks, as well as identify opportunities in a post-COVID market. That’s the core part of active management, that a manager can adapt to new scenarios, to new information, to continue making the best decisions for their clients.
From our product perspective, the core needs of clients in terms of allocation to types of goods hasn’t changed. Clients still want to access European equities. They still want to access global equities. They still want to access global high yield. What we have tried to do is pay attention to the way the flows have gone since the crisis first started. When it first hit, there was a big risk-off environment where people were moving their money out of traditionally higher risk asset classes. Once the market picked back up, people started taking back on risk again, particularly in equities because they wanted to capture the rally.
Our perspective from the client’s side is to try to understand if clients will change their behaviour in more subtle ways over the future. We talk about responsible investment and “ESG” (Environment, Social, and Governance) being a core part of our investment processes at AB. One of the things that we anticipate is that the corona virus will trigger even more people to look at responsible investing strategies, and/or place more importance on the integration of ESG considerations.
Take another example. In some ways the visibility of the Black Lives Matter movement could impact the way people invest in the same way that the corona virus has because that impacts the way people think. People are becoming more attune to social issues in relation to not only their investments, but when they are choosing where to spend their money. As such, the important thing for us is to keep monitoring these changes and ensuring we understand what people want and what is important to them as people and investors. We need to ensure we have the ability to meet these client needs through appropriate investment strategies.
Coming into 2020, were there factor inputs that you believed would play a bigger role?
There wasn’t anything special coming into the year. Of course, as active managers we might try and predict which market might perform well each year; however, we don’t actually know that for a fact until it happens. So, what we do on an annual basis is we look at an array of strategies in collaboration with our sales team across Europe and we say “this year we think emerging market debt or U.S. equities, for example, are going to perform well”. Or, we have a really strong competitive advantage in certain areas and so we prioritise our sales efforts towards those strategies. What has happened is that healthcare has become a really hot topic this year and we've been talking to clients a lot more about that. Thus, the sales team has pivoted to promote those types of strategies. It is amazing how trends can come around – health care is a new hot topic this year, but AB’s strategy in health care is actually been running longer than I have been alive!
Investor Trends and Needs
What proportion of investor trends coming into this year was driven by existing investor needs and newly identified investor needs?
From an ideal perspective, what we would love to have is that when a client wants something, we would have the fund there: built, designed, launched with three years of good track record. If we have that already, great, but if we don’t, that means I need to work out what clients are going to want in 2024! That is the holy grail, if you can work out what clients would want 3 to 5 years in the future. But we also need to think about what clients want today. That’s why we talk about strategic and tactical. Strategic is us trying to look forward and understand new trends, new market opportunities. For example, we spotted growth in sustainable strategies. Consequently, we launched sustainable funds, built our track record and hopefully we’ll see interest in them now and over the next few years, resulting in positive flows. However, the sales team wants something right now so they can offer that to clients immediately (tactical). My role is to make sure that what they have to offer now is good, while also trying to have one eye on the future on what we can distribute going forward.
Do you see any differences in the way investors are going to allocate their money between different asset classes?
One key topic of discussion has been between active and passive investment. With passive investment, there’s no active decision making, you get beta exposure often at a low cost, which makes it attractive to a lot of investors. Active management is about using expert research and analysis to build a strategy to outperform the market or provide a particular outcome. When the market goes up, some investors just decide to take the market beta. However, when the market has volatility, like recently, this can be an opportunity for active management to really shine.
Are there any other potential influences to investor behaviour outside of sustainability that you see in the near future?
One thing that this crisis has done is that it’s impacted people’s livelihoods. People have lost their jobs or if they haven’t lost their jobs, they’re feeling uncertain and may not want to invest. I think there’s going to be a little bit of nervousness for people investing. On the other hand, we could have a boom because if the economy goes back and jobs return, we could have a boom in retail spending. People may not necessarily spend their savings in investing but maybe in buying the things to paint or decorate their front room, things like that. There is also a change in the way the economy is probably going to look in the future. Are people going to be working from home as they have done during this period? There was already a boom in online shopping before but this has caused people who were reticent before to now change their minds. This impacts investing in a multitude of ways. It impacts companies that we’re analysing, impacts people because their job security impacts how they invest and it also changes how they spend. The challenge, going back to what we said earlier, is how will this impact what type of equities people want in 2024. That’s a much harder question to answer.
Future Market Expectations
How varied are these expectations when looking at different asset classes?
They can be hugely very broad, and with active funds we often think about market outperformance - it’s about our competitive advantage. What we find is that there might be a market where there is not that much great performance (across the market), but because we can outperform versus our competitors, or may have better downside protection compared to our competitors, all of a sudden, we’re now attractive to clients. It’s also about understanding our clients. A Ferrari for example is one of the fastest cars you can buy, but it’s not very practical if you have a family. The best, the flashy, the faster isn’t really for everyone.
Going back to the start of my career during the Global Financial Crisis, equity markets crashed, but later recovered. But what became apparent was that there were investors close to reaching retirement who had all their investments in equities (sometimes the equity of the very financial firm they were working for) and suddenly saw a dramatic reduction in their retirement pot, the pot they had spent their entire career building. These were people who were not in a position to take on such risk at the point of retirement. This is just one example of a wide array of different clients with different needs and risk appetites and tolerances. As an asset manager, we need to think about providing strategies and solutions for a wide variety of potential investors. Not all about Ferraris, it’s also about reliable family cars!
Are there differences within the EMEA region that make it difficult to come up with a fund product?
Oh, yeah! That is one of the biggest challenges that I have, the individual countries that make up EMEA are heterogeneous. For example, people sometimes talk about the divide between northern and southern Europe. The yield levels in government issued bonds in Germany are very different to what you get in Italy. So Italian investors may be thinking like: “I can get x yield on an Italian Government bond, so you’ll need to offer me better risk/return to invest in something else”. However, someone in Germany, where bond yields are lower, may be seeking a more cautious strategy. Take Brexit for example. We have that uncertainty of not knowing what’s going to happen to UCITS funds domiciled in the UK. Major asset managers have had to move flagship fund ranges from the UK to EU countries in order to ensure they can continue to use the UCITS brand and distribute globally. But it can also be an opportunity - for example we have now launched five funds in the UK where we’re actively seeking to grow our UK client base. The challenge ultimately is trying to find strategies that match up with as many different markets and different investor types as possible.
It’s also challenging when you’ve got limited resources. Setting up a fund is expensive, there’s a lot of costs involved including seed money and all the costs involved to set it up. Sometimes you will have one team in one country wanting one thing, and a team in another wanting something different, but you have only the resources for one – how do you ultimately make that decision? Can you imagine not only telling one of the teams that we cannot pursue their regional need but that we would like them to back one of the other regions need? It is a difficult conversation.
How do you overcome that?
Generally, by a commercial plan. If you try and create something that pleases everyone, it generally pleases nobody. What we try and do is work out where we have the best chance of succeeding. Often that means where we think we’ll get the biggest flows over a set amount of time versus our costs of setting up. Also, what we tend to do is rotate a little bit. If you focus on one region and set up a couple of funds, they will need time to go out and generate the flows for those funds. After that, we’re not going to launch any more for that region because investors have got enough there that will keep them busy because there’s a nice, focused, diverse offering within that region. We do the same with different regions, which effectively keeps us from spreading ourselves too thin by focusing on different areas at different points.
Does that depend on the current state of the market or does that depend on generally predictions or forecasts?
We always think about one to three years ahead. There are so many moving parts. Marketing is the big part in this. If you want to push into a certain region, you need to have your brand awareness. You need to have the appropriate marketing. You need to have the appropriate PR. All of that takes time to coordinate. We’re thinking now about our 2021 prioritisation, which markets we are going to focus on, where is our budget going to be spent on. So, as a region we need to make sure that we’re aligned. There’s no point deciding that we’re going to launch a product for France for example and then all the budget’s going to Italy. That would be a waste. We have to make sure that we’re coordinated. I’m not an island. Product Development can only work well in conjunction with investment, sales & marketing - I can’t just say “this is right so this is what we’re going to do”. I need to make sure that investment, marketing, sales and product are all aligned, which generally means that I’m the one that has to compromise.
Nick Burgess is a Director/VP & Head of Product Strategy, EMEA, at AllianceBernstein