[This interview originally appeared on our sister site, IndexUniverse.eu.]
Diana Mackay, joint CEO at asset management consultant Mackay Williams, tells IndexUniverse.eu editor Paul Amery why the onus is on fund managers to regain investor confidence in the products they sell.
IndexUniverse.eu: How has the financial crisis affected the funds business?
Mackay: The crisis has had a profound impact. Retail investors have basically disappeared as buyers of funds in most European countries. The UK and Sweden are slight exceptions, but in most of Europe, fund investing is now the province of high-net-worth individuals and wealth managers, plus institutions. Retail investors have largely gone back to holding bank deposits or to making direct investments in bonds, depending on the country.
This is partly because banks have been attracting deposits to boost their liquidity ratios, but it’s also because investors are just scared and don’t really trust anything to do with financial services. I think things will stay like this for a while.
IndexUniverse.eu: Is this a good or bad thing?
Mackay: For banks, it doesn’t make too much difference. Customers’ funds have largely moved to where the banks want them. But bank-owned fund managers have been suffering, particularly in countries like Italy and Spain.
For cross-border, independent fund managers, this has arguably been a healthy development. All the people buying funds now tend to be sophisticated investors, who are willing to do their own research and invest via boutique managers.
Since the Madoff scandal, the value of regulated funds has risen and the value of independent, specialist asset managers has also gone up.
The recent appeal of emerging markets has also helped boost the appeal of funds, as it’s typically more cost-effective to invest in them in such markets via funds than by buying individual stocks.
IndexUniverse.eu: What do you make of John Kay’s recent comments? After conducting a review of UK equity markets and long-term investing, he says that we need fewer toll-collectors and more stewards—fewer intermediaries involved in the investment chain, in other words. Should we all go back to buying stocks directly, rather than via fund managers?
Mackay: There’s been so much focus on regulating investment products that the distribution structure—how those products get sold—has tended to go by the wayside, and I think that’s where many problems have arisen, particularly in continental Europe. In the UK, there’s traditionally been more regulation of the selling process.
But even in the UK, the costs of funds are still an issue and whether the Financial Services Authority's Retail Distribution Review (RDR) will address them adequately is still an open question. Of course, simply by highlighting costs RDR will have some beneficial effect by making the end-investor more aware of how much he’s paying.
It’s important to remember, though, that there’s a push towards more cost-effective fund structures, independently of what’s happening on the regulatory front. Vanguard’s recent decision to launch a series of low-cost retail tracker funds in the UK is very significant, in my opinion. The firm has been looking at Europe for two decades but has chosen now to step in, and via the UK.
Other independent fund managers, whether active or passive, are also launching low-cost products, as well as simplifying what they offer.
IndexUniverse.eu: So you don’t think there will be a big move back towards direct individual ownership of stocks?
Mackay: No, for most people I think that’s a scary prospect. But the average retail investor will be looking at low-cost, simpler funds, and in many cases I think those funds will be index trackers.
IndexUniverse.eu: Several experts have pointed out the inadequacy of conventional measures of fund cost—total expense ratios don’t reflect the effect of investment turnover, for example. With all this increased focus on cheaper investing, does it matter that we can’t agree on what low-cost actually means?
Mackay: I don’t think the average retail investor understands the total expense ratio (TER) at all. Personally, I’ve always favoured looking at the total cost of investment, where the effects of turnover are shown. But I’ve yet to see fund managers or independent experts put forward an effective way of measuring that. Perhaps a total cost figure is an ideal that can’t be achieved in practice. In the meantime, we’ll all fall back on TER as a reasonable starting point, though it’s not perfect.
When we consider whether costs are reasonable or not, the subject of complex and non-complex investment products also rears its ugly head. The European securities regulator (ESMA) has decided it's not going to make a ruling on the subject, leaving the topic to form part of the ongoing review of the Markets in Financial Instruments Directive (MiFID II).
I think it would be a good thing for the industry to come up with some kind of definition of complex and non-complex products by itself. By doing this, asset management firms would start to regain the trust both of retail investors and advisors. I think a lot of advisors are very concerned about what’s going into some portfolios. Advisors also struggle to understand some fund structures and such uncertainty can’t help anyone.
You’ll have heard all the arguments from the fund industry as to why such a common definition can’t be reached. But in my opinion if fund managers can’t agree, then the regulators will come up with a definition that’s heavier handed, harder to implement and more expensive.
IndexUniverse.eu: BlackRock suggested last year that physically replicated ETFs and derivatives-based ETFs should be classified as fundamentally different. In its ETF guidelines, ESMA has ignored this suggestion as it seems to have no appetite to split the UCITS fund market into two parts, which such a classification would suggest. What do you make of all this?
Mackay: Yes, in effect it would have been necessary for the regulators to step back a few years and rewrite the rules on eligible investments.
The first version of UCITS, which came into force in 1985, was very well accepted. Over time, it became clear that some modifications and extensions of the rules were required. But when UCITS III came into force in the last decade all funds became reclassified automatically as UCITS III-compliant. That, in turn, meant the expansion of the type and range of investments they could use to include derivatives.
With hindsight, it might have been better to have kept UCITS I funds as they were and to have allowed only newer, UCITS III funds to use the new toolbox. I know there’s an argument that funds may be using derivatives to create a simple and safe product. But I think the industry should grapple with this itself, as sorting out classifications would engender trust among retail investors.
IndexUniverse.eu: What’s your opinion of exchange-traded funds?
Mackay: I like ETFs, and you can’t deny their convenience for gaining exposure to particular markets at a particular price. A few years ago I was asked regularly at industry conferences about the competitive challenge from exchange-traded funds and I used to say that they might grow to 10-15 percent of the overall funds business, at most. Now I think they may get to be much bigger than that.
More broadly, our surveys of fund selectors tell us that investors are primarily concerned with getting value for money from their asset managers. Those fund groups that offer this, whether via index trackers or active products, will do well.