Jenny Blinch explores the growing convergence between the institutional and retail markets and the impact of this on the asset management industry
"The industry buzzword is 'insti-retailisation'," stated Richard Royds, managing director, international retail clients, BlackRock. "The fact that these two markets which ten years ago were very separate have come together in a pretty dramatic fashion." The first of the many convergence strands is the growing appetite seen from institutional investors for fringe asset classes that were previously the reserve of the nimble governance- and liability-free ultra-high net worth individual (HNWI).
"What institutional investors are now seeking, which retail investors have known [about] for a while, is the potential beyond traditional sources of return from new assets like commodities," said Mark Johnson, head of UK institutional sales, BlackRock. Money managers are realising the appeal of alternative asset classes to institutional investors and acting accordingly. "A lot of wealth managers are building very scaleable models," said Mike O'Brien, head of distribution for EMEA, BGI. "So they're trying to take what they used to do on a tailored basis for the ultra-HNWIs and start to do that on a scaleable basis for the mass affluent."
The need for alpha and a greater focus on managing liabilities has led many defined benefit (DB) pension funds to adopt a core satellite approach - a strategy which naturally lends itself to the use of pooled funds normally associated with the retail side. "[With] core satellite, a lot of core building blocks [are] passive, but there's increasing use of pooled solutions on the satellite side," said David Aird, managing director, UK Distribution, Investec.
"Satellite investments have a propensity to go pooled because they're smaller amounts." Doug Naismith, managing director, UK Institutional Business, Fidelity International, corroborated this view: "[There's a] willingness of institutional investors to look at pooled funds and different styles of portfolio management - to actually look at a series of retail funds and retail managers, whereas traditionally it's always been the segregated account mandates, going through the consultant.
"Now people are willing to pay for alpha and often retail pools, despite the fact they have relatively high fee structures compared to institutional mandates, actually have huge liquidity, much more in fact than institutional pools might." According to Naismith, this trend has led some retail funds to introduce institutionally priced share classes.
Institutionalisation of retail
While institutional investors are becoming increasingly attracted to pooled funds, retail investors are seeking to emulate institutional standards. At its most fundamental level, this relates to the thinking behind the investment process, according to Charley Stunkard, managing director at Wilshire Consulting.
"I see convergence at an overall thought process level if you will. There were various studies back in the 1980s that talked about how asset allocation was the most important decision and would explain the majority of return in a portfolio, and institutional investors have focused on [that].
"We're seeing the retail market moving in that direction - it's taking a little bit of time, but it is accelerating. I've seen smaller consulting firms and financial advisers that deal with HNWIs over the last few years acquiring institutional quality investment technology, asset allocation, asset liability-type tools that institutional investors had been using and applying them to their HNW clients."
Stunkard's colleague, JJ Wilczewski, national sales director at Wilshire Funds Management, claimed in 2003, when markets began to pick up again post-tech crash, the retail market had entered an "institutional phase", also called an "informational stage". "Financial advisers [are] saying, 'I'm not in transactional business anymore: I don't need golf balls or trinkets, I don't need friends, I don't need sales ideas; I need institutional-level concepts, products and thought-leadership to bring to my HNW clients and prospects.'"
Away from HNW territory, institutional traits are creeping into the retail world at a more general level. In fact, some of the traditional retail giants are starting to behave much more like institutional investors.
BlackRock's Royds stated: "You've got what were retail companies behaving much more institutionally in terms of the way they are looking after their investments, a classic example of this is Skandia, which has launched Skandia Investment Group - a business that's got £100bn of third party assets and is truly industrial-strength in terms of the quality of screening and staff they've got looking at managers. The retail life companies have upped their game dramatically."
The overlap in demands from the retail and institutional worlds has in turn meant there is less need for the asset managers themselves to distinguish between clients. Guy Davies, director, portfolio management, IMS, stated: "There's probably recognition that the business streams are looking more similar overall and the source of those business streams is becoming more homogenous.
"There are synergies in terms of distribution which haven't really been taken advantage of yet, but I think the larger firms are doing that." In fact, while many asset management firms continue to run their institutional and retail arms separately, there are a few that no longer see the need to do this.
"Whether it's managed in a separate account or a pooled product [shouldn't matter]," stated Investec's Aird. "Like a present, the wrapper should be incidental. So the sales team and the service team are the same. "It wasn't that long ago [people] would have different teams for pooled and segregated - that approach is totally foreign to us. They're buying your process and team; the wrappers are just the delivery mechanisms."
Even for those firms that continue to run institutional and retail assets separately, there is one area of institutional business that tends to straddle the two departments and arguably encompasses the entire institutional/retail convergence story: defined contribution (DC) pensions.
The similarities between traditional retail business and DC are obvious, as Fidelity's Naismith pointed out: "Once you've gone through the corporate gateway, the relationship then starts with the member or employee, and that pretty much has a similar degree of intensity as it does with a member of the retail public who becomes a client.
"Clearly there isn't the same sort of solicitation of business, but there are the same sorts of processes in explaining the funds and switching options, looking at annual statements, looking at decision-making, those are all things where there's a big convergence of retail practice into the institutional space."
In the US, Fidelity Investments recently moved both its DC business and its retail business onto the same underlying record-keeping platform to allow the firm "to interact with customers very easily, rather than moving between one business and the other". Commented Naismith: "That business is now under single leadership and I think that's the shape of things to come." While at the servicing level DC is institutional taking on retail traits, at the product level DC is more retail looking to become increasingly institutional.
BGI's O'Brien commented: "As more and more pension funds move away from DB towards DC, you are finding retail-style thinking around product development converging with institutional, industrial-strength product manufacture. What that means is we're getting a greater variety of products, which is required by people in DC schemes, being manufactured by institutions which have historically been in the institutional space."
For O'Brien, the main driver behind the growing complexity of the DC world is the individual member. "If you look at a DB scheme, the amount of complexity and thought that goes into building an investment policy there is quite extreme, with LDI, the growing use of hedge funds, and the wider diversification into exotic betas. But, on the other side of the coin, DC plans have generally been kept very simple to do with the concern employers have that if they create too much complexity on the DC side, they'll be held accountable if those products do not deliver.
"That's held back the development of the DC world, but we are now seeing growing demand from DC investors who are seeing what they can get in the retail world, and would like to see some of those ideas replicated inside a DC plan."
In fact, for O'Brien, the individual appears to be key to the entire institutional/retail convergence story: "With the way the world is going, with individuals taking up more responsibility for providing for their retirement, there will be convergence between retail and institutional - not least because individuals will migrate from becoming savers to investors."
O'Brien is not alone in thinking this way. As BlackRock's Royds put it: "You've got institutional going retail, retail going institutional - the reason why [in both cases] is an empowered customer."
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