September 2011

• Welcome
• Time to focus on solutions, not products
• Product structure vs. value
• Strategies for marketing Middle East funds

Welcome

Jervis Smith
Global Head of Client Executive

We look at two topics in this edition of Spotlight. In the first section I discuss investment innovation. A recent report by CREATE-Research, commissioned by Citi’s Global Transaction Services together with Principal Global Investors, found that most of the product innovation of the past decade had failed to add significant value. Why? Because fund managers did not get customers engaged in the innovation process.

The message is that, increasingly, asset owners want fund managers to improve the design features of their offerings and focus more on solutions than products.

The second topic considers the challenges of marketing funds focused on the Middle East. A region of extraordinary promise, Middle Eastern markets suffer from low retail ownership locally and are often misunderstood internationally. In a recent research paper, Citi argues that the key to successful distribution of Middle Eastern funds lies in investor education, flexible mandates and an openness to alternative distribution channels.

Time to focus on solutions, not products

The CREATE-Research study, Investment Innovations: Raising the Bar, looked at 35 product innovations to determine which of them had delivered value – and which had not. It surveyed more than 500 respondents from pension plans, fund managers, consultants, administrators and distributors worldwide with combined assets of more than US$29 trillion.

Top of the list of successful innovations were emerging market equities and bonds, high-yield bonds, liability-driven investment (LDI) and exchange traded funds (ETFs). Bottom of the list were leverage, guaranteed equity bonds, portable alpha, currency funds and global equities. These were considered to have delivered the least value.

Product structure vs. value

There is a relative over-emphasis on structure in the products that delivered less value. They were not necessarily complex but they were driven by models.

LDI, too, is structured in nature. But that it distinguishes itself by focusing on outcomes. This chimes with another key finding of the report – that 50% of pension plans believe the key driver of innovation in future will be solutions, not products. Outcomes are important for people. Asset managers need to move away from product sales to a more customer-focused business.

This will be more difficult for independent fund managers than for those owned by banks and insurance companies. While the former tend to get their business through intermediaries, the latter are closer to their customers — and so better able to assess their needs, he says.

The survey found a disconnect between asset managers’ views on innovation and those of their customers. While nearly two-thirds of asset managers expect further product innovation to deliver genuine value over the next three years, only 39% of their customers feel the same way.

‘The CREATE-Research findings show that the asset management industry needs to focus not on new vehicles but on the innovation process itself,’ says Neeraj Sahai, Global Head of Securities and Fund Services, Citi Global Transaction Services. The demands of defined benefit pension schemes that responded to the survey are instructive. They want their asset managers to improve the design features of their offerings, not invent new ones. They want them to work on improving governance in emerging markets. And they want them to develop deeper insights into the risk-return features of all asset classes and create a distinct overlay of human judgment on all risk models.

Nick Lyster, Chief Executive Officer at Principal Global Investors Europe, says the findings show that lack of customer engagement is a major factor behind failed innovation. ‘There should be a direct link between innovation and customer need,’ he says: ‘That means building tailored investment solutions that are relevant and additive to customers’ business objectives rather than creating copy-cat products or those which rely on financial engineering.’

Strategies for marketing Middle East funds

Ben Poor
Manager of Markets Intelligence
Global Transaction Services, Citi

In a recent research paper on the Middle Eastern asset management industry entitled How Can Middle East Managers Raise Investor Awareness?, Citi argues that any investment strategy focused on the convergence between developed and emerging nations must consider the tremendous potential of the Middle East. Yet, the region has been largely overlooked – even before the ‘Arab Spring’ injected new political risks. A review of US-domiciled retail funds, for instance, shows that Middle East and North Africa (MENA) funds account for only 5% of the USD100 billion invested in regional emerging market funds. As for institutions, few have much appetite for regional mandates in any part of the world, although interest in emerging and frontier mandates is strong.

Benchmarking MENA assets poses its own challenge. As one manager in the region notes, the MSCI Frontier Market index derives around 70% of its composition from Middle Eastern countries. Yet Egypt (which is part of the MSCI Emerging Market rather than Frontier index) and Saudi Arabia (which is inaccessible to foreign investors) are excluded.

In this situation, the paper highlights a number of strategies for distribution success: Combat misperceptions and craft a compelling Middle East growth story. This will inevitably focuses on a fast-growing population, massive oil reserves and corporate reporting based on IFRS accounting.

Be flexible with mandates and open to partnerships. That may mean convincing clients to accept deviations from frontier/emerging benchmarks, creating custom benchmarks or partnering with Latin American or Asian managers to deliver global country mandates. Absolute-return, multi-asset mandates are another possibility – being benchmark-agnostic.

Press regulators and governments for changes to improve the shareholder experience. The paper advocates active lobbying to loosen capital controls and raise market infrastructure standards. This is an area in which Citi plays an active role.

Encourage best practice in corporate governance. Companies controlled largely by governments or wealthy families may not exhibit best governance practices. Investors should encourage corporate management to make changes as a precondition to initial or subsequent investment, says the paper.

Pursue a retail strategy to build assets under management and establish a track record. Given the concerns that many institutions have regarding Middle East investments, asset managers could find it easier to sell through private bankers and financial advisers working with clients open to new ideas and less concerned with headline risks. A similar strategy, says the paper, could include working with funds of funds, multi-managers and sub-advisory partners.

Focus on the long-term. Saudi Arabia is expected to open up to foreign investment over time. It is also conceivable that Qatar and Bahrain might seek to compete with Dubai as a financial centre – something that would encourage best practices in governance and market infrastructure. One asset manager comments: ‘We think Middle East strategies will be back in vogue when investors start to realise that the region is still growing and that the political upheaval is not changing their long-term potential.’

Investor acceptance will not change overnight. But, with appropriate messaging, flexible portfolio construction and openness to new distribution channels, Citi believes that Middle Eastern managers should be able to grow their businesses considerably in the medium term.