By Ian Fraser
Published: Financial Times
Date 23 May 2011
As Antonio Horta-Osório, chief executive of Lloyds Banking Group, weighs up whether or not to sell Scottish Widows Investment Partnership, the bank’s asset management arm, the consensus in the City is that he should plump for a sale. He is due to announce the decision as part of a strategic review next month.
Colin McLean, chief executive of SVM Asset Management believes Lloyds will have offloaded both Swip and Scottish Widows within a year. “I think it will happen quite quickly. There’s a reasonable market for insurers and asset-managers right now.”
The Portuguese-born banker’s decision is likely to be driven by strategic and capital concerns, together with governmental pressure intended to boost competition in the financial services markets. However, if Lloyds Banking Group was motivated by end-investors’ best interests, it would definitely sell off Swip, argue campaigners. This is not because of any hard evidence the bank has failed to contain the conflicts of interest that are known to arise when a bank owns an asset manager, but has more to do with perception.
Guillaume Prache, managing director of EuroInvestor, a Brussels-based lobby group representing small investors, says: “This is a huge issue in continental Europe. In the US, the big asset management companies are not owned by banks. In Europe it is the inverse. This is obviously a source of conflict of interest. Most of the distribution is also done by banks, and they tend to steer clients into their own funds.” In an ideal world, asset managers would be entirely independent of big banks and insurers, says Mr Prache. “It’s not that we believe banks are abusing the potential conflicts of interest to their full magnitude. However, the mere fact they exist is an issue.”
Diana Mackay of research consultancy Mackay Williams argues that, in continental Europe, banks’ ownership of asset management companies has not been particularly glorious for retail investors. “Traditionally in Europe, sales have been much higher for new funds with no track record than for funds with a long track record. So banks became product houses, shovelling out new funds every month, which the branches were then told to sell. Then, after one year the funds were just drifting along with no further selling activity.
“That has produced a huge proliferation of funds in Europe and served investors poorly. We are not seeing that so much now, because banks are not as active as they once were, and they have become more active in gathering deposits. Asset management is no longer as sexy as it was for banks.”
Ms Mackay says, over the past two decades, banks’ sales forces have tended to herd retail investors into often poorly performing products, usually for reasons that suited the bank – perhaps as a result of the levels of profitability and commission generated. She says harmful side-effects over the past two decades have included the inflation of the mid-1990s bond bubble and the equity bubble of 1998-2000. “Those were largely driven by the banks’ desire to earn higher fees from front-end commissions and management charges,” says Ms Mackay.
Even though there has been a trend, since the crisis, for banks to offload asset management arms and for independent investment managers to secure more business as end-investors wise up to performance, banks are returning to the asset management sector in other ways, for example with the launch of exchange traded funds and structured products.
There are fears this too could be antipathetic to end-investors’ interests. Structured products are often presented as simple savings products, even though they are in fact quite opaque and incorporate derivatives. One consultant who declined to be named says: “Many of the current generation of structured products are dressed up with a nice simple message and a Ucits III facade, when the underlying structure is highly complex. These are investment banking products that enable the structuring bank to make a turn at every level from its derivative trading desk. The aim is to earn commission on sales and once the funds mature to roll out a new edition and collect the front-end fees all over again.”
There is a growing body of research, including a paper from José Marin, professor of finance at Madrid’s IMDEA Social Science Institute published in October 2010, suggesting that banks’ ownership of asset management companies gives rise to the problem of “double agents” in the asset management sector. This is where fund managers buy and sell shares for reasons that suit the interests of their banking parents.
Mr Prache says another problem regulators must address is commission sharing between asset management units and custody units, sometimes called depositories. He says this too can drive behaviour that is against clients’ interests. In continental Europe he says asset managers often receive incentive payments and commissions from their custodians whenever shares are traded. “Some asset managers earn hundreds of millions of euros that way,” says Mr Prache.
Mr Prache also highlights the scope for conflicts of interest where bank-owned asset managers’ shares get voted. He says banks tend to “double up” their shares, combining the ones they hold directly with the proxy votes from shares owned by asset management arms. He says banks invariably vote in ways that suit their commercial lending or investment banking arms, not in ways that reflect the interests of end-investors.
First published in the Financial Times’ FTfm section on May 23rd, 2011. Read this article on FT.com