New Star has recently acquired six Aberdeen Asset Management unit trusts worth £1.85bn. In this economic environment, can you see other acquisitive fund managers cherrypicking the funds of rival firms instead of buying businesses outright?
Patel: The New Star and Aberdeen deal was unusual in that Aberdeen's name has already been tarnished over the splits debacle and selling their biggest funds to New Star has probably been one of the best moves they could have made. I am not sure if most investment groups would be willing to sell only their best funds to rivals and be left with a range of poorly performing or unpopular ones. I think it is quite possible to see more of these types of deals but they are likely to be among firms that are struggling to build a brand name and make profits in this environment with established and successful businesses.
Bevan: Part of New Star's strategy from launch was to build the business through “strategic acquisition” and this deal will help them to almost treble their funds under management. At the same time, Aberdeen will be able to balance their books and, importantly, retain their independence.
The deal is ideal for both parties but I would suggest it will prove to be fairly unique. I do not think that there are many investment houses out there in the current environment with either the confidence or the cashflow to fund this type of venture and, on the flip side, I question how many companies out there will be willing to give up control of their flagship funds. I think that there is further consolidation to come in the industry but I would expect it via the more traditional merger or takeover route.
McDermott: I think it is very likely that we will see more of this sort of thing in the future. The industry is being squeezed tightly at the moment and only the toughest will survive if the market continues spiralling downwards. I think fund managers will still buy business outright but I do suspect there are a few other acquisitions on the cards in the near future.
According to the Investment Management Association, net sales of retail investment funds fell to £8.3bn last year from £9.3bn in 2001. Corporate bonds accounted for more than 25 per cent of that figure, with £2.6bn of sales. Can you see this trend towards bonds continuing or will equity income funds be the best sellers in 2003?
Patel: If markets continue to behave like they did in January, flight to safety will remain prominent and sales of corporate bond funds will buoy. But uncertainty of war has been priced into the market and while it could fall further until war breaks out, historically, markets rally after war starts.
If, on the other hand, geo-political events get sorted out, this will provide some stability to equity markets. In either case, there is plenty of upside potential for equity income funds from current levels as valuations have fallen. The yield on the FTSE is close to 4 per cent and the potential total return is looking attractive. Therefore sales of equity income funds should overtake sales on bond funds.
Bevan: Growing corporate bond sales are no real surprise, given recent performance relative to equities coupled with increased provider marketing activity and consumer desire for lower risk in this safety-first environment. Investors have been looking for alternatives to equity funds and the trend is likely to continue unless confidence improves dramatically.
Equity income funds, although fairly popular, attracted just £1.4bn in net retail sales in 2002 compared with the £2.6bn in corporate bonds. This is a marked difference and, given the current climate, I really do not see the gap being closed in 2003. In fact, I think that it may widen further.
McDermott: We would always urge people to avoid investing in market trends just for the sake of it. Both types of fund have had and will continue to have their moments of being favoured and being out of favour. I still believe there is good reason to include a mix of bonds and equity income stocks in any portfolio for the long term. Now should be the time to determine whether clients are overweight or underweight in particular areas of their portfolio.
The Treasury now seems unlikely to reverse its decision to scrap the dividend tax breaks on UK equity Isas in April 2004 despite pledging to close the savings gap. How much of an impact could the imposition of the tax have on future sales?
Patel: Even though this will probably make little difference to the individual, the removal of this tax break added together is going to widen the savings gap further by billions of pounds and I abhor this decision.
On the one hand, the Government is trying to encourage savings but on the other hand, they are slowly taking away one of the main benefits of saving through equity Isas. Furthermore, the removal of this tax break will push more people towards fixed-interest investments and those who have 20 to 30 years until retirement are unlikely to benefit from the potential income and capital growth from equity-based investments.
Bevan: However much I disagree with the move, I question whether scrapping the tax break on Isa dividends will really have much impact on sales. Factors such as the economic climate will, as always, be a much greater influence.
I do not think that the public in general will be aware of the implications, much as we saw with the abolition of the dividend tax credit on pensions. Also, for those that are aware, careful fund selection throws up an answer. For example, if one selects corporate bond funds for income and nil/low-yield equity funds for growth, the problem is either removed or very much reduced. What may be impacted, however, is the sector split, since the hardest-hit type of fund will, of course, be equity income. It will be interesting to see whether sales in this currently very popular sector are dented.
McDermott: We are disgusted with the decision. We are at a time where investment into the market should be encouraged to stimulate the economy. The last thing that investors need now is another excuse not to invest in the market. We have campaigned about this but it seems that the Government is taking away one of the major incentives that make Isas so attractive. If the decision had come in a time of market stability, I think the effect on sales would be minimal but with sales down and investor confidence extremely low, this does not exactly encourage people back into the market.
Credit Suisse income fund manager Bill Mott believes growth stocks have no chance of making a comeback for five years unless the economy falls into recession. He argues that excess capacity and poor earnings' growth will prevent growth stocks from returning until both problems are resolved. Do you agree or will growth return to the fore sooner than Mott expects?
Patel: I have to say I agree with Bill Mott's views. We have an enormous problem of economic mismanagement, with huge overcapacity. The UK consumer is overspent and undersaved. The debt burden has grown enormously over the last few years. Deflation is unlikely to take place and if inflation creeps up, this will merely serve to work its way into the economic system and will allow the debt burden to fall first before any growth can be achieved.
Furthermore, with signs that the consumer is slowing down, house prices likely to fall and unemployment potentially on the increase, people will feel less wealthy, they will cut down on spending and this will have a negative impact on corporate profits. A five-year horizon for growth stocks to make a comeback is probably quite realistic.
Bevan: Bill Mott's predictions are interesting if not rather disturbing. I can see the point he is making and, to an extent, I agree with the economics. However, I cannot share his level of pessimism. Making an accurate prediction over six months in this environment is difficult. Over five years, I would say it is impossible.
There are too many other factors in play, market sentiment perhaps being the most important. It could be some time before we see any substantial or sustained rise in growth stocks. However, from these levels, there is value in the market and I would still suggest that growth stocks should form part of any medium-term balanced portfolio.
McDermott: I agree to an extent but I still think that there are some good well managed companies (who have growth characteristics) out there whose share price will outperform. It is up to good fund managers to find them.
IFAs such as Bates Investment Services are predicting that single-manager funds could lose market share to multi-manager funds as IFAs become disillusioned with rapid manager turnover and poor investment performance. On what scale can you see this happening and will it only affect fund managers with poor performance?
Patel: Growth of multi-manager funds is likely to increase on a large scale as a lot of IFAs want to pass on the responsibility of managing a large pot of money to experts, as many do not have the adequate resources to do so. However, whether they will be successful is questionable, just like singlemanager funds, as there are no guarantees. There is nothing stopping a manager of a multi-manager fund to jump ship or be fired for poor performance.
Bevan: Rapid management changes are disruptive and a number of the high-profile moves in 2002 did cause us great concern. Saying this, however, I think that now as much as ever there is a place for the single fund manager and for a new fund launch, this is perhaps the most effective way to get funds under management quickly.
This has certainly been borne out by New Star, who over the last 18 months have pulled in £1bn using this approach. Where I think Bates is right is when it comes to performance. The bottom line is that investors want returns and if a fund is not performing, then money will move.
This is where multi-managers have an advantage since they can quickly and cost-effectively remove under performers from the fund. Multi-managers in general, however, will need to produce consistent outperformance to justify the higher cost and I do think that consumers will mark their performance directly against other types of fund. If via this service value can be added, then market share is sure to increase. However, if not, they are likely to go the way of the broker fund.
McDermott: People tend to follow a manager that has a consistently good track record and I cannot see IFAs moving all client money into multi-manager funds just because they become disillusioned with manager turnover. There are so many more factors to consider when recommending funds but it is frustrating when a manager moves. Multi-managers have a place in the market but there are too many already and some companies are simply offering “me-too” funds.
Meera Patel, Senior analyst,Hargreaves Lansdown
Jason Bevan,Senior consultant, David Aaron Partnership
Darius McDermott, MD, Chelsea Financial Services