The UK’s fund industry has had its fair share of challenges especially with the pandemic and Brexit thrown into the mix, but experts say there are always bright spots in the clouds
With Brexit, the COVID-19 pandemic and other significant challenges, the UK’s fund industry is working hard to keep afloat.
Experts say the UK is on a multi-year run of negative net flows for domestic funds, and most asset classes are in the red for flows in 2020 while equity is just managing to lift its head above water.
The industry is mature and older investors are often drawing down savings to live on. Chris Chancellor, senior director, Broadridge, says at present “there is not enough water pouring into this bath to offset that draining away.”
While absolute return funds have been massive sellers in the years gone by — providing an alternative to low yielding fixed income — experts believe they dragged the mixed asset area to be the worst selling investment type in 2020.
However, Chancellor highlights there are always bright spots in the clouds in asset management and simple mixed asset ranges have been selling well like those from Vanguard, J.P. Morgan or Assurance Services International.
Meanwhile, the industry continues to rotate from active to passive with large outflows to active and vice versa.
Areas of particular interest in the UK’s fund industry encompasses new product launches — to ensure cost efficiency — as well as the continuing shift towards the use of separately managed accounts rather than pooled accounts for large investors who are demanding more control over fee structures and customised solutions. In addition, no longer a niche, environmental, social and governance (ESG) gained even greater momentum last year in the UK and this is something that experts suggest will continue this year and for many years to come.
ESG was enhanced by the pandemic’s effect on how funds view risks of all types, as well as regulatory drivers and demands from employees, consumers and investors.
Funds are now focused on ensuring greater disclosure of non-financial data and information and ensuring that ESG requirements are met by their products.
“We expect this trend will only continue to intensify in 2021 and differentiate the service providers which offer value-added services in these areas,” comments Apex Group UK’s managing director Niall Pritchard.
Increased interest in alternative funds
In line with increased growing interest worldwide, the alternative funds space is growing in the UK. This is while investors of all types look to generate returns and diversify to reduce risk.
Alternative funds are mutual funds, or exchange-traded funds (ETFs), that invest in non-traditional securities.
While some investors may find these funds are inappropriate for them, they can be used as diversification tools if used properly.
According to Chancellor, the challenge in the retail space remains the difficulty of having relatively illiquid investments in a liquid vehicle causing well known issues that investors in the UK will be especially sensitive to.
Over at Apex, an interest in a wider variety of different strategies has been identified as the group operates in the new working environment evolving under COVID-19.
Pritchard says there has “undoubtedly” been increased allocations to private equity, private debt, real estate and infrastructure as these asset classes “continue to grow rapidly and become more important in investor allocations”.
“The private equity industry has proven itself to be very adaptable and faster at deploying capital than public markets, and with so much dry powder ready to invest it is in a good position to access deals and drive meaningful recovery,” he adds.
Indeed, the industry will have a key strategic role in rebuilding the economy through rapid, targeted capital deployment.
The volume of distressed deal activity alone within funds is expected to continue to increase largely because the falling valuations have created attractive opportunities for those who have capital to deploy. As well as this the public finances are feeling the strain in the wake of the pandemic and so private capital will remain in high demand.
A greener future?
Across the globe, financial institutions are paying more attention to ESG. Countries like Luxembourg, for example, are taking big strides towards sustainable finance with the opening of the Luxembourg Green Exchange (LGX) in 2016.
Experts especially noticed a trend developing in lockdown in the ESG space as more and more people are aware of nature in their surroundings during 2020.
According to Brian Charlick, principal consultant at CGI, this accelerated the push towards ESG which started in Europe a few years ago and has really taken hold in the Nordic states.
“The EU has now drafted an ESG regulation that will mean greater control and standardisation of the ESG market. It is also noted that most of the asset management and fund management firms now have a policy on ESG and ESG funds available,” Charlick comments.
Moves are being made in this space as the European Commission has stated their intentions to introduce regulation about the Alternative Investment Fund Managers Directive (AIFMD)/UCITS and Advisory.
In August 2020, the European Securities and Markets Authority recommended adding a reference in the Directive that ESG factors should be considered in the AIFMD reporting in order to monitor ESG related risks.
Experts anticipate that projects such as the accelerated carbon footprint move in the UK will need to be factored into fund strategies.
There have long been ‘exclusion’ funds, which do not invest in certain industries as well as ‘impact’ funds for whom ESG impact is a key component of their investment strategy.
But Pritchard says increasingly, many UK managers now have ESG teams or outsourced solutions to assist with ESG analysis during the investment due diligence phase as well as ongoing monitoring of their portfolio from an ESG perspective.
“A low ESG rating should not be viewed as a ‘make or break’ for an acquisition, but the fund should be aware of this as an area which needs to be addressed and improved during the period they hold the asset,” Pritchard adds.
Keeping the challenges at bay
Brexit is one of the most obvious challenges facing the UK’s fund industry. The effects of no equivalence granted for UK financial services is likely to impact fund managers in the long term. Experts suggest the very clear objective of EU27 policymakers, both nationally and in Brussels, is to use regulatory standards to build local presence — meaning a transfer of jobs from the UK.
For investment banks, the primary issue will be what standards local supervisors take on the issue of ‘substantive presence’, according to consultant Tony Freeman.
“Today, this is undefined. For fund managers the crucial issue is delegation: will they continue to be allowed to manage funds in a globally flexible model, or will the fund have to be managed within its legal domicile?” Freeman comments.
Meanwhile, Pritchard says: “Getting past Brexit may mean a sigh of relief for the industry and flows may return but there may be complexities for those with Luxembourg or Dublin ranges.”
Low savings rates mean that UK investors should become interested in funds as a good way to save for their future, allied with ESG this may bring new investors in.
Chancellor cautions that getting the interest of new investors is not easy and the industry has yet to find the right voice to attract millennials to investing.
Despite the ongoing challenges and uncertainties around Brexit, experts are confident that London will remain the financial centre for alternative asset classes and will continue to fuel investment into these sectors.
Freeman affirms: “The City of London is creative and extremely adaptable. It believes that the growth in its overall business — green finance, derivatives/risk management, non-EU markets — will more than compensate for the loss of business into the EU.”
Harry Chopra, chief client officer at AxiomSL, suggests that in order to compete effectively, UK asset servicers will have to be able to deliver value to investment managers that will be operating under UK and European rules and regulations.
“Take a new regime, such as the Investment Firms Regulation. The rules for calculating risk exposures have been defined by Continental European regulators, and a similar set is being defined by the UK,” says Chopra.
He explains: “Asset servicers will have to be competent across both concepts to deliver a seamless experience in helping their clients meet their regulatory obligations.”
Opportunities for 2021
For 2021, experts predict funds service providers will continue to expand their product suites tailored to alternative investors such as private equity and real estate.
“We anticipate that the buyer demand for a ‘one-stop shop’ providing single-source solution will also continue to grow as managers further recognise the major advantages of having one provider – the cost and administrative efficiencies achieved, a reduced level of due diligence required, seamless integration and a single point of contact for ongoing management of the relationship,” says Pritchard.
Looking to the rest of the year, experts also expect 2021 to see the continued adaptation to a post-pandemic world, with a renewed focus on areas such as cyber-security as remote working continues.
Looking more broadly at the UK’s financial services as a whole, Tej Patel, partner and regulatory practice lead, Capco, explains that now that Brexit has happened and political tensions begin to ease, “it will be important for supervisory bodies to remember the productive and close working relationship which has existed with the UK for so many years”.
“A renewed focus on this positive relationship will be key to delivering much needed equivalence decisions in a timely manner, as the priority has to be market stability, protection of investors and detection of abuse/manipulation — not political agendas on either side,” Patel adds.
