The fund managers' new faith

TEN years ago, the boards of fund management companies saw performance as the major issue. Then, as the great bull market gathered pace, they switched to the rate at which the funds under management were increasing. Now attention has switched again. Today the focus is on revenue growth and profitability.

The results can be startling. These days managers don't mind too much if they lose business, provided the money they bring in is more profitable than that flowing out. That was the lesson of the latest results from Schroders. The trick is to steer customers into products on which they can charge significantly more.

The nation's pension fund trustees and finance directors of the sponsoring companies are sitting ducks for this. They got a nasty fright from the bear market in equities and the collapse in interest rates, which left their pension funds with insufficient assets to cover their liabilities so most are looking for ways to get higher returns for no extra risk to help restore the funds to health.

Unfortunately, they are like generals planning for a re-run of the last war. They have lost faith in conventional active fund managers because their equities fell in value while these fund managers continued to hit their benchmarks. So they are polarising.

Massive slugs of money are going into trackers run by Legal & General and Barclays Global Investors where they will deliver benchmark returns far more cheaply. But to get the growth they hope will solve their funding problems, they want absolute rather than benchmarked returns. So they are flirting with hedge funds, whose basic promise is huge performance at huge cost.

Huw van Steenis, the highly respected analyst with Morgan Stanley, ran a seminar for the fund management industry in London yesterday to discuss this phenomenon. He describes what is happening as a barbell - as in fitness training.

At one end of the bar, money is pouring into index trackers where costs are low and the client knows exactly what is offered. At the other end, money is pouring into hedge funds and private equity. Conventional fund managers - the bulk of the industry - are caught in the middle and seeing their funds draining away to either end.

Hence the scramble to reinvent themselves and persuade clients they can offer hedge funds and all the other fancy products with the best of them. Though they may retain less money, this strategy enables them to charge so much more on what they do have that their overall revenues keep growing.

Inevitably, most people and pension schemes buying hedge funds will be bitterly disappointed. Going in now is the equivalent of retail investors buying unit trusts at the top of the market. Few wish to confront that truth, though many are suffering already.

But it was ever thus. Stock market investment is a zero-sum game - for one person to win, someone has to lose. Fund managers perform well when they are small and nimble and can do something different. It all falls apart when they get big and everyone copies them.

Hedge funds are no different. People merely think they are because they charge so much. That, of course, is one of the oldest marketing ploys in the book.

Landmark deal

PERHAPS because the fund management industry is so entrenched, significantly fewer people buy securities directly in this country than in much of Europe.

Here, people participate in the stock market via pooled funds - pension schemes, insurance policies or unit trusts. In Italy and Germany, however, it is reckoned individual retail investors buy about e8bn (£5.3bn) a year of securities.

In France the figure is e6bn and in Switzerland e4bn. High Street banks in each country handle most of the business, which is why a deal done by Xchanging, the British outsourcing firm, is highly significant.

This firm was created by David Andrews, who a decade ago as an Andersen Consulting partner handled the IT outsourcing deal with the Stock Exchange, which financed and created the electronic trading system Sets.

It also introduced industry-wide back-office IT to the London insurance market and handles personnel for BAE Systems.

Now it has established a significant presence in mainland Europe by persuading Deutsche Bank to hand over to Xchanging all the processing, trading, settlement and asset servicing of its retail investor base.

It is one of Europe's biggest financialsector outsourcing deals, runs for 12 years and will involve the transfer to Xchanging of some 900 IT staff.

It is one of those landmark strategic moves Deutsche Bank's competitors will find very hard to ignore.