New lease of life for the high street

Abbey is a financial services group with a prominent high-street presence, and £24bn of investment funds under management. Its investments team is headed by James Bevan, chief investment officer, and John Kelly, head of client investment. The team is based at Abbey’s head office in London and comprises seven managers and analysts. Funds are actively managed on a manager of managers basis. Abbey was acquired by Banco Santander in 2004.

Abbey – or Abbey National as it used to be known – is one of the biggest and most recognisable financial institutions in Britain. Millions of people trust it with their mortgages and savings accounts. But its investment fund performance has been less than impressive in recent years, with just one fund out of 10 with a three-year track record reaching the top half of its sector. Seven of the funds are bottom-quartile over three years, including the flagship UK Growth fund.

But Abbey recognised it had a problem, and in January 2004 the group closed down its in-house equity and bond fund management teams and outsourced the management. The one-year figures show a slight improvement as a result, with four out of an expanded range of 15 funds in the first or second quartile, and only two funds still fourth-quartile.

John Kelly, head of client investment at Abbey, says of the move: “We took the decision at the end of January 2004 because the in-house performance was rubbish. Some of the funds were dreadful. It was a very hard decision. We agonised through 2003 and in January 2004 we bit the bullet. We made 50 fund managers and 26 analysts and support staff redundant from the Glasgow office, which made us very unpopular in Scotland for a while. But at the end of the day, it is the customer you are working for.”

Kelly had come to Abbey to run Inscape, a multi-manager business that runs its funds on a manager of managers basis. This helped make the case for outsourcing. “Such an operation is in conflict with internal fund management as it holds that no one manager can be the best in all markets. From day one Inscape invested in non-Abbey fund managers,” he says.

With £30bn under management, Kelly says Abbey was big enough for the regulator to take an interest in its decision, requiring that the objectives and risk profiles of the funds would not suddenly change as a result of the move. This made the choice of destination critical. “To find such a partner is a huge amount of work: the choice is either a myriad of specialists or a single giant,” says Kelly. “Of the £30bn, £20bn of it changed hands; the property, cash funds and structured products stayed with Abbey. State Street Global Advisors won the beauty parade and on January 27, 2004 it picked up £20bn as a sub-adviser for us.” He says Abbey was comfortable it had gone to a broader, higher-quality fund manager with a discipline more suited to its clients.

State Street still manages a large portion of the assets, particularly where Abbey has chosen to use index-tracking, although some of the funds initially transferred to the group have been moved on to other managers. In these cases, says Kelly, State Street was more of a “staging post” that allowed Abbey to effect the transfer in one go and find managers for smaller pots of assets later on.

Bambos Hambi, director of the Gartmore Portfolio service and by definition a supporter of the multi-manager approach, says Abbey made the right decision. “It shows what a strong proposition multi-manager is, either from the fund of funds or the manager of managers perspective,” he adds. “I commend them for it. Their historical performance numbers were poor and they realised they did not have the resources to do it themselves. I think it’s a brave decision, and one in which they are ahead of the curve. Other major institutions that are struggling with their performance could well follow suit.”

BestInvest investment adviser Justin Modray also welcomes the move, though he is not convinced it will solve all Abbey’s fund management woes. “It was definitely the right move as the internal management was hopeless,” he says. “But while it was sensible we are yet to see the benefits really being delivered. Marginal underperformance is better than serious underperformance but it is still a long way short of the stars that are available. Using passive management for some of the money may mean we never see really good performance from the Abbey funds.”

Kelly too is pleased with the outcome. “In general, Abbey has done a good thing in terms of public perception,” he says. “We have not had huge feedback from clients, but with staff it has been stupendous. Our branch staff tend to be local people serving other local people. They are not the most expert investment advisers but they empathise with the customers and they will quickly lose confidence with unfit products. It is easy to understand that what we have now is as good as anything on the high street.”

Abbey’s one above-average fund over three years, and its best performer in absolute terms, is its Balanced Portfolio Income fund – one of a number of funds to have been moved on from State Street to another external manager. Its three-year return of 17.64% places it 25th of 70 funds in the UK Corporate Bond sector, where the average return was 16.66%. Over one year the fund is top-quartile in its sector with a return of 7.08%.

Worst in absolute terms over three years was Abbey National Technology, whose 32.28% decline placed it 16th of 18 funds in the Technology & Telecoms sector, where the average loss was 21.48%. This fund’s relative position has improved over the most recent 12-month period, although it is still below average in its sector.

For Modray, the relative improvement across the range is unimpressive. “They had some dog funds over the long term before they moved to multi-manager. The worst offender was UK Growth, which is now split between three managers, some of it on a passive basis. Over the past 12 months it has underperformed the FTSE All-Share by about 2%, so it’s still not even good, let alone great. The same is true of most of the other funds. Multi-manager might turn the funds from mediocre into just below average but it still won’t solve the long-term performance problem.”

He adds that he finds it hard to believe advisers would reconsider Abbey without a major turnaround in performance, though the funds will probably continue to sell through Abbey’s branches.

Before taking the decision to outsource all its funds, Abbey had launched a range of multi-manager funds in September 2003. These are similar to the Inscape products, which are aimed at Abbey’s more affluent clients. Kelly says: “The in-branch Abbey funds are a product and Inscape is a service, so you pay a bit more. The philosophy, team and managers are the same, as are the portfolios, largely. Inscape includes things like tax, legal and estate planning advice, depending on the requirements of the individual. But Inscape has been pulled into branches, so it is part of Abbey rather than separate from it.”

Choosing the managers for all the funds starts with a blind quantitative screen that aims to assess performance against a benchmark and also to uncover style or market capitalisation biases. Since the wholesale transfer to State Street, assets have been moved on to about 13 further external managers, including Merrill Lynch, Pimco, RCM, Schroders, State Street and Western Asset Management. Abbey is focused on risk control, and Kelly says the managers it chooses tend to be large and institutional-style.

“People call quantitative fund management a black box, but really it’s a transparent box, as you know exactly what is going on inside it,” he says. “The biggest black box is a fund manager’s head. To understand the risks he is taking you have to know what he is doing and why, which is why we want people who are capable of explaining their process.”

For this reason, says Kelly, “we rarely go for personality-led teams. If we do, we will put it in the contract that we will void the deal if we find the named manager is less involved than they might be.”

But while access to lesser-known fund managers, often in America, may be an attractive idea, Hambi says he would rather build such relationships himself than invest even through one of Abbey’s single-manager funds. “Abbey has moved away from managing its own funds and has in effect become a rival to us. Even where they have single-manager mandates, if we wanted access to those managers we would go to them direct rather than through an Abbey fund, as we wouldn’t want to pay an extra layer of fees.”

Fees are central to the Abbey proposition, and Kelly points out that its multi-manager funds have particularly low charges. “The total expense ratios of our multi-manager funds range from 135 basis points to 180, which is more in line with what you’d pay for a single-manager fund and is half what you’d pay on a lot of multi-manager funds. We can’t promise performance but we can promise on costs.”

This has been achieved partly because of Abbey’s recognition that its clients may have been disappointed in the past. “What we have done is what all retail fund managers should do, and that is stand in the client’s shoes,” says Kelly. “It’s not about sales so much as partnership. We will do the things they can’t do in terms of finding managers and managing risks, and we will keep costs down.”

But Modray thinks that investors are looking for more than this. “Investors look for value for money, and that is measured by consistent outperformance after charges. They would rather pay a bit more and get better performance than have a really cheap fund that marginally underperforms. Abbey could look at introducing performance-related fees, which would allow it to strip its basic fees right back, but at the moment low charges are a red herring. There’s no point buying something cheap if it’s no good.”

Abbey is still adjusting after its takeover by Banco Santander last year, and has not yet settled on its post-depolarisation fund distribution strategy. But it seems likely it will concentrate its efforts on meeting the needs of its branch-based customers with multi-manager funds rather than pursuing the more demanding intermediary market. It is also important to recognise that one year is probably too short a timeframe over which to judge the success of its move to outsource.

Kelly says: “The trend of performance is moving in the right direction, and I think we’ve done the right thing. What really matters is our reputation with intermediaries and with our customers. We don’t have all the answers but we’re trying to get there.”