Jeremy Soutter of Aviva Investors talks to Tomas Hirst about regulatory pitfalls for complex products.
Q: What were the big surprises of 2010 in terms of products hitting the market?
A: One of the aspects that I thought would be a major growth area was the risk/reward feature of the Ucits IV directive. The problems with the risk-rating models that were suggested, however, have meant that it doesn’t look like these types of risk-rated funds are going to come to the market for some time.
There has clearly been a surge of interest towards absolute return products. A large portion of funds that launch next year will undoubtedly be these types of products.
But there will also be a lot of hedge funds being launched into the market.
The hedge fund industry has moved on a bit in recent years. There is a lot more clarity in these products and due diligence has improved dramatically. The types of funds that are being created would traditionally fit comfortably into the Ucits framework but there are a couple of areas where they will just fall foul of the regulations.
Now we have AIFM [Alternative Investment Fund Managers] passports, some people are looking at it as Ucits part B. You get a badge that you can show investors and they will be comfortable holding these types of products.
Q: With several regulatory changes being prepared for the asset management industry, what pitfalls could await fund groups?
A: Generally we are going to see a divergence away from vanilla investment products. [But] under Mifid [Markets in Financial Instruments Directive], IFAs are not going to be able to sell complex financial products. The problem is knowing what exactly falls under that definition.
Interestingly, in Hong Kong the regulator has sent out a note warning that if you buy derivatives from anyone based there they have to be qualified up to a certain level. Unfortunately many people could be caught out.
There is a risk in Britain that there will be a lot of unforeseen consequences of this legislation. What is needed is a definition of what exactly constitutes a complex product and a need for better policing of the sale of these types of instruments to retail investors.
There was a debate at the Treasury about creating transparent funds. The debate centred on whether it was possible to stop retail investors from buying into a fund under the Ucits framework. Some people claimed that it was impossible to prevent, but of course you can do it simply by raising the minimum investment of these funds to something like £1m.
Then you’re restricting yourself to sophisticated high-net-worth individuals and institutional investors.
The question with all of these types of products is are they being administered properly. Gars [Global Absolute Return Strategies] is not overly complex. In terms of its composition it is pretty vanilla, but where it is complex and difficult to replicate is in its strategy.
If there is a massive collapse in one of these Ucits funds, which I do not think is completely improbable, the European regulators will be looking closely at that.
(Q&A continues below)
Q: Is any pressure being put on the regulators to improve the regulations that have already been announced?
A: Sometimes it seems as if the people who come up with these things are unaware of what is going on outside their offices.
We are already seeing some revisions, particularly to the AIFM, so we do not yet know what final form they will take, but certainly we are going to see some substantial revisions when these things go live.
One revolution that has already taken place in recent years is in lobbying. Lobbying has moved on to a new level where it is not simply left to trade bodies but companies are hiring people themselves to lobby on their behalf so that should have an impact.
If we took each of these to the letter at the moment it would be almost impossible to do anything next year. What we have to do is to continue to build sensible products for our clients that are able to produce decent real returns.
Q: What are your predictions for 2011 in terms of the industry and product innovation?
A: I think we expected to see a huge growth in risk-rated products, but that has not happened. The Retail Distribution Review should, however, lead to a growth in the fund of funds business. Of course, this could all have been made much easier if the regulators had not been quite so hasty in bringing forward all of this new regulation.
Another theme we are looking at for 2011 is fixed income. People are already looking at different ways to play the asset class and there should be a growth of new strategies next year. One area people are looking at is emerging market debt, with emerging market corporate debt presenting new opportunities for investors.
Along with fixed income, real estate looks in a position to do well next year and it is an area that we are looking at closely.
In Asia Pacific, for example, there are regions where the real estate markets are doing well and even in Britain, where the outlook is less certain, the yield is still looking appealing.
As we have seen volatility grow in markets, people have also been looking to real returns over benchmark returns. Time horizons have changed dramatically in recent years but to some extent I think that is right.
Ucits III was a necessary change, but it happened so fast that it took the industry by surprise. It has been six years since it was brought in, but it is only in the past couple of years that the industry has realised the full implications.
Next year a lot of these funds will be coming of age, having been launched three or four years ago, so it will be a good time to gauge how successful they have been. Up to now it has been difficult to judge solely on short-term performance figures.