What drives consolidation in asset management

Robert Crispen, a 35-year industry veteran, came out of retirement to become chairman and CEO for the Americas at ING Investment Management. Officially based in Atlanta, he works primarily from his residence in Maine, but recently visited Hong Kong to talk about the big trends in the global economy and the funds industry.

Does Eliot Spitzer's crusade against market timing affect the rest of the world?

Crispen: It's predominantly a US issue. But the same issues will move around the globe. Fund managers need to know what are the expectations of regulators, and ensure we have the proper corporate governance measures in place to support activities in Europe and Asia Pacific.

What changes does this imply?

The problem in the US involved fund managers trading in their own accounts. The regulators have focused on what they were trading in those funds at the expense of the other shareholders. It's a legitimate issue, but I'm schizophrenic about it. How do we ask third-party investors to buy into a fund if the managers aren't putting in their own money? We need to establish a lengthy, defined holding period in which managers can't exit quickly or take advantage of overnight pricing disparities or inside information. It's hard to argue market-timed trades by portfolio managers doesn't harm other shareholders - but it's a good thing to see portfolio managers put in their own money over the long term.

The other thing the regulators looked at was arbitrage between markets using stale pricing: a portfolio manager's international fund may close at 4:00pm in the US but then an event takes place elsewhere and the manager trades his own account in another market at a different price. Fund management companies are instituting fair value pricing to remove the arbitrage opportunity.

From your perch in the US, what do you see happening to capital flows?

You have to look at the artificial restraints on capital flows like trade constraints and constraints on currency moves. These restraints have become acute given the weakness of the US dollar. I'm not a portfolio manager, but based on 35 years of experience in this industry, it seems clear to me that what we have is a massive creation of money supply, record fiscal deficits and a depreciating dollar, and that bodes for a rise in US interest rates that is larger than people now suppose.

The flow of funds to support US Treasuries has been huge, so the question is what might change that at the margin. We've recently had a shot across the bow when the Treasury department indicated less interest in having a number of Asian countries acting as the marginal buyer.

The dollar's not going to crash, because interest rates are too low, but money will come out and make its way into the real economies of these countries, and into more equity market products. The whole attitude toward risk has changed in the past 12 months from apoplectic fear to unfettered greed, and we see that in spreads on high yield and emerging market bonds.

Will this capital head to Europe given the strong euro?

I'd be hard pressed to see Asian investors inclined to invest in European securities. I know this is an American view, but European economies are really fumbling.

What do you see as the big unknown in the global economy?

Inflation. In America we've convinced ourselves that inflation is never going to be a problem again. But the current stimulus package is likely to sow the seeds of inflation. George Bush knows what killed his father's re-election to a second term as President, and he's going to do whatever is in his power to mitigate economic malaise. Alan Greenspan is not in Bush's pocket, but he also agrees on stimulating the domestic economy. Tax cuts have clearly been a major reason this recession wasn't deeper and instead has turned around. If George Bush doesn't win re-election, there will be an attempt to roll back some of these tax cuts, but nothing could be implemented until January of 2006 anyway, so nothing will change this stimulated environment in 2004 or 2005.

Who benefits?

The relative flow of capital will still be significantly toward the US. The question is, will it be in the form of M&A? In 1999 and early 2000, the difference in valuations and currencies really encouraged European insurance companies to buy US insurers. European insurers ended up with too much equity in the balance sheet while the dollar was strong. Now the euro's at a 30% premium to the dollar and PEs are narrowing again between US and European stocks. Will we now see interest in cross-border M&A? For now the M&A in the US is domestic.

What about the fund management industry?

There will be rapid consolidation in the US. In 2001 and 2002 and even in early 2003, the motivation for consolidation in the funds industry was declining assets under management and pressure on fees. But there were few transactions, because the expectations of the sellers didn't reflect the new earnings reality.

From mid-2003 to now, equity markets are up and fee flows have snapped back. Some fund management CEOs are saying hey, no harm done, I didn't sell out before, so why sell the business now? But the settlements of Putnam, Alliance Capital, Franklin Resources and Invesco with [New York State attorney general] Eliot Spitzer over market timing have changed the bar. These settlements called for lower fee schedules. Spitzer's determining fees! It's naïve to assume that, even though our firm was never involved in these settlements, that we don't now face new competitive fee levels. Even in a good market, your margin is 40%, and when your fees are cut 20%, that's pretty big.

Who is vulnerable?
Last year, ING bought a small value firm with great management. They were willing to sell to us because they lacked distribution. The industry doesn't just face macro pressures on fees, but the high cost of distribution if you're not already established. The ones who have it, have it: Fidelity, Vanguard, AIM, Franklin, us - we have longstanding, deep capabilities in distribution. For mid-sized managers without this, their days are numbered.

I expect more M&A domestically in the US, and within Europe. The European experience of buying US fund management companies has been less than satisfactory, they paid at the top of the market and integration has been difficult. But look at JPMorgan Chase's merger with Bank One. Both have strong asset management businesses, which will become a special part of the resultant company. It's the same thing with Bank of America and Fleet. And we'll see lift-outs of portfolio management teams from the $5-8 billion fund houses without distribution.

Is there a minimum AUM to survive?

ING Group has $500 billion under management so we can play. I'd say if pressed a firm needs at least $150-200 billion, but this is less important than what you've got locally. We have $54 billion managed in Asia, which means the business here can be run in a global sense but we don't try to manage each market as if they were the same. We can run each unit under best practices for risk management and compliance, but each centre will have a different alpha generating component.