Market pressure blurs the line between US asset and wealth managers

Should regulators step in? Time will tell and no doubt there will be some bad actors

Gabriel Altbach

James Gorman intends to double the size of MSIM to at least $1tn in assets (Giulia Marchi/Bloomberg)

American colleagues often say Europe is about proprietary distribution via bank networks, while the US is all rough-and-tumble, survival-of-the-fittest open architecture.

They point to the disproportionate share of fund flows that go to bank-owned asset managers in some of Europe’s largest markets, notably Germany and Italy, and the US’s predominantly third-party marketplace.

But times are changing.

In the US in the mid-2000s, the big full-service wealth managers had sizeable asset management units that pushed their products largely internally. But starting in 2005, many were offloaded due to regulatory pressure (ie, the conflict of an adviser recommending their own firm’s more profitable product over an outside one) as well as in response to the financial crisis. Merrill Lynch sold its money management business to BlackRock while Morgan Stanley offloaded Van Kampen to Invesco.

Few US asset managers sold direct to retail consumers and the overwhelming majority of flows were via intermediaries. There were a few exceptions, including Fidelity, Vanguard and T Rowe Price, but in general the roles were clearly defined: the asset managers, as “manufacturers” sold on a wholesale basis to the broker-dealers, the “distributors” that owned the retail relationships.

A similar, stark demarcation existed in the institutional arena: asset managers forged relationships with investment consultants who, in turn, advised public and private pension funds.

Now the lines have blurred due to developments including the growth of passively run ETFs and downward pressure on fees, greater regulation and technology. Even so, little attention is paid to how the various players increasingly sidle on to each other’s turf and the implications of that.

More and more, the companies that own the relationship with end-investors focus on expanding their own asset management capability — a reversal of the accepted wisdom at the time of the financial crisis. Examples abound, including Raymond James’ Carillon Tower Advisers arm, Edward Jones’ rapidly growing Bridge Builder fund line-up, and Charles Schwab’s Laudus funds.

The point is best made by looking at Morgan Stanley and its Morgan Stanley Investment Management business. James Gorman, Morgan Stanley chief executive, has said he intends to double the size of MSIM to at least $1tn in assets, and that selling Van Kampen was a strategic mistake.

Not unrelatedly, more asset managers have forged relationships with end investors and sell directly to them.

The size of direct-to-consumer businesses at Fidelity and Vanguard has grown dramatically, while in December BlackRock and Microsoft announced a partnership to bring technology-based investment and planning solutions to address America’s vexing retirement savings shortfall. Details of this venture are scant but my bet is it will involve investors being offered BlackRock products and services on a direct basis supported by a seamless technology platform developed by Microsoft.

The industry is seeing the change. According to Strategic Insight, of the top 10 asset managers in the US ranked by 2018 net inflows, five are either part of an institution that owns the client relationship or are companies that primarily sell direct to the consumer (not counting MSIM in 11th place).

Some of this reflects a tug of war over shrinking revenues associated with managing portfolios of investors of all stripes.

As with any industry, if the ultimate price the customer is willing to pay shrinks, providers need to cut costs to preserve margins. Wealth managers have shrunk the shelf space for outside managers and increased the price of entry to their systems, in addition to slowly taking on asset management activities. Likewise, asset managers have sought out new ways to distribute their capabilities.

Is all this a cause for concern? Do regulators need to save investors from conniving asset and wealth managers driven to bend fiduciary obligations? Time will tell, and no doubt there will be some bad actors.

Most of these developments, however, serve to lower the cost borne by investors, and the response to declining margins will more often be the consolidation of small and midsized providers, rather than anything nefarious.

There is no doubt that the environment is now more complex for asset managers. Chief executives will have to put more focus on corporate strategy and how to deploy finite resources. Some will be up for the challenge while others will wither, probably to be acquired.

Squint just right and the US asset management industry is beginning to resemble that of Europe.

Gabriel Altbach is founding principal at Asset Management Insights

Trump’s Counter-Intelligence Strategy

Although Donald Trump is not the first US president to have reservations about America's spies, he is the first to attack the intelligence community so openly. As US intelligence analysts' job becomes ever more difficult, other national-security policymakers must support them in providing in-depth, fact-based assessments.

Kent Harrington


ATLANTA – For more than two years, US President Donald Trump has heaped praise on the world’s authoritarians, disrespected America’s democratic allies, and pursued an ego-driven effort to solve the Gordian knot of North Korea’s nuclear weapons program. But now, the effects of Trump’s demented foreign policies are coming home to roost. Nowhere is this more evident than in the United States’ intelligence agencies, where professionals charged with safeguarding the country’s national security are struggling to acquaint the president with realities he does not want to see.

Following the annual threat briefing to Congress in January, Trump issued a flurry of tweets challenging the credibility of his own intelligence chiefs’ testimony. Though the content of these tweets was characteristically sophomoric, it would be a mistake to dismiss them as a mere tantrum from the Toddler in Chief. Trump’s petulance bears directly on the intelligence community’s ability to do its job.

Trump’s intent in undermining his own intelligence chiefs is hard to miss. Unnamed White House sources recently suggested to reporters that Trump is eager to be rid of Dan Coats, the director of national intelligence. By quickly dismissing reports about intelligence officials’ testimony as “fake news,” Trump delivered an important message to Coats: his job depends not on his performance, but on his willingness to carry water for the president.

Of course, all presidents appoint their top spies and periodically make changes within the ranks of the intelligence community. Generally, questions of who briefs the president or offers advice on risky covert actions receive the most public attention. But historically, the intangibles that shape such relationships – not least the president’s personal views about intelligence – have had the most dramatic effect on how intelligence is used.

For example, Richard Nixon regarded the CIA’s top officials as enemies, and thus kept the agency in the dark about his strategic plans. Similarly, when intelligence analysts raised their estimate of North Korea’s military strength, Jimmy Carter suspected they were plotting to derail his campaign pledge to bring a US Army division home from South Korea. And Bill Clinton, for his part, simply wasn’t interested in spies and their business. After a small plane crash near the White House in 1994, many joked that it was an attempt by the CIA director to get in the president’s door.

But Trump has broken new ground with his public attacks on US intelligence agencies. The problem probably started when those agencies unanimously concluded that Russia had waged a cyber and political war to put Trump in the White House. And intelligence agencies certainly haven’t helped themselves by repeatedly contradicting Trump’s off-the-cuff pronouncements on Iran, North Korea, the Islamic State (ISIS), and other threats. 
Yet even putting these instances aside, Trump came to office with a deep and abiding ignorance of national-security policy and the role intelligence plays in it, which means that the situation for US spy chiefs is not going to improve. Consider the analysts who are responsible for assessing developments in North Korea. Like their colleagues who monitor other threats, they aren’t there to criticize US policy or tell policymakers what to do. Their role is to consider intelligence from all available sources, and then assess the likely effects of potential US action across a wide range of strategic areas.

But Trump has not been happy with US intelligence analysts’ latest findings. North Korea’s recent threat to resume missile testing would seem to reinforce the judgment that the country’s leader, Kim Jong-un, is nowhere close to giving up his nuclear arsenal. Yet the response to that news from Secretary of State Mike Pompeo, a reliable Trump weathervane, was to dismiss North Korea’s own official statement and reaffirm the administration’s faith in Kim.

Those briefing Trump on the actual intelligence should consider themselves warned not to expect praise for doing their job. After all, assessments of the North Korea threat will undoubtedly continue to invite Trump’s ire. Trump’s recent summit with Kim in Hanoi was a failure, and the effort to denuclearize the Korean Peninsula has gone nowhere. At the same time, Kim has made significant progress in bolstering his own position.

With international support for sanctions weakening, China has begun to allow more cross-border trade, offering an economic lifeline for the Kim regime. Kim has also managed to secure a suspension of major US military exercises on the peninsula, while driving a wedge between the US and South Korea. With or without a nuclear deal, South Korean President Moon Jae-in’s own political future requires that he pursue further North-South rapprochement, while playing Cupid to Trump and Kim’s bromance.

Whether Trump will sit still for an uncongenial intelligence assessment is anybody’s guess. In public, Coats and CIA Director Gina Haspel insist that Trump is an engaged, informed consumer of intelligence. But such claims are refuted by the fact that Trump himself has dismissed the need for daily briefings and repeatedly rejected established facts and contrary opinions. With in-person briefings already down to just two per week, those who conduct them have reportedly begun playing to his limited attention span by focusing more on business and trade.

But regardless of whether Trump wants in-depth analyses, Coats and the other spy chiefs must insist on them, while ensuring that intelligence assessments are reflected in the White House agenda. Trump’s solipsistic worldview and antipathy toward intelligence officers have alarmed others who have a stake in national-security policy. As Adam Schiff, the chairman of the US House Intelligence Committee, wrote in a letter to Trump prior to his recent summit with Kim, “We are perplexed and troubled by the growing disconnect between the Intelligence Community’s assessment and your administration’s statements about Kim Jong Un’s (sic) actions, commitments, and intentions.”

America’s intelligence chiefs are obliged to present the president with the facts, whether he likes it or not. Anything less shortchanges the people who work hard to collect and assess intelligence. Worse still, it amounts to a major threat to US national security.

Kent Harrington, a former senior CIA analyst, served as National Intelligence Officer for East Asia, Chief of Station in Asia, and the CIA’s Director of Public Affairs.

A Rising China Is Driving the U.S. Army’s New Game Plan in the Pacific

New missiles and large-scale exercises part of long-term strategy to deter Beijing.

By Lara Seligman

Idaho Army National Guard and Montana Army National Guard Soldiers from the 116th Cavalry Brigade Combat Team conduct a live-fire exercise with Royal Thai Army Soldiers at the Cavalry Center in Thailand’s Saraburi province on Aug. 28, 2018. (Department of Defense Photo)
Idaho Army National Guard and Montana Army National Guard Soldiers from the 116th Cavalry Brigade Combat Team conduct a live-fire exercise with Royal Thai Army Soldiers at the Cavalry Center in Thailand’s Saraburi province on Aug. 28, 2018. (Department of Defense Photo)

FORT SHAFTER, Hawaii—As an organization based solidly on dry land, the U.S. Army’s increasing focus on the Pacific might seem puzzling to some.

But with China continuing to expand its military, building islands in the South China Sea, and spreading fear among neighbors, the Army wants to up its game in the region with more firepower and additional rotations of U.S. troops—not only to reassure key U.S. allies such as Japan, South Korea, and Thailand that the United States has their back, but also to prevent a potential war.

“China is the priority,” said Gen. Robert Brown, U.S. Army Pacific commander, during a March 19 roundtable with a handful of reporters at Fort Shafter in Hawaii.

The push to ramp up presence in the Pacific is in line with the U.S. military’s strategic shift from the counterterrorism fight in the Middle East to competition with potential near-peer adversaries such as Russia and China. Former Secretary of Defense James Mattis laid out the approach in a National Defense Strategy last year.

“We’re kind of at an inflection point,” said Army Vice Chief of Staff James McConville in an interview, citing almost two decades of wars in Iraq and Afghanistan.

“Great power competition is not great power conflict,” McConville stressed. “What we are doing is positioning ourselves so we can compete. Really, you want to compete from a position of strength.”

But the Army’s new road map for countering China is contingent on persuading Congress to fund it. And there are many skeptics on Capitol Hill and in the broader community who are unconvinced that Beijing really poses a military threat to the United States and its allies.

Stephen Orlins, the president of the National Committee on U.S.-China Relations, took issue with the Pentagon’s aggressive stance toward China, saying that the area where Washington should really be competing with Beijing is in the economic and diplomatic domains.

“What we’re doing, in effect, is we’re demonizing China,” Orlins said during a February event in Washington, D.C. “I don’t disagree that [China is] an economic competitor and a diplomatic competitor. But when we brand them a strategic competitor … that diverts spending from what we really need to compete with China to the strategic side.

“What we’re seeing is an exaggeration which has terrible policy consequences for America,” he said.

Orlins acknowledged that China’s actions in the South China Sea have violated international law but said that does not mean it poses a “strategic threat” to the United States.

But while a near-term military clash is unlikely, Ely Ratner, the executive vice president and director of studies at the Center for a New American Security, argued that it is critical for the U.S. military to maintain an effective defensive posture in the Pacific as a check on China’s growing influence. He cited concerns that “the lack of American deterrent could lead to instability over Taiwan or otherwise.”

“I am much more worried about a creeping Chinese sphere of influence, often in what military strategists call gray-zone tactics—nibbling away below the threshold of military activity, which they’ve done in the South China Sea,” Ratner said. This “could have a whole set of knock-on effects into the economic sphere and the political sphere.”

For its part, the U.S. military is increasingly concerned not just about China’s efforts to modernize its military, but also about what it sees as Beijing’s underhanded economic practices. Through the Belt and Road Initiative, China is developing infrastructure and investing financially in countries across the world, particularly in its Pacific backyard. But the investment has come with strings attached for some countries, including unsustainable debt, decreased transparency, and a potential loss of control of natural resources.

In December 2017, Sri Lanka handed over control of the newly built Hambantota seaport to Beijing with a 99-year lease because Colombo could no longer afford its debt payments to China. Adm. Phil Davidson, the commander of U.S. Indo-Pacific Command, cited the case in an appearance before the Senate last month.

“China represents our greatest long-term strategic threat to a free and open Indo-Pacific, and to the United States,” Davidson said.

Part of the Army’s efforts to deter China focuses on strengthening alliances and partnerships in the region as a counterweight to Beijing’s increasing influence. This means more rotations of thousands of soldiers at a time from the mainland through short-term Pacific deployments, Brown said during the press conference.

The Army already has roughly 85,000 soldiers in the theater, mostly in South Korea, Washington, Alaska, and Hawaii—which is home to the U.S. Indo-Pacific Command’s headquarters.

It also potentially means more, larger-scale exercises in the region. In an interview, Army Undersecretary Ryan McCarthy said the service included in its budget request for fiscal year 2020 money to beef up the existing Pacific Pathways exercise—which in its first iterations involved Indonesia, Malaysia, and Japan—and establish a new, division-level exercise called Defender Pacific, designed to show the capability to deploy a much larger force.

Another way to strengthen partnerships is through selling foreign militaries U.S. equipment, McCarthy said.

“We can teach them and show them and help them grow their capabilities,” he said.

But another part of the strategy is building up the Army’s own arsenal in the Pacific. As a land-based service, the way the Army fights in the Pacific is with long-range missiles and artillery—extremely long-range.

At least until August, when the United States officially withdraws from the Intermediate-Range Nuclear Forces (INF) Treaty with Russia, the Army’s conventional and nuclear missile capability is limited to 500 km (about 300 miles). China has never been a signatory, which has allowed it to build up a vast arsenal of conventional weapons that now threaten freedom of navigation in the region, including the DF-21 “carrier killer.”

But the INF Treaty does not cover a new type of weapon, hypersonic missiles, which travel at least five times the speed of sound and could reach 1,000 miles or farther.

The Army is hoping to use this fact to its advantage. In this year’s budget request, the service said it is planning to spend more than $1 billion in fiscal year 2020 to develop a land-based hypersonic missile. Meanwhile, the service’s new Strategic Long-Range Cannon could be fitted with a hypersonic round that could travel vast distances. These capabilities could be fielded in 2023, McCarthy said.

If the United States withdraws from the INF Treaty, the Army’s Precision Strike Missile, a replacement for the legacy Army Tactical Missile System, could be adjusted to extend its range beyond the current INF Treaty limit of 499 kilometers. That capability could be fielded in 2022.

In addition, the Army is currently developing an extended-range artillery cannon, designed to reach up to 70 kilometers, about 40 miles.

The Army could potentially position these missiles on any of the Pacific theater’s 25,000 islands, Brown said.

In addition, the Army is establishing a “multidomain task force” concept designed to fight on the modern battlefield, which involves not just the traditional air, land, and sea domains, but also cybersecurity and space threats. In a conflict, such a task force would allow the Army to penetrate China’s sophisticated defenses, which push America’s traditional capabilities such as aircraft carriers and non-stealth fighters further from its shores.

Finally, the Army is also looking at deploying a Security Force Assistance Brigade a specialized unit designed to train, advise, and assist partner nations, to the Pacific. The Army’s first such units are focused on Afghanistan.

McCarthy stressed that the Army currently does not have any concrete plans to deploy the new missiles, task force, or Security Force Assistance Brigade to the Pacific. That decision will ultimately be made by the secretary of defense, in conjunction with the chairman of the Joint Chiefs of Staff and the combatant commander—Davidson—as part of the force allocation process, if leaders ask for those capabilities.

But Brown said U.S. allies in the region, even ones with more peaceful postures, such as Japan, are open to the possibility of additional U.S. troops and weapons.

“They have reacted in a more positive manner than I’ve ever dreamed of,” said Brown, noting that regional allies have recently been alarmed by North Korea’s missile testing and China’s aggression. “There is tremendous cooperation and excitement, because they have the same dilemma—they are facing a very capable potential adversary.

“It’s a huge advantage for us when you look at China, it doesn’t have those types of relationships,” Brown said.

Lara Seligman is a staff writer at Foreign Policy.

Geography and the American Colonial Period

By George Friedman


In the fifth installment of this series, I will focus on the origins of the United States and the geographical elements that were critical in defining American politics, strategy and culture. In particular, three geographical features defined the English colonies and helped shape the United States into the country it is today.

The first was the long Atlantic coast. Both the Jamestown and Plymouth colonies were funded by British investors who sought to profit from primarily agricultural goods produced along the coast that could be shipped to Britain. Over time, the long coastline allowed for more extensive settlement, the development of a North American shipping industry and an orientation to Europe. The colonies were therefore an extension of Britain not only politically but also economically.
The second defining feature was the flow of major rivers in the colonies. In the south, the west-east flow of most rivers from the Appalachians to the Atlantic meant that north-south transportation, and even communication, was difficult. As a result, the southern colonies were isolated from the northern colonies and from each other. They saw themselves as distinct because of the lack of river transport and the lack of a road system, which would have been expensive to build. The northern colonies were less fractured. The rivers there ran north-south, the area was much smaller, overland transportation was much easier and the colonies were less distant and distinct.
The third and, by far, most important geographic feature was the Appalachian Mountains. The Appalachians were extraordinarily rugged, not because of their heights but because of their vegetation. The mountains were steep in places, and the vegetation made the area almost impassable except at a few points. It wasn’t until after the American Revolution that passages along the mountain range were forged by men like Daniel Boone. The Appalachians were, until then, the western boundary of both the northern and southern colonies.
One of the most important characteristics of the Appalachians is the curve toward the coast as they stretch north of Maryland. It’s here that the terrain of the mountain range becomes much hillier and rockier compared to the south. South of Maryland, the Appalachians are a couple of hundred miles from the coast, and a large, relatively flat plain emerges between them and the Atlantic.
Thus, the south, unlike the north, provides perfect conditions for large agricultural undertakings, including plantations. This geographic distinction led to the primordial divide in the colonies. Plantation farming requires low-cost labor. In Europe, this was provided, prior to the Industrial Revolution, by a social system that created a large class of serfs legally bound to the land. But in the colonies, such a system did not exist, and migrants from Europe weren’t willing to take on such a role. The alternative solution was the importation of African slaves.
But this solution was applied only in the south. In the north, there was no slavery because the economy couldn’t support it. The economy there was built around small farms, shipbuilding, crafts and finance. The roots of the Civil War were shaped by this geography. The question of slavery was embedded in the different economic and social structures that evolved in the colonies.
But before the Civil War, there was the American Revolution, which also turned on the Appalachians. The French, allied with indigenous nations, controlled much of the area west of the Appalachians but didn’t settle there as export of massive agricultural products would have been impossible. They instead traded primarily with indigenous groups for furs. During the Seven Years’ War, called the French and Indian War in the United States, the French sought to cross east, over the Appalachians and into the British colonies. They were stopped by the rugged mountains and also by American militias. British forces, trained for battle on the North European Plain, could not manage combat in the Appalachians, though they held the colonial troops in contempt for the way they fought while also suffering disastrous defeats themselves.
That was the moment that the concept of America as a distinct nation was forged. Americans like George Washington realized that the defense of the colonies depended on them and that the British were of little help and much annoyance. At the same time, they knew an economic break with Britain was impossible but, if it did occur, it could not be on British terms. They also knew they couldn’t protect the long Atlantic coast against the British navy. To have any chance of survival, they had to build many roads running north to south so they could mass a defense along the length of the colonies.
Geography has thus defined much of America’s history – both during and after the colonial era. The story I laid out here is obviously incomplete; it’s not intended to be the definitive history of the colonies by any means. But it is intended to begin to show geography’s effect on history. As always, this is just a fragment of the full story.

Garcia’s death highlights Peru corruption scandals

Former president was one of five accused of graft as country tries to clean up politics

Gideon Long, Andean Correspondent

Alan García is reported to have received more than $100,000 in kickbacks from Odebrecht during his second spell as president © AFP

As police converged on his home in Lima on Wednesday, former Peruvian president Alan García shot himself in the head rather than submit to arrest in a corruption case.

His death, hours later, was the latest tragic chapter of a long tale of graft scandals in the Latin American country.

The past five presidents, who together governed for 33 years, have each been investigated or jailed for corruption. Current president Martin Vizcarra took power last year on a promise to clean up politics following the gargantuan Odebrecht corruption scandal which implicated four of the former leaders.

One, Ollanta Humala, is in Lima awaiting trial. Another, 80-year-old Pedro Pablo Kuczynski, is in intensive care with high blood pressure after being arrested last week. A third, Alejandro Toledo, is on the run in the US where he spent a night in a police cell last month for being drunk in public.

Prosecutors believe the fourth, Mr García, received more than $100,000 in kickbacks from Odebrecht, a Brazilian construction company, during his second spell as president from 2006 to 2011. He denied the charges. “I never sold myself, and that’s been proven,” he wrote on Tuesday in his final tweet before his death.Peru, more than any country other than Brazil, has been shaken to its core by the Odebrecht revelations. The company admits it paid nearly $800m in bribes in 12 countries to win contracts for infrastructure projects, some $30m of it in Peru.

Some in Peru see the pursuit of the four former leaders as evidence that Peru is more corrupt that its neighbours. Others take the investigations as proof that authorities are doing their job — in contrast to other Latin American countries where progress in the Odebrecht probe has been slow.

“The lesson from Peru is that judges can go after graft, however deeply ingrained, and without destabilising the economy,” a senior International Monetary Fund official said. “The key variable is that the macroeconomic accounts have to be in good shape.”

While corruption scandals have dragged down the economy and hit business sentiment in Brazil, Peru’s economy seems less susceptible to the political and judicial intrigue in Lima.

Antonia Eklund, senior analyst at Control Risks, said that while corruption shaved an estimated 0.8 per cent off Peruvian gross domestic product in 2017, in Brazil the figure was 2–3 per cent.

Peru’s economy grew 4 per cent last year, compared to Brazil’s 1.1 per cent and South America’s 0.1 per cent, according to the World Bank. It predicts another 3.8 per cent of growth this year and 3.9 per cent in 2020.

Running like a Shakespearean subplot below tales of corruption in Peru is the story of the Fujimori family, a powerful and controversial political clan. Alberto Fujimori, the authoritarian ruler from 1990 to 2000, spent 12 years in jail for ordering killings and kidnappings as well as embezzlement, only to be pardoned on health grounds by Mr Kuczynski on Christmas Eve 2017.

In a memorable video, Mr Fujimori, dressed in a white hospital gown and connected to tubes, addressed the nation from his hospital bed and asked his detractors “for forgiveness with all my heart”. But the Supreme Court overturned the pardon and the frail 80-year-old was sent back to jail this January. “The end of my life is close,” he tweeted alongside a mournful, handwritten letter posted on his feed.

Alberto’s daughter Keiko Fujimori, leader of the opposition, is also in prison, in preventive custody, accused of accepting more than $1m in illegal funding from Odebrecht.

Adding sibling rivalry to the family saga, she has distanced herself from her brother Kenji Fujimori, a congressman who quit her party over support for Mr Kuczynski. He said his sister harboured “a criminal attitude” and her party lacked moral authority.

A Champion Investment Bank Is the Wrong Solution for Europe

Even if Deutsche Bank and Commerzbank merge, they will still struggle with Europe’s flawed capital markets

By Paul J. Davies

The headquarters of Deutsche Bank and Commerzbank are seen in Frankfurt. Photo: Thomas Lohnes/Getty Images 

Newsflash for financial deal makers: Europe doesn’t need an investment banking champion.

If Deutsche Bank DB -1.57%▲ and Commerzbank CRZBY -1.08%▲ agree to a merger, their executives should remember this and it should govern where they make cuts and invest for the future. Investment banking and trading should be curbed dramatically, especially in the U.S. The priority should be corporate and transaction banking.

To be fair, all Europeans should be thinking this way, not just the two struggling Germans. This isn’t defeatism in the face of powerful U.S. competitors; it is about the lack of proper capital markets in Europe.

European capital markets just aren’t that big, and despite years of European Union-level negotiations and proposals, they aren’t developing either. In fact, European equities-trading revenue in 2018 was down by nearly 20% from 2011, according to data from Coalition, a research firm owned by S&P Global. In the U.S., it has grown nearly 50% over the same period.

In bond and currency trading, which has struggled almost everywhere, the European picture is even worse than other markets. In capital raising and deal making, revenue has held up better, but is still less than half U.S. levels.

Advisory and capital-raising work matters because it is what creates the securities for investors to trade. The big reason Europe is so far behind in this area is well known: It still relies much more heavily on bank financing than capital markets. Three-quarters of corporate debt in the U.S. comes from bond markets and the rest from banks, while in Europe only around one-fifth comes from bond markets.

European capital markets have struggled to develop partly because of national rivalries within the EU that help local banks dominate their domestic markets. National champions tend to lead league tables in each country, followed by big U.S. banks, with other Europeans bringing up the rear.

But there is also a problem with savings and investment habits: Europe has more pay-as-you-go pensions, by which current employees or taxpayers bear the cost of retirees, which means there are fewer pension funds to be invested.

Also, European households keep a greater share of savings in bank deposits rather than investing them in financial assets. Europeans keep about 30% of their funds in banks or cash savings, according to New Financial, a think tank, while Americans hold less than 14% this way.

This is a serious issue. It isn’t only bad for the bonus prospects of investment bankers, but it is bad for Europe’s ability to recover from financial or economic shocks. In capital markets, assets get revalued quickly, investors lose money and they move on. In banks, executives don’t want to take the losses so bad loans hang around, capital remains tied up in poorly performing assets and new loans and investments aren’t made.

Senior European officials know this, which is why they continue to push for reform to create the right sort of regulatory playing field. But as long as national politicians want to protect their local banks and Europeans prefer to keep savings in cash, none of those high-level reform efforts will do the trick.

Only in this old-fashioned world of national champions does a commercial-banking focused merger between Deutsche Bank and Commerzbank make sense. If Europe changes, a European investment-banking champion should emerge—but there is no point creating a vehicle for a road that hasn’t been built.


Fund Investors Believe That Cheap is Better. But That’s Not Always the Case

By Crystal Kim 

Fund Investors Believe That Cheap is Better. But That’s Not Always the Case
Photograph by Ken Cedeno/Bloomberg News          

It took some three decades and a financial crisis, but the evangelicals of index investing finally got their message across—low fees lead to better performance.

The past decade has seen unprecedented amounts of money going into index funds. And not just any index funds, but the very cheapest: More than 97% of flows into the $4 trillion exchange-traded fund industry last year went to ETFs that charge 0.2% or less, Bloomberg data shows.

Except some new research indicates that cheaper isn’t always better. That new message is coming from an unusual corner—noted Vanguard expert Dan Wiener, editor of the Independent Adviser for Vanguard Investors and chairman of financial advisory firm Adviser Investments.

“Vanguard’s late founder, Jack Bogle, had it wrong when he said that investors always ‘get what they don’t pay for.’ Sometimes they don’t,” he tells Barron’s. Of course, Bogle wasn’t referencing ETFs, but the performance of Vanguard’s mutual fund share classes versus their ETFs is illuminating, Wiener contends.

Vanguard’s funds require a bit of an explanation. The $5.3 trillion money manager has a unique exception, enabling it to launch an ETF as a share class of an existing mutual fund, so both have the exact same holdings and strategy. Other firms must introduce a whole new fund with an ever-so-slight difference in holdings. This makes performance comparisons difficult—whether you’re weighing an ETF against a similar, but not quite exact, mutual fund, or against another ETF with a similar, but not quite identical, index as its basis. The exception is the handful of BlackRock(ticker: BLK), Vanguard, State Street Global Advisors ,and soon JPMorgan Chase(JPM) ETFs that track big indexes, such as the S&P 500 or the Barclays Aggregate Bond Index.

“It is exceedingly rare to be able to compare ETFs, apples-to-apples. You can’t hold all else equal, which underscores the fee obsession,” says Ben Johnson, director of global ETF research at Morningstar.

Because of the quirk, however, the performance of the portfolios in Vanguard’s ETFs and mutual funds can be compared directly. The firm’s Institutional Plus share class, which has a buy-in of $100 million, has the lowest fee. Admiral shares used to be the next cheapest, but Vanguard’s latest annual report shows that the ETF prices below Admiral shares—though we’re talking about a difference of maybe 0.01%. The firm also lets Admiral share class investors exchange their holdings for an equivalent ETF.

One might think that the share classes advertised as having lower fees would produce better results if both had the same holdings. But that’s not always the case.

Consider the Vanguard Total Stock Market Index fund. In the 10 years through 2018, the Admiral shares (VTSAX) returned 13.25% annually; the ETF (VTI), 13.26%. The ultracheap Institutional shares (VSMPX) did even better, rising 13.31%. That’s to be expected. However, the ETF also returned more than the previously pricier Admiral shares net asset value over certain periods in those 10 years. All the differences were only a matter of basis points—each equal to 0.01%, or just a dollar for every $10,000 invested—but they still might puzzle some investors.

Wiener, who shared with Barron’s how a real portfolio of Vanguard funds performed in his Roth IRA, noted that his return on the ETF shares differed from Vanguard’s stated return on market price—that at which you can buy or sell ETFs, which, in turn, differs from the NAV. Vanguard calculates the market price by taking the midpoint of the bid-ask spread for the trading cost of the ETF.

Why? Well, trading ETF shares involves more variables than buying and selling mutual fund shares. As a result, no ETF trade is done exactly at NAV and depending on when and how it’s executed, an investor could pay more or less than the next person.

A buy-and-hold investor like Wiener, who purchased the ETF at launch in 2008, never doing anything subsequently except reinvesting dividends, might find his real return differing by a few basis points from that reported on Vanguard’s website, because of the trading cost variable. In contrast, open-end mutual funds always change hands at NAV. Thus, gripes: “When you go to sell, how do you know you’ll get as much for your shares as someone who sells at NAV in an open-end mutual fund?”

Rich Powers, the head of ETF product management at Vanguard, says that the price differences “could be a function of penny rounding, which might present as such that one product has outperformed. “It’s a theoretical possibility.”

While the difference in performance is only a few basis points, Wiener says: “Isn’t the whole conversation around fees about basis points?” Indeed, as most investors know, a few basis points more can add nicely to the value of an investment held for many years.

BlackRock’s Fink says markets are poised for a ‘melt-up’

A dovish Fed and robust global economy will lure big investors back to equities

Robin Wigglesworth and Richard Henderson in New York and Owen Walker in London

BlackRock’s shares have lagged behind those of its rivals this year © Bloomberg

Global equity markets are poised for a “melt-up” as signs of healthier economic growth in the US and China reassure big investors that have largely stayed on the sidelines of the 2019 market recovery, according to BlackRock’s Larry Fink.

The chief executive of the world’s largest asset manager said he is optimistic that a “Goldilocks” scenario of improving economic data and more dovish central banks will compel institutional investors that have kept ditching stocks this year to reverse course.

Investment strategists have dubbed the 2019 stock market rally the “flowless recovery”, with equity funds continuing to suffer outflows even as the FTSE All-World index has climbed over 14 per cent — its best start to a year since 1998.

“There’s too much global pessimism,” Mr Fink said in an interview. “People are still very underinvested. There’s still a lot of money on the sidelines, and I think you’ll see investors put money back into equities.”

Bond funds have attracted $112bn of inflows already this year, but equity funds have suffered almost $90bn of investor withdrawals, according to EPFR, a data provider.

BlackRock cemented its position as the world’s biggest fund manager, growing its assets under management to $6.5tn in the first quarter, thanks to strong market returns and inflows of $65bn.

The impact of last year’s market tumult was apparent in the quarter, however. Year-on-year, base fees decreased 5 per cent, because it started the year with less than $6bn in assets. There was a 7 per cent decline in revenues to $3.3bn, which resulted in a 1 per cent fall in diluted earnings per share to $6.61.

However, this comfortably beat analyst expectations of $6.13, and the group saw technology revenue for the 12 months to March 31 increase 11 per cent, driven by its widely used Aladdin investment platform.

Listed investment groups saw their shares tumble almost 26 per cent on average last year — their worst performance since the financial crisis — as investors feared buoyant markets would no longer mask mounting fee pressures across the industry.

BlackRock has this year trimmed jobs and reshuffled its senior management ranks. Mr Fink took a 14 per cent pay cut.

“With fees coming down a lot of the big players are looking for new ways to generate revenues,” said Kyle Sanders, an analyst with Edward Jones. “For BlackRock it’s through software and Aladdin, which isn’t tired to moves in the market.”

The asset manager’s stock rose over 2 per cent on Tuesday to trade at its highest level since early October.

BlackRock is in a years-long battle with Vanguard to dominate the global fund management industry, with the latter catching up fast. However, BlackRock has claimed the top spot for exchange-traded fund global flows this year, which it said was driven by its fixed income products.

The iShares ETF business it acquired from Barclays almost a decade ago now manages almost $2tn, which alone would make it one of the world’s five biggest investment groups.

The average expense ratio of US equity funds have almost halved since 2000 to 0.55 per cent last year, and industry executives expect the trend to worsen. Morgan Stanley and Oliver Wyman’s latest annual study of the asset management industry predicted that revenues from traditional, actively-managed funds in developed markets will shrink 36 per cent by 2023.

BlackRock remains comfortably profitable, but to counteract these pressures it is doubling down on China. Mr Fink has told the FT that the company was in discussions with Chinese regulators over taking control of a local fund manager and ramping up its “alternatives” business.

The Morgan Stanley-Oliver Wyman report estimates that alternative asset classes such as private equity, direct lending and real estate will keep growing at a healthy clip and account for 40 per cent of all investment industry revenues by 2023.

The ravenous appetite for alternative investments has stirred concerns among some analysts and investors, and Mr Fink said that the sheer scale of the inflows should be watched.

“It’s something everyone should be focused on, as there are extraordinary flows going into an illiquid asset class,” he said. “But if you have a client base with longer-dated liabilities you can have a higher percentage of illiquid investments.”

Beware the Fed’s Feedback Loop in Emerging Markets

Many countries’ economies look healthier because of volatile investment flows, not real economic progress

By Jon Sindreu

The Federal Reserve’s shift away from raising interest rates has once again driven investors toward juicy returns in emerging markets. They need to be careful of a dangerous feedback loop: The very fact that money flows into these countries makes them look safer.

Fed Chairman Jerome Powell doubled down Wednesday on his new wait-and-see approach to monetary policy. This will prolong the good times for emerging markets, where stock markets have returned 2.8% over the past six months, compared with a 1.2% loss for all stocks globally, according to the respective MSCI indexes. Currencies in countries with high rates have also rallied more, pointing to speculative yield hunting.

Developing economies are looking impressively resilient, especially considering worries about a China-led global slowdown. Earnings expectations have stabilized and investors seem to have decided that the sharp selloff in emerging-market assets last summer had more to do with isolated problems in Turkey and Argentina than broader concerns.

A welder at a factory in Nantong, China.
A welder at a factory in Nantong, China. Photo: str/Agence France-Presse/Getty Images 

The problem is that investors’ confidence could be creating a deceptive sense of calm. This will suddenly reverse if the dollar appreciates or cash flows out.

Two papers recently released by the Basel-based Bank for International Settlements highlight new evidence of this effect. First, by looking at a database of nonfinancial firms in Mexico, the BIS found that corporations tend to do the same as international investors when the U.S. dollar is weak: They borrow in greenbacks at low rates to lend in pesos at higher yields, and pocket the difference.

Their aim isn’t usually to speculate, but to extend trade credit to partners with less access to global capital. Still, the need to preserve these business relationships means that, when the dollar strengthens again, companies tend to offset losses by slashing investment rather than closing the credit taps, researchers found. This means that bouts of currency volatility—like last summer’s—likely damage these countries’ long-term productivity growth.
The research flies in the face of the economic-textbook idea that weaker currencies improve poorer countries’ chances because their exports get cheaper.

A second piece of BIS research, released this week, found that sovereign-debt investors in emerging markets tend to demand less compensation when the dollar is weak, even when buying bonds in local currency.

This is shortsighted: A weak dollar boosts credit to emerging markets, making them look stronger than they are. Investors often don’t give enough weight to this, mistakenly attributing both economic improvements and crises to local political developments rather than the ebb and flow of global capital.

Right now, investors are happy to clip their coupons, lulled by the Fed’s dovish mood music.

But they should be less blasé about the risks of a weaker-than-expected global economy and the return of a stronger dollar.

George Soros famously dubbed “reflexivity” the phenomenon whereby markets are subject to feedback loops between sentiment and reality. Volatile exchange rates make emerging markets particularly extreme examples.

German Defense Spending Is Falling Even Shorter. The U.S. Isn’t Happy.

By Katrin Bennhold

The NATO secretary general, Jens Stoltenberg, with German soldiers last October in Norway.CreditCreditJonathan Nackstrand/Agence France-Presse — Getty Images

BERLIN — Germany, which had already announced that it will fall significantly short of NATO’s defense spending goals, annoying the United States, risks provoking Washington further by failing to reach even its own slimmed-down target.

Chancellor Angela Merkel’s government had a falling-out with the Trump administration last year when it said that, despite signing a commitment to work toward spending 2 percent of gross domestic product on defense by 2024, its target would instead be 1.5 percent.

Now, projected spending levels are expected to fall below even that lower path in a three-year budget plan due to be announced on Wednesday, portending another confrontation with Washington.

The timing could not be worse, with NATO preparing to celebrate its 70th anniversary in Washington in April.

Mr. Trump’s resentment toward European allies he perceives to be coasting on America’s security guarantee is well known, and recent reports that Washington is considering billing allies for hosting American troops has further shaken the alliance.

Even in Europe, some diplomats in neighboring countries privately complain that Germany’s failure to meet its commitments is putting not just its own relationship with Washington on the line, but that of the whole Continent.

Ms. Merkel insisted on Tuesday that her government could still hit the 1.5 percent target in budgets down the road. But few still believe her — least of all Mr. Trump’s ambassador in Berlin.

“NATO members clearly pledged to move toward, not away, from 2 percent by 2024,” Richard Grenell, the American ambassador to Germany, told reporters on Monday after budget numbers were first floated. “That the German government would even be considering reducing its already unacceptable commitments to military readiness is a worrisome signal to Germany’s 28 NATO allies.”

With Mr. Trump calling the European Union a “foe” and NATO “obsolete,” trans-Atlantic relations have been badly strained for some time.

But in recent months, the tone has become openly hostile, especially between the United States and Germany, Europe’s largest economy.

Mr. Grenell has demanded that Berlin scrap Nord Stream 2, a planned gas pipeline from Russia, or risk possible sanctions for the companies involved; stop German companies from doing business in Iran, or risk restrictions on doing business in the United States; and ban a Chinese company from building a new communications network, or risk losing access to some intelligence sharing.

The threats have not gone down well in Berlin, with one German politician this week even demanding Mr. Grenell’s immediate expulsion for interfering in Germany’s sovereign affairs, although that is unlikely to happen.

“Any U.S. diplomat who acts like a high commissioner of an occupying power must learn that our tolerance also knows its limits,” said Wolfgang Kubicki, deputy chairman of the opposition Free Democrats.

The Social Democrats, Ms. Merkel’s center-left coalition partner, have put Mr. Trump’s scowling oversize face on a campaign poster ahead of European parliamentary elections with the caption: “Trump? Europe is the answer.”

Mr. Stoltenberg with the German chancellor, Angela Merkel.CreditAndreas Gebert/Reuters

But even some of Mr. Trump’s fiercest critics say that Germany’s failure to live up to its NATO spending commitments has given a hollow ring to the country’s vocal defense of the international order.

“You can’t have it both ways,” said Julianne Smith, a former adviser to the Obama administration who is currently in Berlin as a senior fellow at the Robert Bosch Academy.

“You can’t at every turn stress the importance of multilateralism and keep it as the foundation of German foreign policy,” Ms. Smith said, “and then renege on the commitments you’ve made to multilateral institutions like the NATO alliance.”

“I appreciate that Donald Trump has made it more difficult,” she added. “It’s become a liability to stand shoulder to shoulder with this guy.”

But she and others point out that Germany had committed to moving toward the 2 percent target long before Mr. Trump’s election — most memorably in 2014, shortly after Russia annexed part of Ukraine.

“Any German who frames this as bending to Trump’s wishes is missing the broader point,” Ms. Smith said of NATO’s 2 percent target.

German officials point out that in absolute terms, German military spending has increased for five straight years, up 36 percent, and that Germany is NATO’s second-biggest contributor of funds and troops. They say that a fair measurement of a country’s contribution to NATO should take account of wider factors, including foreign aid spending and the rate of economic growth.

Given the size of Germany’s economy and years of consistently high economic growth, 2 percent of G.D.P., some also argue, was a fast-moving target — and one hard to meet in a short period of time.

But many security experts have questioned that argument.

“We are just not credible anymore,” said Jan Techau, director of the Europe Program at the German Marshall Fund in Berlin. “First we said 2 percent, but we didn’t really mean it. Then we said 1.5 percent, and it turns out we didn’t really mean that either.”

Defense spending is still on course to increase next year, rising from 1.35 percent of G.D.P. this year to 1.37 percent next year, finance ministry officials said. But by 2023, according to the latest budget figures, it is expected to be back at 1.25 percent.

The latest trans-Atlantic conflict is in part rooted in Germany’s domestic politics.

The finance minister, Olaf Scholz, who drafted the new budget plan, is a member of the Social Democrats, the center-left coalition partner of Ms. Merkel’s Conservatives. Ahead of a string of European and regional elections this year, the Social Democrats, whose poll ratings have plummeted in recent years, are eager to distinguish themselves by giving priority to social spending over defense.

Some political leaders like Michael Grosse-Brömer, the conservative caucus whip, said that Parliament was expected to approve a continuation of its current military missions in Afghanistan, Mali, South Sudan and the Mediterranean, and that Germany still intended to uphold its spending commitments to its NATO partners. But he, too, conceded that “the current plan looks somewhat different.”

One wild card is economic growth, which is set to slow in coming years, making it easier to increase defense spending as a percentage of G.D.P. The German Council of Economic Experts scaled down its growth forecast for the current and coming years to 0.8 percent and 1.7 percent, respectively, saying that “the boom years are over.”

But it is time for Germany to look beyond electoral horizons and consider defense spending in a longer-term, strategic framework, said Ms. Smith, the former Obama adviser.

“Imagine Trump left NATO tomorrow,” she said. “Imagine the investment Germany would have to make in its own and Europe’s security then.”

“This is the cheap version,” she said of the current NATO spending targets.

Christopher F. Schuetze contributed reporting.

SEC to examine competition among US asset managers

Regulator fears that industry consolidation will hit investor choice

Chris Flood

Dalia Blass said the SEC would look at whether technologies such as blockchain could improve access to fund distribution for small and midsized managers (Capital Insights)

The US financial regulator is set to examine whether investors’ choice of asset management companies will be damaged by competitive pressures that threaten to destroy smaller players.

The fight for survival in the fund industry is driving merger and acquisition activity, with many small and midsized managers seeking to forge alliances.

This situation is of concern to the Securities and Exchange Commission, which will begin an investigation this year.

The SEC wants to see if any barriers exist that make it harder for small and midsized companies and whether these can be addressed without sacrificing investor protection.

“I am concerned about what it will mean for investors, particularly main street investors, if the variety and choice offered by small and midsized asset managers becomes lost in a wave of consolidation and fee compression,” said Dalia Blass, director of the division of investment management at the SEC.

Ms Blass was speaking on Monday in San Diego, California, at a conference hosted by the Investment Company Institute, the trade association.

As many as a third of managers could disappear over the next five years, according to Marty Flanagan, chief executive of Invesco, the Atlanta-based asset manager. “The strong are getting stronger and the big are going to get bigger,” said Mr Flanagan in a recent interview with the Financial Times.

A price war raging among US asset managers has led to the cheapest mutual funds winning an increasing share of new business.

BlackRock and Vanguard, the largest asset managers, have spearheaded price cuts with their low-cost index-tracking funds attracting record inflows. Last year, the big two together grabbed more than half of global net new inflows into long-term mutual funds.

Fees have been driven down as a result of competition for the business of institutional clients and the bargaining power of large distributors selling funds to retail investors.

Many distributors have culled funds from their platforms as investors shifted to low-cost index trackers.

Five of the eight leading US distributors have rationalised shelf space by dropping 4,900 funds in the past two years, according to Deloitte, the financial services provider.

Ms Blass said the SEC would look at whether technologies such as blockchain could improve access to fund distribution for small and midsized managers.

The SEC may also set up an advisory committee to take a broad view of asset management issues. This could look at the effect of indexing on markets, common ownership, the consequences of the scale of investment management companies and the participation of funds in markets historically associated with banks and brokers.

Ms Blass said that while an advisory committee could not answer every question it would lend “transparency, engagement and rigour” to industry debates.

Her speech highlighted other priorities for the SEC in 2019. The finalising of new rules for both exchange traded funds and fund of funds has a “high priority” for the SEC. It will also seek public comments on proposals for the reform of business development companies and closed-end fund offerings.

Ms Blass said the SEC anticipated that it would publish proposals for modernising the advertising and solicitation rules for investment advisers as well as a proposal on the use of derivatives by investment companies.