Contributing Firms:
Investment Funds 2021: Rethinking cross-border distribution
RONAN DOYLE, Global Head Product Management at RBC Investor & Treasury Services, recently moderated a panel on new approaches to cross-border distribution at FundForum International’s digital event in October 2020. The panel explored the evolution of industry attitudes towards fund distribution1, addressing the challenges associated with the lack of ‘a consistent customer onboarding process across markets’. Here he shares some of the insights discussed, which could contribute to a solution, including multi-market KYC and AML solutions, products that put higher yield assets within reach of retail investors, and new frontiers in emerging markets.

As the funds industry looks to increase assets under management (AUM) in the wake of COVID-19, consideration should be given to changing existing distribution models, entering into new emerging markets, and perhaps providing retail investors with access to high-yielding illiquid assets.
Ronan Doyle: 'One of the most significant barriers impeding cross-border fund distribution is the lack of a consistent customer onboarding process across markets'.
Ronan Doyle: 'One of the most significant barriers impeding cross-border fund distribution is the lack of a consistent customer onboarding process across markets'.

Key insights
• Improvements to KYC and AML checks could help make the investment experience simpler, leading to greater inflow.
• Emerging markets could provide asset managers with sources of new investment at a time when established economies are struggling under the weight of COVID-19 .
• Illiquid assets could be 'retailized', although longer lock-up periods may be a deterrent.

Fundraising conditions are rather challenging at this time, particularly for active managers running equity and fixed income strategies that may have struggled to beat their benchmarks due to volatile market conditions. Morningstar, for example, reported that only 43.8 percent of active large cap UK equity funds outperformed their passive equivalents, while the same is true for 20 percent of active funds trading euro-denominated corporate bonds and global bonds.2

Rationalizing cross-border distribution
One of the most significant barriers impeding cross-border fund distribution is the lack of a consistent customer onboarding process across markets. In many countries, the know-your-client (KYC) and anti-money laundering (AML) regulations are very complex and document-heavy making it difficult and time-consuming to open new accounts.

There are several possible paths to improve the current situation. The first would be for regulators to adopt equivalency arrangements on KYC and AML standards which would make the on-boarding process for investors purchasing funds on a cross-border basis materially more efficient. This would allow providers to focus efforts on bringing improved digital experiences to the investors, and working with asset managers collaboratively to grow their distribution footprint. Service providers would prefer to compete on the services we can provide to asset managers and, critically for Transfer Agents, the digital experiences we can offer to their investors. The appropriate AML/KYC controls absolutely have to be in place but there is an opportunity for regulators to collaborate to a greater degree on what is deemed and adopted as an equivalency standard.

Others advocate for the establishment of industry utilities for KYC and AML processing, although some intermediaries express reservations about where the liability might fall should issues arise with that utility. There have been attempts to get such utilities started but they have not yet taken off for various reasons. Such initiatives tend to be focused on specific markets (e.g., Luxembourg or Ireland), which does not solve the broader challenges around onboarding.

Retailization of illiquid assets – a source of new capital?
With dividends temporarily suspended and interest rates ranging from low to negative, retail investors are finding it increasingly challenging to generate satisfactory returns from traditional asset classes. In response, some experts are making the argument for retail investors to be given access to illiquid asset classes, principally private equity, private debt, venture capital, real estate and infrastructure. The performance case for permitting retail investor allocations into illiquids is compelling. Analysis conducted by the American Investment Council in 2019 found private equity delivered a median 10-year annualized net return of 10.2 percent surpassing public equities, which produced returns of 8.5 percent.3

In addition, traditional fund managers could strengthen AUM by developing a range of illiquid products for retail investors. Allocations into illiquid assets have been very healthy over the last few years. Private equity, for example, attracted record institutional inflows in 2019, bringing its overall AUM to USD 4.11 trillion.4

Illiquid assets aimed at retail buyers would, however, require additional safeguards and protections. They could, for example, be distributed using traditional and familiar asset management fund structures. Investors would also need to be fully educated about the nature of the illiquid assets they are exposed to, something which can be facilitated through transparent and easy-to-understand reporting.

Retailization of private capital faces an uphill journey
Illiquid assets may offer lucrative returns but they could struggle to attract meaningful buy-in from a retail audience. The absence of liquidity is a major obstacle to success, according to one panelist at FundForum. Retail customers value the generous liquidity terms provided to them by daily-dealing funds, and may be reticent about investing in private capital structures which have multi-year long lock-up periods. A panelist suggested it might be more prudent for retail customers to invest in listed fund managers who themselves have exposures to private capital strategies or unlisted assets.

There are also potential legal issues precluding the retailization of illiquid assets, at least in the US. Law firms have repeatedly urged the Securities and Exchange Commission (SEC) to give 401(k) pension plans access to private equity but simultaneously concede there have been a number of litigations against those very same 401(k) plans about their investment selections, most notably around the inclusion of funds with high fees.5

Chasing new markets for investment
With asset managers looking to boost AUM, many are now targeting investors in emerging markets. COVID-19 has caused enormous uncertainty for asset managers in Europe, but so too is the rising risk of a no-deal Brexit, which could potentially – over the long-term – make it harder for UK investment firms to distribute their funds into EU member states, and vice versa. One panelist said that growth in wealth is not being generated in Europe but in emerging markets, namely Asia-Pacific and Latin America, both of which have seen significant inter-generational transfers of capital. I acknowledged that fund clients have been active in these regions for some years and are continuing to seek to expand their footprint in emerging markets.

In order for the funds industry to successfully and quickly recover from the shock of COVID-19, it is imperative to consider implementing changes to its business model. The process of purchasing a fund is complicated and could be simplified by streamlining inefficient KYC and AML checks.6 Moreover, asset managers can continue to distribute into emerging markets to widen their investor footprint. Whether or not retail clients will venture to invest in illiquid asset classes is uncertain. While some investors will find the returns attractive, they may be less supportive of the strict liquidity terms.

Ronan Doyle is Global Head, Product Management at RBC Investor & Treasury Services

11IM|Power Fund Forum (October 9, 2020) Panel: 'Cross-border distribution - new approaches'. 2 Financial Times (September 1, 2020) 'Active funds fail to outperform passive funds despite COVID-19 opportunity'. 3American Investment Council (June 5, 2020) 'Correcting the record – private equity has outperformed for pension funds and other investors'. 4Preqin (February 4, 2020) 2020 Preqin Global Private Equity & Venture Capital Report. 5Ropes & Gray (May 8, 2020) 'Ropes & Gray partners discuss retailisation in a Private Equity International Special Report on the Future of Private Equity'. 6 Calastone (April 8, 2020) 'Digitalising distribution: If you don't, someone else just might'.