Fidelity Mutual Fund, which started its India operations in 2004, recently announced its decision to quit the Indian Mutual fund industry. L&T Finance, a subsidiary of L&T Finance Holdings Ltd., is likely to acquire Fidelity’s India business. The new entity is likely to have a 2% market share and 13th position in the industry in terms of asset base. This will be L&T’s second acquisition in this market after the acquisition of DBS Chola Mutual Fund in 2010. India’s mutual fund industry has witnessed many such exits by market participants at different points in time, but this is perhaps the most high profile case of an internationally established major player deciding to shut down its India operations.
In India the mutual fund industry has been heavily dominated by the corporate segment, unlike other countries where retail investors account for most of the industry assets. Fidelity had a very high proportion of its business coming from the retail and the HNI segments. As a result equity investments accounted for bulk of Fidelity’s assets as the focus was on meeting clients’ long term financial goals. Therefore the Fidelity L&T deal has been priced much higher (5-6% of asset) as compared to other such deals in the Indian industry which are usually valued at 1-3% of assets under management.
Fidelity’s decision to quit the industry comes in the backdrop of its accumulated losses, driven mainly by a high cost structure. In 2010-11, the company’s staff cost grew around 50% over previous year and was around 90% of its revenue, while staff cost accounts for only 13% for some of its competitors in the  industry.
This decision has once again brought to the fore issues relating to the regulation of India’s mutual fund industry and its impact on firms’ profitablity. Many argue removal of entry load and limiting payment of upfront commision to distributors (to prevent misselling of products) is hurting fund houses’ ability to sell more and grow the top line at a time when costs are rising rapidly. At the same time it needs to be said that a recent study found that ‘among 15 of 46 AMCs operating in the fund industry, which collectively manage 85-90 per cent of the entire industry’s assets und­er management,10 large AMCs registered net profit in FY11 and 12 AMCs had positive accumulation of net profits over the years till FY11′.
This then raises the question if the Indian Mutual Funds industry is more favourable to the larger players and what is the critical asset base a fund house must garner to break even or become profitable, especially in the changing economic scenario. This also raises the question if the new regulations are affecting the smaller players more than the larger players.
In this evolving scenario when growth has been hit, regulations are changing fast and firms are increasingly finding hard to stay competitive, some Indian fund houses are looking to partner with global players to attract global funds, investors as well as expertise. In such arrangements, the local expertise of domestic firms complement the supeerior knowledge and capabilities of global partner to create a win win strategy for all.

Yesterday, the Bank of International Settlements released consultative document sets out a revised market risk framework that proposes a number of specific measures to improve trading book capital requirements. (BIS Fundamental Review of the Trading Book)

Amongst the points to consult on is whether to replace the “poster child of failure” in the 2008 financial crisis – the value-at-risk (VaR) measure, with  expected shortfall (aka CVaR), a risk measure that better reflects “black swan” events.

Is this really news? One could argue not in certain respects. Academic research (from at least a decade back) has showed CVaR to hold advantages compared to VAR from a mathematical standpoint. Also, many financial institutions have already incorporated expected shortfall as part of their internal dashboard of risk measures.

So what is the issue?

• For one, good or bad, because expected shortfall also measures highly improbable risks, it opens up the door to a greater degree of ambiguity related to modeling assumptions.
• Secondly, the metric is also sensitive to rare “tail risk” events that are many practitioners consider low probability. Some consider that these events should be determined by a firm’s view of the world and not be imposed through regulatory mechanisms for every firm.
• With expected shortfall, this is likely to increase regulatory capital required (in addition to what is currently already on the table to be met by banks)

In a time where there is a drought of liquidity and  capital in the banking industry, most bankers will be hoping (and arguably lobbying hard) that the proposals in this consultation should be carefully weighted out rather than hastily imposed. Let the debates begin!

I have seen several impressive examples of wealth managers leveraging social media technology by using games and establishing interest groups/public communities to expand its relationships with clients. For example, HypoVereinsbank has created a Facebook page and a “Youth Culture” blog, which features fashion discussions, concert ticket giveaways, information on upcoming festivals and on art collections at the bank, etc.  Wells Fargo has been very active in setting up interest group blogs not only around wealth management-related topics (College budgeting for students, retirement blogs, etc), but also on the environment (“Environmental Forum”), and on museums (Wells Fargo History Museums Facebook page). Citi Private Bank is also offering a social media network to the children of UHNW clients (“NextGen” clients), which features functionality as diverse as allowing users to rate restaurants.

I was recently asked to assess the usefulness of these sorts of social media endeavours: “Why would any client care about what my advisor or my bank has to say about fashion?” My response to this question is very simple: This client doesn’t care what his bank has to say about fashion; he cares about what his peers, whom he met exclusively through the bank’s social networking site, have to say about fashion. Firms developing these sorts of social media services are not relying on them to enhance the advisor/client relationship; instead they are hoping to increase a sense of loyalty and connection between clients, and in turn, become reliant on the wealth management brand that has enabled this connection to be formed and maintained through its sponsorship of the portal/community.

Furthermore, many firms are still collecting valuable data through these seemingly irrelevant games, interest topics. For example, while Citi Private Bank provides NextGen clients the ability to rate restaurants, they also send quizzes to these users to complete that the bank uses to score and assess risk tolerances. This allows advisors to begin building profiles for these NextGen clients.

It is admittedly difficult to analyse ROI for these of social media endeavours. However I believe that such tools provide vital “know you client information”, and may increase the points of connection between the client and the wealth management brand. Now, a client not only has to consider his relationship with his advisor, but also to his peers, and to the brand that provides the connection between peers.

The Indian capital markets regulator, SEBI, is talking reforms as it recently announced a blueprint that is potentially set to increase competition among exchanges. The regulator’s stance on increasing competition and allowing foreign investment in exchanges was closely anticipated in recent months, especially among large global banks. SEBI had to address pressing concerns on attracting foreign investment (Figure indicates the drastic fall in FII inflows into India in 2011) and failing to keep pace with developments in global capital markets.

The new move by SEBI has cleared the way for listing of stock exchanges. This decision comes after an expert committee headed by former Reserve Bank Governor Bimal Jalan submitted its report in 2010 on governance and ownership issues relating to market infrastructure institutions. While SEBI has broadly accepted the recommendations, it has gone ahead with the move to allow public listing of exchanges despite the committee recommending against such a move on ‘conflict of interest’ grounds. The blueprint indicates that public holding of exchanges should be at least 51%, while exchange operator, banks and insurance companies are allowed to hold up to 15%. Foreign investors are allowed to hold up to 5%. Exchange operators, however, would not be allowed to list on their own exchanges.

SEBI is watching developments in global capital markets closely. The developed markets in US and Europe are far ahead in terms of maturity of market infrastructure, while India is yet to reach a stage where alternative trading venues can compete with incumbent exchanges. The NSE started in 1994 to compete with the then singly dominant exchange, BSE. But ironically the NSE has today itself become what it set out to defeat, accounting for close to 75% of equity volumes. The attention is on regional exchanges to play more aggressively. With an intention to infuse more competition, the regulator has warned that dormant exchanges that are not attracting liquidity would have to be wound up. SEBI has stipulated a minimum annual trading volume of INR 1000 crores for exchanges to continue operating and the same would be reviewed after 3 years. While we see it as a timely warning bell, it is not enough. We have to wait and see how SEBI looks to empower and encourage regional exchanges. The Delhi Stock Exchange has already woken up to the competition by following in the footsteps of LSE in upgrading its IT infrastructure by partnering with MilleniumIT, a technology player which provides ultra-low latency trading solutions. The debate in ongoing in the case of clearing houses and the regulator is expected to come out with its view soon on having a single clearing house versus introducing interoperability. Although it appears that policy challenges facing SEBI are similar to those faced by regulators in developed markets in the past, and despite indications that SEBI is trying to align with developed markets, we should be careful while concluding that the Indian regulator would eventually follow in the footsteps of US and Europe.

Net FII flows into India

During my last post, I posited a question that many wealth managers are considering when it comes to social media: How do we measure influence?  What happens when a peer (John Doe) on a social networking forum says something that contradicts your advisor’s opinion? If John Doe has 1,000 followers, will that make his opinion more trustworthy than if he had 200 followers? Is there a tipping point where if John Doe says something enough times or has enough followers your advisor will find his “expert” opinion mattering less than John Doe’s? Social psychology has been addressing the concept of trust of social impact for decades. One particularly relevant theory is Bibb Latané’s “Social Impact Theory”.

While some may dismiss a look at social psychology theories as “merely academic,” previous research and results have been borne out of practical considerations that are directly applicable to social media strategies. One such practical application is the consideration to allow advisors to participate on Facebook, LinkedIn, Twitter, or to keep advisors “above the fray”.  

A brief introduction to social impact theory: it uses mathematical equations to predict the level of impact created by social situations, and it is composed of three basic rules:

1. Social impact is influenced by the strength (S), immediacy (I), and number (N) of its sources. Thus social impact = f(SIN). Strength is a measure of how much influence or power the individual perceives the source to be. Immediacy is how recent the event occurred or whether there were intervening events. Number is essentially the number of sources. Thus social impact is higher when the source has higher status, when the statement is more immediate, and when there are a higher number of people saying it.
2. The most significant difference in social impact occurs in the transition from 0 to 1 sources. As the number of sources increases, the incremental impact lessens.
3. The more targets of impact that exist, the less impact each individual target feels. That is to say, a person will feel more of an individual impact if the source is directing a comment to 3 people versus if it is directed at 50.  

So what does this information mean to the advisor and to the wealth manager? There is some good news and some bad news.

First, the good news. Strength: Advisors are likely to have a higher measure in the “strength” category than are an investor’s peers; since the “strength” is affected by things such as status, education, and perceived expertise, the implicit and explicit designation of the advisor as an “expert” gives his advice a higher degree strength (and thus impact) than would a peer’s. Furthermore, the advisor need not be overly concerned with his advice being drowned out by a sea of other sources claiming something contradictory. Since the largest difference in social impact occurs in the transition from 0 to 1 sources, the advisor needs to be less concerned with having many different sources agree with his opinion, and more concerned with getting his opinion out on a social network.  

Now for the bad news. Immediacy: social media enables peer-driven information and opinions that are far more immediate and real-time than are client-advisor meetings, or even weekly scheduled phone calls. For example, if John Doe poses a question on a dedicated Facebook page, he may get immediate responses from several other investors. Given the number of clients an advisor has, he may not necessarily be able to respond to an email from John Doe with the same speed. Number: While the largest difference in impact occurs between 0 and 1 sources, the measure of “N”, and thus the measure of social impact, still increases incrementally the more sources. So an advisor need not worry if 2 people are contradicting him, but if 50 people are, then he’s got a problem.

Below I’ve presented some basic advice as to how to improve each measure of social impact (Remember, social impact = f(SIN).

Immediacy. The advisor needs to be present on Facebook, Twitter, LinkedIn, and be able to track or participate in any private forums for clients. Advisors must be able to follow their clients on Facebook and Twitter, and on any private client networks hosted by the wealth management firm. This will allow the advisor to track what the clients are saying and immediately respond if John Doe poses a question, and mitigate the impact of other sources’ influence.  

Strength. The advisor has an inherent advantage in the strength category, given that he is marketed as an expert. However, when creating a private social network hosted by the wealth manager (i.e. “the sandbox in which clients play”), the wealth manager must be careful about how it promotes status-building functionalities on the social network. For example, several online brokerage social networks assign clients who have many followers or who have had strong stock performance special designations like “expert” or “pro”, etc. This is perfectly suitable for the self-directed world, but is less suitable in the advisory world. Assigning such a status to another client or investor will elevate his status and may thus dilute the advisor’s status and therefore his “strength”.

Number. Here collaboration is important. Advisors may want to coordinate their messages with messages coming from the wealth management firm. Also, the audience to whom you are speaking matters. The larger your audience and the more general your content,  the less the impact on each person. Advisors participating on social networks must direct their content to either individual clients or specific sub-segments. This will increase the impact of the advisor’s message.

These are just a few instances in which social impact theory can be applied to social media strategies. There are many more and I encourage you to read up on the theory on your own.

Disclaimer: For more information on Bibb Latane’s theory of social impact, one can consult any introductory psychology textbook or social psychology textbook. Personally, I like:
 Aronson, E. (2008). The Social Animal (10th ed.). New York: Worth Publishers

CA Cheuvreux, the agency broker owned by Crédit Agricole, will this week relaunch Blink, its broker-crossing network, as a multilateral trading facility (MTF) aimed at institutional investors and retail. The Blink-MTF will trade 1,700 stocks across 14 European markets, after receiving approval from UK authorities.

However, it aims at differentiating itself from rivals Bats and Chi-x Europe by excluding the proprietary trading desks of big banks and high-frequency traders. The launch of yet another Equity trading venue in European’s fragmented post MiFID market reflects the divided opinion of market participants towards High Frequency Trading.

 European regulators are concerned about potential market instability created by High Frequency Trading. The draft report of European Commission rapporteur Markus Ferber published on March 16th on MiFID2 goes in the same direction of Blink, restricting HFT in many ways, even trying to ban Direct Market Access functionalities offered by brokers to investors. 

HFT is basically trading with extremely complex automated algorithms that take advantage of market discrepancies in thousandths of seconds. It now accounts for 60% of daily trading volume on European markets, and is higher in the US.

European corporates have found a new way to finance themselves: issuing bonds on regulated markets. Indeed it is reported that during the first quarter of 2012 European Corporate Bond Issues have over-passed European Bank loans.

Historically European corporates would typically have used market funding for only 9% of their debt, vs. their US counterparts at 64% of their debt coming from bonds. The latest ECB LTRO will realistically not have any impact on real economy financing so the Debt Capital Markets team of investment banks can stay on the road to get the corporates in the door.

Unfortunately though, if European institutions are able to cherry-pick the issues that provide good risk/return profiles, the retail investors are still looking for safe heaven investments. Currently, even in Germany, the retail tends to prefer to invest in negative yielding government bonds than on the corporate market.

So, for investor pools, European corporates have to look further: if they already comply with SEC reporting rules, they can issue directly on the US market in USD with a prospectus. About 50% of issues done in USD are now not from US company vs. about 30% in previous years. They could also do a US private placement (144A) without having to do a prospectus, by selling shares to only a specific set of qualified investors.

For corporates aiming at growing in Asia/China, the so-called “Dim-sum bonds”, issued in Yuan in Honk Kong or London, could also be an alternative to issuing in Euro. Many banks and asset managers are investing in this business but it still only nascent compared to the USD or Euro issues.

Foreign investor pools will also be able to invest in the Yen market. This week ING has become the first bank to register a programme of bond issuance under a new system designed to make the domestic Yen market accessible to non-Japanese borrowers.

Until European banks and investors get better…

Blackrock Solutions recently announced it had set up a bond crossing network with the working title “Aladdin Trading Network”. The idea is that the buy-side would be able to anonymously cross corporate bonds, mortgage securities, or other fixed income instruments, bypassing dealers for some portion of their trading lists.

The announcement has attracted a lot of US press, but market participants should understand that neither the theory nor application of the crossing concept is in any way new. Of course, buyside to buyside crossing is not a new concept- it exists in equities for example via ATSs, broker crossing networks and even exchange crossing.
However, anonymous, buyside to buyside crossing of fixed income is not even new. State Street FICross has been in existence since 2008 for example.

Many questions remain, such as whether dealers would be willing and interested to stream prices into Aladdin when the market already has Bloomberg, MarketAxess, Tradeweb, etc. And if the answer is no, buyside to buyside crossing is typically hamstrung by the ships passing in the night problem where firms have difficulty finding a match with another party at precisely the time when the trade needs to occur.

This is not to entirely discount the idea. Blackrock has deep relationships and if they can increase crossing rates by even a small amount it could save the buyside significant money and improve performance.

            Facebook pages. Twitter Accounts. Chatrooms. Blogs. Dedicated client social networks. All of these venues are not only places for people to “connect”, but have become sources of information on trends, investments, and companies. As Celent has noted in multiple reports and blogs, trends continue to show that individuals are trusting financial institutions less and less, and themselves and peers more and more. To adapt to these trends, wealth managers have begun launching Facebook pages, Twitter accounts, blogs, chatrooms, and private client networks where investors can post messages, follow one another, read opinions, develop charts, etc. In all of these venues, one thing remains constant: the wealth manager provides the “sandbox” in which clients play, but remains largely a brand in the background (and not liable for any advice or content made on the network). By doing so, the wealth manager hopes that the client’s loyalty to his peer network will translate into loyalty towards the wealth management brand. Furthermore, by keeping a disclaimer that the institution does not endorse any opinions made on these forums, the wealth manager elevates the advisor’s expert opinion from the rest. But what happens when “John Smith” with 200 followers says something that directly contradicts what your advisor says? Whose opinion with have the biggest social impact? Does the advisor’s official status influence you as much as does the number of John Smith’s followers? If he had 1,000 followers, would it make a difference?

            These questions are no longer hypotheticals. These questions can have real consequences on the advisor’s book of business and the wealth manager’s bottom-line. Luckily, wealth managers need not grasp in the dark to answer these questions. Social psychology has been addressing the concept of trust of social impact for decades.  In a series of blog posts, I will present some social psychology theories that are particularly relevant to social media and how wealth managers should think about implementing strategies. The first theory examined later this week will be “Social Impact Theory” and how it may answer the above questions.

The US Federal Reserve last week announced summary results of the latest round of bank stress tests, which show that the majority of the largest U.S. banks would continue to meet supervisory expectations for capital adequacy despite large projected losses in an extremely adverse hypothetical economic scenario. This is essentially a report card of how 19 of the largest US banks would fare under ‘worst case’ scenarios around unemployment, house price crashes, equity market drops and bank collapses, taking into account that institutions could (or need to ) pursue capital related actions such as issuance of capital, dividend payments, and share repurchases through stressed market conditions. For more details, see US Federal Reserve Stress Tests March 2012.