2008 has been a very difficult year for European investors and fund managers. The global financial crisis, which started in the United States in the summer of 2007 to become one of the most serious financial market crises in history, had a severe impact on investment funds in Europe and other regions. The full-blown repercussion of the crisis from the financial markets on the banking sector and the real economy explains why investment funds were severely hit: • Crisis in financial markets: the massive losses recorded in stock markets across the globe led many investors to pull out record amounts, thereby accelerating the decline in stock prices and equity fund assets. In parallel, the liquidity crisis and the fear of credit and counterparty losses following the bankruptcy of Lehman Brothers led to a breakdown of credit and money markets, which accelerated outflows from bond funds. The difficulties experienced by some money market funds, which were best illustrated by the suspension of redemptions by the Reserve Primary Fund – one of America’s oldest money market funds – also led many investors in money market funds to redeem their shares in the autumn of 2008. • Competition from banks: investment funds continued to suffer from competition from structured products and bank deposits, especially in countries where banks are main distribution channels for savings products. The solvency crisis among banks intensified the war for deposits, escalating further when European governments decided to provide guarantees for all bank deposits.
• Fear of recession: the worsening of growth prospects for Europe in the second half of 2008 put downward pressure on investor demand for investment funds. This development is in line with our research findings that confirm the importance of stable economic conditions for household demand for investment funds.
The direct implications of this vicious spiral for the European fund industry can be summarized by the following figures: total investment fund assets fell by 22 percent in 2008, or EUR 1,768 billion, with UCITS recording total net outflows of EUR 335 billion, or 6 percent of UCITS assets at end 2007. It is important to note that this percentage would have been lower if UCITS would play the same role as U.S. mutual funds in retirement saving.
Even if the European investment fund industry is suffering seriously from the crisis, it remains an essential and vital part of the European financial system. It is also important to put the crisis into perspective.
• Investment fund assets in Europe have doubled in size over the last decade, from EUR 3,042 billion at end 1998 to EUR 6,142 billion at end 2008. Over the last five years, European investment fund assets have grown by more than 30 percent. And in relation to aggregate European GDP, total investment fund assets represented half of the European Union’s GDP.
• Market losses were responsible for 77 percent of the decline in UCITS assets. For equity funds, this percentage represented 84 percent.
• Almost 40 percent of the total outflows from UCITS in 2008 were recorded in the single month of October. Knowing that the financial crisis brought the financial system on the brink of disaster after Lehman Brothers’ bankruptcy, it is not too difficult to understand that investors tried to protect their remaining financial wealth by hoarding cash.
• The run on funds stopped in November when governments and central banks stepped in with bold bailout plans and stimulus packages to prevent a financial meltdown. The situation continued to improve in December with equity and balanced funds attracting positive flows (see page 5 of this report).
• Taking into account net inflows in special funds reserved to institutional investors (EUR 51 billion), net outflows from European investment funds were EUR 284 billion in 2008.
Notwithstanding the encouraging signs from the figures released for November and December, the demand for investment funds is likely to remain subdued until the uncertainties surrounding financial markets and economic growth have subsided. When this will happen, we are confident that UCITS – thanks to their qualities in terms of product transparency, asset diversification, liquidity and fiduciary responsibility – will again attract strong inflows. A combination of other factors will help strengthen investor demand in the coming months and years:
• Low short-term interest rates: central banks are likely to keep short-term interest rates very low for a prolonged period of time to support the real economy. This should convince investors to seek alternative investments to bank deposits to secure higher returns.
• Low stock valuations: the collapse in stock prices in 2008 and the resulting low price-to-earnings ratios have increased the attractiveness of equity funds. Whilst many investors remain concerned for what they regard as risky investments, others are ready to switch investment back towards equity funds to benefit from positive earnings rebounds.
• Growth perspectives in Asia: while China and other rapidly developing countries could not isolate themselves from the global economic turmoil, they will continue to enjoy significantly higher GDP growth than Europe and the United States. We trust therefore that these countries will remain an important source of demand for UCITS in the short and long term.
To benefit fully from these factors and leverage further the value proposition of UCITS, it is important to achieve progress in the following areas:
• UCITS IV: the new regulatory framework, known as UCITS IV, will allow UCITS managers to develop their cross-border activities and operate investment funds at lower costs. The Key Investor Information will also ensure that investors receive clear and easily understandable information in order to assist them in their investment decision. Quick and effective implementation of these provisions is essential to take advantage, as quickly as possible, of the expected benefits of the package.
• Level playing field: closing the gap between UCITS and other retail investment products in terms of information disclosure will increase transparency, thereby strengthening investor confidence in the financial services industry. EFAMA looks forward to the White Paper announced by the European Commission and trusts that the proposals will be sufficiently ambitious.
• Retirement saving: one of the many unfortunate consequences of the financial crisis is its adverse impact on public finances. Consequently, further comprehensive pension reforms will be needed in many Member States to prepare for ageing populations and avoid an explosion of public debt. This means that households should save “more and better” to ensure adequate retirement income. To achieve this goal, as recently requested by the European Parliament, the European Commission should prepare a regulatory framework for pan-European pension products to stimulate competition and reduce the cost of saving for retirement, and Member States should encourage higher participation and contribution levels of employees in pension schemes.
The realization of these objectives will strengthen the competitive advantage of UCITS, thereby increasing further the role of the UCITS industry in the management of long-term savings and the creation of jobs in Europe.