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Schroders' Lloyds deal signals more bank-asset manager tie-ups, say analysts

Schroders PLC's £80 billion wealth management tie-up with Lloyds Banking Group PLC will likely mark a broader return of distribution models linking banks and investment houses in the U.K., as both confront Brexit and slowing growth, according to analysts and asset managers.

The arrangement combines Schroders' investment and wealth management expertise with Lloyds' "significant" base of roughly 27 million retail customers, Schroders said in an email.

The U.K.'s second-largest listed investment manager, Schroders had been in dire need of inflows: Its third-quarter AUM in its asset management division increased to £392.3 billion, compared to £389.3 billion at June-end and £389.8 billion at the beginning of 2018.

Other managers have confronted similar concerns: Listed U.K. asset manager Jupiter Fund Management PLC reported net outflows of £800 million in the third quarter of 2018, while Standard Life Aberdeen PLC reported £16.6 billion net outflows in the first half.

Outflows have been visible across Europe. In June, funds domiciled on the continent saw their worst month since 2013 with €27.5 billion in outflows, while asset managers globally saw net outflows in the second quarter of 2018.

But the situation has been especially bad for U.K. asset managers, who have confronted outflows from their U.K. and European equity funds amid investor fears of a no-deal Brexit. Worldwide, inflows have instead targeted North American funds and the U.S.-heavy global sector.

U.K.-focused equity funds have seen £9.1 billion outflows since the June 2016 Brexit vote, according to the Investment Association, the trade body representing U.K. investment managers. In May 2018 alone, U.K. funds saw £1.2 billion in outflows, while North American funds saw £211 million in inflows, and global funds registered £460 million inflows the same month.

'Highly accretive'

Schroders' new mandate — comprising £67 billion from Scottish Widows Group Ltd. and £13 billion from Lloyds' wealth management — will represent a welcome 20.4% increase in AUM. Schroders' share of the £109 billion Scottish Widows Investment Partnership mandate is "likely to be very low fee margin, but it comes with limited incremental cost to manage so should be highly accretive," said Ben Thomas, an equity analyst at Investec Wealth & Investment.

Wealth management clients "tend to be stickier and pay higher fees than large institutions," and are attractive business for Schroders, Thomas said. However, it is expensive to distribute to individual retail customers and Lloyds potentially offers extra customer reach, he added.

From Lloyds' perspective, CEO António Horta-Osório's bank needs to "sharpen up its toolkit" if it wants to reach its goal of 1 million new pension customers by 2020, said Laith Khalaf, senior analyst at Hargreaves Lansdown.

Lloyds' new strategy involves expanding into financial planning and retirement, and with the gains it made during the U.K. government's pension auto-enrolment program of 2012 "now firmly in the rear-view mirror," Lloyds needs more investment capabilities and experience in managing pension assets "to pinch many of these new customers off someone else," Khalaf said.

Access to Schroders' Cazenove wealth arm, which it purchased in 2013, will assist Horta-Osório's new strategy. Against headwinds from Brexit and U.K. first-half growth at its lowest level since 2011, expanding across market segments into insurance and asset management "is about the only thing a large retail bank can do these days in the U.K.," added Constantin Gurdgiev, a professor of finance at Trinity College Dublin.

The Schroders-Lloyds partnership also represents a reversion to the "tied distribution model, which is very common in Europe but has been out of favor in past years in the U.K.," said Andrew Johnston, managing director of Scythian Asset Management, a London-based boutique.

'Old ways'

U.K. banks largely stopped distributing investment products to savers with the 2008 financial crisis, said Johnston. The Retail Distribution Review, published in 2013 by then-regulator the Financial Services Authority, further coaxed investment away from banks directly into the more developed domestic investment market. Distribution links between banks and investment persisted elsewhere in Europe "due to the greater distribution strength" of banks there and a more supportive regulatory environment, Johnston said.

It is "really a turnaround back to the old ways of the industry" when insurance providers were left in charge of retail banks' traditional wealth management business, agreed Gurdgiev. Younger U.K. investors have focused on cash management and sought lower risk and more liquid asset allocations, said Gurdgiev, and Schroders' "conservative, higher-cost, lower-risk exposure approach probably matches better the younger generation of investors."

One possible problem is the "somewhat acrimonious divorce" between Lloyds and Standard Life Aberdeen, currently being contested in an arbitration tribunal, creating "some uncertainty about when £67 billion of assets may be transferred to Schroders, which could be as late as 2022," Khalaf added. Even if the new assets arrive in 2022, "all of this is new money, so it's all positive," said Khalaf, though a delay could mean the uplift in Schroders' fortunes would not arrive in time to tide it over past Brexit.