The shift toward an equity culture in continental Europe and its implications for IROs
The pundits have been out in force once more over the past few months. This is it. Continental European investors have developed a penchant for equity like never before. Forget the fixation with fixed-income investment or real estate plays, continental European institutional investors are shifting assets into equity like nobody's business. And they're hungry for more.
This may well be it, but 'this' is nothing new. Hype about the development of a real continental European equity culture has been around for a long time. Too long, some might say. For every optimist about the creation of a shareholding culture, there's a cynic who's seen it all before and is reluctant to believe anything much has changed. Or will change for the foreseeable future for that matter.
So what is the real state of play? Certainly, many continental European institutions have upped their equity allocations in recent years. Armed with its latest statistics, Lipper Analytical confidently highlighted a 'swing away from fixed interest towards the riskier profile of shares' in its Summer 1997 Quarterly Bulletin.
Lipper maintains that the growth in equity assets on the Continent - in particular growth in non-domestic equity investment - has increased dramatically over the last two years. It puts the growth at just under 90 percent. That's some increase in equity funds in a relatively short period of time, even taking into account the effect of a healthy bull market.
'It is equally noticeable that the trend is common across most European countries,' continues Lipper's assessment of the situation, 'even in traditionally risk-averse countries such as Spain, where semi-guaranteed funds linked to equities have risen by 36.7 percent over the first quarter of the year, with overseas equities featuring strongly.' Elsewhere, Lipper claims, foreign invested equity funds increased in the first three months of the year by 17 percent in Italy, 26 percent in Sweden and 'a staggering' 258 percent in Norway (as regulatory relaxation kicked in).
John Grainger, editor at Lipper Analytical Services, adds a word of caution, however: 'It is only when the bourse bubble finally bursts that we shall see whether the new-found European enthusiasm for equities is a long-term trend or merely a passing fad.'
Bearing Up?
Grainger echoes some of the cynicism expressed by a number of other commentators. It's all very well predicting a true European equity culture while things are tripping along quite nicely and the market remains fairly bullish. But what happens when things start to go sour? Perhaps the true test of an equity culture is whether equity allocations hold up when investors have had their fingers burned by a falling (or, even, collapsing) market.
At the moment things are going well. Institutional investors are struggling to obtain adequate percentages of continental European privatizations as individual investors get carried along in the equity rush. That's no bad thing: the desire of individual investors for equity helps drive institutions in the same direction, as products are developed to match. But there's a suspicion that it won't be quite so easy once the market experiences a fall.
Cees Westland, manager of the Netherlands office of the WM Company which monitors pension fund activity, is convinced that the switch into equities is a truly long-term trend. And that it won't necessarily be drastically offset by a bear market. He notes that Dutch pension funds have increased their equity allocations due to a realization that shares tend to outperform fixed-income investments over the long term. The possibility of market corrections is included in that reckoning and there won't be a rash dash back to the safety of fixed-income if one occurs.
According to WM's figures, Dutch pension funds have slowly increased their equity allocations over the past ten years from 19 percent to 31 percent at the end of last year. Some 18 percent of the total assets went in the direction of international equities, leaving 13 percent invested in Dutch stocks.
These levels pale in comparison with the equity allocations of some US and UK funds but it's still a significant shift, says Westland. 'Dutch conservatism plays an important role here but that has changed over the last few years. In Holland, everything happens 10-20 years later than in the Anglo-Saxon markets.' He qualifies this by noting that the larger pension funds have been more equity oriented for several years; the big shift in recent times has come from smaller pension funds playing catch up.
'I don't think an end to the bull market will have a big effect on this trend,' adds Westland. He points out that for a few years prior to 1996 half of the new money in Dutch pension funds was allocated to equities. Last year, virtually no new money went in the equity direction yet the overall percentage allocation still rose due to its strong performance. He believes the next few years will see a more normal 40 percent equity allocation by many of the funds. 'Some of the bigger pension funds are already at 35-40 percent.'
Older & Wiser?
The Dutch trend is being mirrored in other continental markets as fears of being able to support ageing populations in the next century grow. Jan Hedman, president of ABB Fonder in Sweden (and formerly the group's Zurich-based IRO), referred to the 'demographic timebomb' in a recent presentation to the International Investor Relations Federation (IIRF) conference in Stockholm. Dependency ratios (those above retirement age relative to those able and willing to work) in Europe are set to rocket over the next 40 or so years if figures from the OECD used by Hedman are anything to go by. The suggestion is it will move from a European average of around 15-20 percent to something more in the region of 40-50 percent.
Low interest rate, low inflation environments are also making the fixed-income option less attractive. Pierre Bollon, directeur gJnJral of the French asset managers association (AFG-ASFFI) argues that, even without the constraints of the Maastricht agreement on European monetary union, the French state would have had to become less indebted by now. Coupled with the Maastricht treaty, the reduction in state debt and the ongoing privatization process have led to a real demand for equity among French savers for the first time. Bollon says the trend toward longer-term saving and the possibility of legislation for private pensions is also pushing the equity argument forward.
'This is all relatively new in France,' he says, adding that there was little real incentive to move towards high levels of equity investment in the past since domestic shares were 'often not a great bet'. High levels of government holding in many leading companies meant that dividends and shareholder value were not at the top of most corporate agendas. When bonds were a more profitable option with high interest rates, why switch into equity?
Today, says Bollon, all that is changing. The continued reduction of government and corporate cross-holdings is forcing more companies into thinking about the creation of shareholder value. Corporate restructurings are becoming more commonplace and hostile takeovers have started to push directors into thinking about the concerns of their owners.
'You mustn't exaggerate the fact that there was no equity investment in France in the past, though,' warns Bollon. 'Our investment firms are perfectly able in equity management issues despite the lack of [an equity culture].' He adds that a few problems in the move toward equity investment - such as higher rates of taxation on savings or a market correction - will not stop the trend in France. 'It's happening and will get stronger.'
Time Implications
So what does the move toward equity on the European mainland mean for investor relations officers? Is the buy-side increasing its own equity research capabilities rather than relying heavily on sell-side research as it has in the past? The signs are mixed. One IRO at a leading Cac-40 stock says she has seen little increase in the level of interest from the buy-side but tellingly adds that domestic institutions have been keen for several years to meet with management and attend plant visits. Several continental European delegates at the IIRF conference in Stockholm backed up this view.
Others detect a subtle change in attitudes. Alain Camon, directeur financier at Havas Advertising, notes that, of course he has always held regular meetings with the domestic buy- side. 'I see the same kind of approach from them as ever. The only tendency would be for more investors to systematically get in touch with the company.' Camon also reports an increase in the ratio of time spent with domestic investors as opposed to sell-side analysts. A few years ago, it was very heavily skewed toward analysts but now French institutional investors are taking up a higher proportion of his time. It still tends to differ from the direct approach of US and UK institutions, however, with a heavier reliance on broker-organized lunches and breakfast meetings rather than one-on-ones.
Anne Guimard, director of financial services and investor relations at Alcatel Alsthom, is more convinced of a trend. She says that the larger French institutions have begun to build true buy-side research capabilities over the past two years. 'All in all it is a significant change,' says Guimard. 'In the past we weren't directly seeing too many French institutional investors - we had to go out and find them.' She believes there is a drift toward less dependency on sell-side research in the French market, caused by a recognition that Anglo-Saxon investors have gained advantages by the development of their own in-house research teams.
Veerle Berbers, at Technimetrics in Amsterdam, sees a similar change in the way that Dutch pension funds are approaching the management of their investments. She affirms that a couple of years ago the large pension funds would generally not be very interested in seeing companies on a regular basis. 'It's slowly changing. They're coming out of their shell and saying they do need to see companies at least once a year.'
The change in attitudes among continental European institutions is undoubtedly slow, however. An IRO at a leading Spanish bank - who did not wish to be identified - says he is getting more direct calls for information from the buy-side in continental Europe but it is minimal relative to the interest shown by US and UK institutions.
'Spain is a tremendous example of how institutional investors do not contact you for information,' he says. 'On the buy-side there is surprisingly little interest in having meetings and they are fairly passive. Sell-side analysts are a different matter. There is a heavy reliance on research reports on the Continent but investors obviously aren't going to obtain the same level of information that way.'
He adds that he doesn't understand how institutions get a good level of information about their holdings and potential holdings without seeking regular meetings. Sure, there has been a trickle of interest from 'a couple' of French and German institutions in recent times but it is certainly not evidence of a trend as yet. In many cases, it is only because he and his team have proactively gone out to establish contact in recent years that there is a direct information link. Even that approach is shunned by some significant shareholders, though. Dutch pension funds are among the worst offenders, often turning down meetings even when they are offered. 'The culture isn't there yet. We meet continental European investors when we go out and see them - not the other way round.'
Pull System
Some observers believe it is only when the buy-side in mainland Europe starts demanding higher levels of information flow from their holdings that investor relations will truly flourish as a discipline. It's a pull rather than push development. Michael Duerr, managing director of Investor Relations AG in Germany, points out there has been slow development of IR among German companies - some of which have really top level international operations. But below that level there is little activity.
'There's definitely been a change in Germany but not nearly far enough,' says Duerr, bemoaning the lack of domestic interest in the services a firm like his can offer. 'When you take the 100 largest stocks, you have 20 or so which are really active in IR. There are few aggressive domestic investors out there demanding information from companies. Germany is still a third world market in this respect. There is a move in the right direction but the push still comes from the foreign investors.'
Relationship Building
Those sentiments are backed up by Gillian Karran, investor relations officer at Dresdner Bank. Aside from Germany, she notes there has always been a fairly small but steady level of interest from the buy-side in Scandinavia and the Netherlands. And Dresdner has found it relatively easy to develop relationships with Swiss investors. 'There's obviously an interest but it's not a huge level of interest. We've not, for example, experienced a huge increase in visits from French investors.'
On the other hand, she reports spending a great deal of time with the Anglo-Saxon buy-side in one-on-one meetings, which she attributes to a more active stock-picking approach based on a higher level of company visits. She says Dresdner would willingly hold more meetings with the continental buy-side: 'It's just that apart from Switzerland we haven't really had the demand.'
Karran says the exception to this rule is deal-related roadshows when the continental European buy-side attends in force. 'There tends to be a continued suspicion of IR departments and much more reliance on the research side in continental Europe. The time allocation is different among investors. They allocate time to processing the research produced by the sell-side and analyzing deals.'
The shift toward equity in continental Europe may well be real this time around and likely to be sustained even in the event of a market correction. But the implications for IR departments in terms of spending significantly more time with the continental buy-side don't yet seem to have worked through the system. Maybe it will take a bear market to see more of an information push from corporate IR departments. Only then can a final assessment of a true equity culture be made.