The €˜Net Effect
In his book Megatrends, John Naisbitt predicted that the 1990s would be "the age of the individual." What an understatement!
The internet has blown through this prediction by allowing individuals to reach out to the world in a myriad of new ways. Through the internet, this is in fact "the age of the do-it-yourself investor." Indeed, cyberspace has become a global "research and transaction centre" that is transforming the world of financial services.
By the year 2000, internet guru Nick Negroponte of the MIT Media Lab estimates that over 1 billion people will be online. That includes most mutual fund investors and stockholders €¦ can any fund company afford to ignore this fact? Apparently not, as an ICI survey in July 1997 indicated. In the survey, 51% of mutual fund members indicated they already had websites, 30% more planned to do so in the next year. More than 10% already permitted online transactions.
For funds, as industry consolidation creates mega-fund managers, it will be imperative for mutual fund companies to be as savvy in their web marketing as in their investment strategy.
The Offshore Market
According to Investment Company Institute (ICI), worldwide there are more than seven trillion dollars invested in more than 32,000 open-ended mutual funds. While the United States leads the pack with $4.5 trillion invested, countries like France, Japan, Germany, the UK, and Canada also have substantial mutual fund activity.
While the "offshore funds" sector falls outside the boundaries of most surveys, we know that offshore funds worldwide hold more than one trillion dollars and are growing faster than their onshore peers.
It may be helpful here to describe who invests offshore. The main clients include:
· Institutions -- such as investment banks, insurance companies, pension funds (including European and Japanese), family offices and the increasing popular fund of funds. This is the business that Bermuda excels in serving.
· High net worth individuals -- including private banking clients and expatriates.
· Retail funds -- most of which are registered and trade in Dublin or Luxembourg to get their "EU passport" into the pan-European market.
Growing Offshore
The offshore market is heating up for several reasons:
· Global investment is expanding rapidly, at the same time bringing increased investor sophistication.
· More complex products like private equity, derivatives, and commodities are going offshore.
· Also, new structures, such as "fund of funds" and "master/feeders" have gone offshore to established jurisdictions.
A key reason for moving offshore is the fact that new complex products and structures evolve faster than the "onshore" regulatory and tax regime can adapt.
The Opportunity
At the same time, the offshore market is heavily fragmented €¦ by distance of geography and language ... by tax codes and regulatory structures ... and by domicile and type of investment.
On the financial services map, the offshore market is clearly the land where only sea monsters, lawyers, and accountants dare tread!
However, complexity and distance mean nothing to the internet €¦ which brings immense power to sort information and to link concepts for even unsophisticated computer users.
Bill Gates doesn't like the term "information highway" - he prefers to call it the "central marketplace." In truth, "electronic battlefield" is probably a more apt description. The internet has impacted the fund world in three ways:
· Distribution
· Administration
· Transaction processing
1. Distribution
The pioneer of online mutual fund investing was Pittsburgh-based GALT's NETWorth set up four years ago. This start-up company was eventually acquired by Intuit's Quicken Financial Network. Within 18 months, over 70 fund families were online at NETWorth, with features including:
· General information on the fund complex
· Sales literature
· Prospectuses
· Portfolio manager reports
· Morningstar ratings
· Daily NAVs
Shortly after the GALT initiative, the major fund companies set up their own websites with greater functionality and more news and education.
Case Study:
One leading example is Charles Schwab's Mutual Fund OneSource which has:
· 33% share of the electronic trading market
· 1.1 million active online accounts
· Over $77 billion in online customer assets.
In fact, more than half of all products sold by Schwab don't involve a salesperson at all!
Schwab designed its internet site with a wide variety of investors in mind -- offering trading of 1,400 domestic mutual funds, as well as stocks, bonds, and options. Internet investors may use innovative tools such as the Asset Allocation Tool Kit and MarketBuzz -- a robust electronic gateway to over 80 different independent financial information providers.
Other features include interactive investment guides, calculators for retirement and college financial planning, as well as real-time quotes.
OneSource's volumes are so immense that it can dictate terms to the mutual fund managers who want to join the site. For example - only no load funds are admitted and there are restrictions on other fees.
2. Administration
Obviously, the "self-serve" model provided by the internet drives immense efficiencies.
While the cost of each query answered by a call centre may be $5 or more - even for simple questions like the current value of a portfolio - the cost for the same transaction, handled through the internet may be only a few cents. Furthermore, the internet is entirely process driven, so customers receive much more consistent information.
3. Transaction Processing
Onshore, in addition to transfer agency companies like DST, the growth of fund companies allowed the development of the centralized subscription system named Fund/SERV.
As the offshore market becomes increasing electronic, a similar global subscription system will likely emerge.
The Future
In 1995, Goldman Sachs predicted that in five years the 2,900 companies that now actively run money will be winnowed down to between 20 and 25 giant institutions, each with more than $150 billion under management - and numerous niche players.
This process is already well advanced, with the acquisition of AIM and GT by Invesco, and Merrill Lynch's acquisition of Mercury Asset Management to name a few.
As key success factor in the future is the companies' ability to offer more information and online transactions €¦ through intranets to employees €¦ through extranets to its distribution networks ... and through the internet directly to investors.
In the United States, one reason for the explosion of mutual funds has been the shift from defined benefit to defined contribution plans. The internet allows people to more easily take control of their 401(k) and IRA investments.
As countries across Europe, Asia, and Latin America reform their pension systems, expect electronic sites to be a most important way to distribute financial information across national boundaries.
The success of OneSource and the Fidelity Funds Network has forced several trading houses to introduce no load funds and lower management fees onshore - this change is likely to repeat itself offshore.
Regulatory Impact
Some regulators have been supportive of the efforts to leverage the internet for investors, most particularly the SEC. In fact the SEC was an internet pioneer with the EDGAR database of company filings. However, success attracts less ethical players - and regulators around the world are beginning to write new rules.
We look at the growth of online trading not as problematic but as promising. It's opening up a whole new avenue for the use of technology to increase investor services and disseminate information.
Howard Kramer, SEC market regulation division, quoted by WIRED magazine
We understand the SEC's position is that foreign firms can avoid registration and compliance concerns related to US securities laws by placing disclaimers on their websites and locking out certain unauthorized investors. In March, 1998 the SEC issued an interpretation entitled "Use of Internet Web Sites to Offer Securities, Solicit Securities Transactions, or Advertise Investment Services Offshore (see www.sec.gov).
With advertising we have reached the view that if what is an investment advertisement for the purpose of the [FSA] Act can be pulled up on a screen in the UK, then it is issued in the UK and must be approved ...
Martin Hollobone, UK Financial Services Authority (FSA)
In the UK however, the Financial Services Authority has stated that if information can be pulled up on a screen in the UK, then it is issued in the UK and thereby should be regulated (with some exceptions). ICI has made representations to the FSA to get a clear ruling on this issue.
IOSCO (the International Organization of Securities Commissions) produed a report in September, 1997 entitled "Enforcement Issues Raised by the Increasing Use of Electronic Networks in the Securities and Futures Field" (see www.iosco.org). IOSCO's Internet Committee is meeting in Nairobi in September, 1998 to begin to build international guidelines.
Some of these issues can be avoided by using registration - but, in any event, the need to involve compliance officers early in the planning process is very clear.
Offshore Examples
The pioneer offshore fund website was launched by Robert Fleming in 1996 (www.flemings.lu). The site included marketing information, online prospectuses, and daily NAVs ... and now features online subscriptions and redemptions.
This, and subsequent sites, all use security software and insist that users pre-register to ensure that only viewers in the appropriate jurisdiction can view the content.
In addition to the fund managers, several offshore service providers and commentators are pioneering the use of the internet.
Case Study:
For example, the Bermuda Stock Exchange - established in 1971 -- now is a premier stock market for offshore funds that choose to list. The fully-electronic BSX currently has more than 110 funds and is growing by about 5 funds per month.
The funds that list on the BSX are primarily intended for institutional investors only, and thus enjoy a more flexible regulatory environment than funds that are marketed to a wider retail market.
Still, the BSX's website (www.bsx.com) attracts more than 50,000 hits each month to its pages.
The BSX's electronic/internet strategy is just one of the tools that has helped the BSX forge a niche as compared to other offshore exchanges - Luxembourg and Dublin. Bermuda also has the advantage of being close to both North and South America and has strong ties to Asia, particularly Hong Kong.
Building on its success with the web, the BSX will soon launch the Offshore Funds Network (www.offshore-funds.net) - which will provide detailed performance data from Lipper's offshore funds database - including in-depth coverage of the funds listed on the BSX.
The target audience here is offshore fund professionals and service providers. The site - which goes online in the 2nd quarter - also contains in-depth articles from leading offshore authorities such as the Financial Times, as well as detailed directories of service providers from all the leading offshore domiciles.
Other sites provide basic fund information and research tools to retail investors and the advisors who work with them. Examples are London-based Interactive Investor (www.iii.co.uk) and IFI's Fund Map (www.fundmap.com).
These sites, which include banner advertising and links out to fund manager sites, are intended for the home user who wants to check in on their investments.
Another example, intended for industry professionals, is IMM's news-oriented Fund Forum site (www.fundforum.com).
Like all pioneers, they will probably be challenged by giants like Fidelity and Schwab as they move into the offshore sector.
What Next?
The internet helps companies to build a better mousetrap - and to improve the mouse as well.
All indications are that players like Schwab will move into the offshore sector - bringing its wealth of retail experience, its client volumes, and its proprietary software.
And this is the mouse part €¦ these large sites do more than simply reengineer the sales process. They allow investors to research, control, monitor, and transact their investments better than ever before.
The Information Island
Of course, you've all been waiting for the "Bermuda Hook." And here it is! Bermuda enjoys an excellent reputation as the world's premier offshore financial centre and have been in the business for many decades. The Bermuda Government and our regulator, the Bermuda Monetary Authority, are recognized in the leading financial centres as conservative and professional. At the same time, they maintain an effective but light regulatory environment.
Because of its unique geographic position, the island is a major telecommunications switching station and has three fibre optic cables as well as satellite access, making it one of the most "wired" places on the planet.
With the large numbers of insurance and other financial companies on the island, Bermuda is carving out a new niche as "the information island" for funds and other offshore companies to base their information resources in a low tax and regulation friendly environment. Bermuda is also well-positioned to play a leading role in global ecommerce as it takes off over the next five years.
Bermuda is the offshore funds specialist - we have more than 1,000 funds domiciled on the island and one of the best infrastructures of service providers in the world. The island has reconfirmed its commitment to the fund industry with our new regulations released in March, 1998.
New regulations for institutional schemes
· Minimum investment > $100K
· Minimum initial offering size >$50M
· Lighter regulatory and supervisory load
· Close fit with listing requirements of the Bermuda Stock Exchange
These new regulations for institutional funds provide a lighter regulatory and supervisory load for funds that are marketed only to sophisticated investors.
Conclusion
In conclusion, the internet is here and is real - it will permeate every aspect of business and financial services. In Bermuda, we are committed to exploit the potential of the internet as a "gateway" to the global digital business world.
Offshore fund companies must learn from their onshore peers and invest now to make sure they have the internet marketing resources for the 21st century. We in Bermuda look forward to welcoming you to "the information island"!
Mr. Sculley spent 25 years with JP Morgan and served as head of the Private Bank, leaving to set up an investment company with his brothers in 1995. He is also chairman of IntraLinks, an electronic communications utility for the financial services industry. Institutional Investor magazine named Mr. Sculley as one of the top 20 individuals revolutionizing online finance in their September, 1997 issue.
For more information contact Stephen Davidson, BSX Development Manager, at sdavidson@bsx.com or 441-292-7212.