Investment management groups in Ireland manage about IR£65 billion, most of which arises from the savings of the Irish population through pension funds and long term assurance policies. This is not a lot of money. It represents the recent savings of a small noveaux rich nation which is dwarfed when set aside the accumulations of larger, wealthier nations.

Prior to 1979 when the Irish pound was linked to sterling, Ireland had no fund management industry. There were a few institutions - principally one life office and a couple of banks - that had small investment operations but this hardly constituted an industry. Since that time, though, the shelter of a small and weak currency coupled with formal exchange controls on overseas investment over most of this period unwittingly created the perfect environment for a fledgling industry to grow. We can say that , in effect, that investment management has been a protected industry in Ireland over the last two decades since the break with sterling.

We are now on the brink of exchanging the Irish pound for the euro. Does the end of our unique currency also bring to an end our investment industry which has only existed under its aegis?

My concerns are not only prompted by history. Take a look around the world. A striking pattern is that for any given currency there exists just one centre of fund management activity. In our own backyard, we note that there is no fund management industry in Donegal. Yet, Donegal is economically more significant to Ireland than Ireland is to euroland (and about equally remote). Why are there no fund managers in Donegal?

The raison d’être of the euro is to unleash competitive forces in industries across Europe to create a truly single market. These forces will tend to coalesce certain industries into one geographical area in euroland. Elementary economics teaches that those industries characterised by specialist suppliers, invigorated by knowledge spill-overs, and requiring a pool of labour with highly specialised skills, are the most susceptible to geographical agglomeration. Industries with these traits provide increasing returns to scale when localised in a small area. The fund management industry satisfies all the criteria, in spades. If we were a little more distanced from our subject we might be amused by the irony: our industry which has so often been the instrument of economic efficiency now finds itself at its mercy.

These are the night fears of this Irish fund manager. History, geography, and economics seem hostile to the future of our industry. But are the fears rational? It is my unpleasant task to make the case that they are entirely well founded. The argument is developed in two stages.

First, I contend that the euro necessitates a portfolio realignment of Irish invested funds from their current unique proportions into a portfolio not very dissimilar to the euro portfolios that will be managed from London or Frankfurt. This part of the argument draws heavily on a paper delivered earlier this year to a seminar organised by the Society of Actuaries in Ireland. When portfolios become similarly orientated across euroland, this brings down the barriers which currently inhibit the free movement of investment mandates and creates an integrated pan-euro fund management industry. This part of the argument is crucial as it represents the dismantling of the protection our industry has enjoyed from international competition.

The second part of the argument draws on the historical, geographical and economic arguments touched on earlier to make the case that our fledgling fund management industry will eventually follow the assets off-shore. This part lapses into storytelling where, in the style of the 1970s television lawyer Petrocelli, I describe a possible evolution of the industry here based largely on a rerunning of the last two decades in reverse.

It brings me no joy recounting these fears. Perhaps, though, something which is so predictable may, with timely action, not be unavoidable. I leave that pleasant argument to the two other speakers this evening.

When Ireland cashes in the Irish pound for the euro it simultaneously changes the reference of the term "domestic asset" to include the assets of all other participants in the euro. This simple observation leads to some profound consequences for both the portfolios held for Irish clients and how, in practice, they will be managed in the future. Irish pension funds assets, already highly international in character, will lead the change.

Irish pension funds have grown in size to stand at over IR£25 billion by the end of 1997 - more than a fourfold increase from the IR£5.5 billion recorded at the end of 1987 when a comprehensive survey began. The dramatic growth is captured in the graph below.

With such impressive growth, pension funds have come to dominate all other forms of savings in Ireland. The Irish Association of Investment Managers, in a separate study of their members, put the proportion that pension fund assets represent of total Irish assets under management now at just over 60% as at 30^th June 1998. They continue to grow, swelled by investment returns and net new contribution in-flow running at about IR£1 billion per annum currently. It is not too pointed to say that the future of the investment management industry is intimately tied to the Irish pension fund industry. If Irish fund managers can keep Irish pension funds happy then their survival is guaranteed. But failure to satisfy these most demanding of clients will cut assets under management by more than half and rob the industry of its organic growth. For this reason, pension funds will dictate the pace of change of the Irish fund management industry and this justifies us focusing our analysis on their demands.

The Irish Association of Pension Funds (IAPF) survey mentioned previously also describes the asset distribution of pension funds in Ireland. The distribution from the survey relating to the year end 1996 is set out below and contrasted with both the average and range of distributions observed since 1989.

The table shows that the average distribution over the last eight years - a period when there was no significant change to the regulatory structure of pension fund investing - was 66% in domestic assets with a total exposure of 53% to domestic and foreign equities. Just as much international equities are held in Europe ex-Ireland as are held in the rest of the world. The spread of overseas equities is somewhat skewed: if the spread was in proportion to market capitalisation, one would expect only 30% to be in European equities. In short, Irish pension funds have a marked preference for Irish pound denominated assets and, in international equities, have a positive bias towards other European equities.

So what major shift is expected in the distribution of pension funds assets after the adoption of the euro?

First, note that from 1^st January 1999 the Irish money market and fixed interest market will cease to be markets in the Irish pound, becoming euro markets. From that time, it will be impossible to tell the difference between an Irish debt security and any other euro denominated one (other than by the intrinsic attributes of liquidity and credit risk). This implies, of course, that the proportion of Irish portfolios held in these securities - about 30% in the case of Irish pension schemes - become like any other bond portfolio managed from anywhere in euroland. Existing overseas securities, whether in Europe or outside of Europe, are equally footloose as to where they are managed. These represent 39% of pension funds, bringing the total non-specifically Irish securities to 69% on 1^st January 1999.

Only the proportion held in Irish equities and Irish property distinguishes Irish pension funds from funds that are managed elsewhere in euroland. But will the Irish equity market be able to maintain its unique attraction for Irish pension funds?

I think not. I hold that the Irish equity market will integrate with other euro equity markets, it is just that it will take a bit longer. During this transition period, the proportion of Irish pension funds in Irish equities will fall significantly to, perhaps, just 10% of total assets in 3-5 years time. This reduction in Irish equities will be accompanied by a corresponding build up in other euroland equities.

Let me set out my conjecture in tabular form: -

The rationale for this expected fall in the proportion invested in our local equity market is straightforward. The Irish equity proportion of pension funds has been artificially high in the last two decades and it will fall to more normal levels over the coming years.

First, in the period 1979-1988, the operation of exchange controls meant that if an Irish pension fund wanted equity exposure then it had to be largely Irish equities. Pension funds, along with other Irish investors, accordingly built up an unhealthily large stake in their local market. They did so against the background of willing enough sellers. The Irish pound proved to be a weak currency and, over this first decade, Irish fiscal management did not inspire confidence in foreign investors. Indeed, since gaining policy independence in 1979, the Irish pound devalued its central rate eight times relative to the Deutsche mark and revalued it just once. The cumulative depreciation of the Irish pound is about one-third relative to the Mark.

When exchange controls were abolished at the end of 1988, foreign investors did not immediately flock back. Why should they? After all, a small and relatively illiquid market principally held by professional locals is not an auspicious place to start a search for value. The currency risk alone demanded an enticing discount on Irish equities. A market presenting just 0.2% of the world market could safely be ignored unless the discount was so large as to amount to a give-away.

With no natural buyers matching the willing sellers, prices took the strain. The Irish equity market languished at a discount to its international counterparts, a discount not sufficient enough to induce foreign interest but sufficient for Irish pension funds to maintain their artificially high exposure after the abolition of the exchange controls. In fact, there was a marginal 1% increase in their exposure to Irish equities after this regulatory change. The comparative good value in Irish equities over their international counterparts tempted Irish funds even to the extent of maintaining an otherwise imprudently high concentration to stock, sector, and market specific risk in their portfolios.

Such a flamboyant claim requires compelling supporting evidence. The ex post observation that the Irish equity market materially outperformed international equity markets over most recent periods lends it some credence. The Combined Performance Monitoring Service (CPMS) put the outperformance as averaging 6.3% per annum between the end of 1988 and the end of 1997. Even more to the point, it is estimated, admittedly rather crudely, that foreign ownership of the Irish equity market has risen from 10% to roughly 40% over the last 5 years. This corresponds with a period of rerating of the Irish market (i.e., higher prices being paid for substantially the same earnings stream). This rerating of the Irish market from overseas demand is, of course, required by our hypothesis.

The redenomination of Irish pound equities into euro equities removes the currency risk from investing for other eurobloc members. But the Irish companies will remain small in a eurobloc context, accounting for about 1½% of the combined equity market. We need another factor to unlock the discount to make Irish fund managers willing sellers.

The Bank of England reflects a popular opinion in fund management circles in a recent publication when they cite survey evidence that suggests that the manner in which investment decisions are made across the eurobloc will alter from one based on a country approach to favour one based on a sectoral approach. Rearranging Irish stocks to be viewed on a euro-sector basis makes them rather more difficult to ignore. This is where the unusual concentration of the Irish market (with more than 70% of the market capitalisation captured in just ten stocks) becomes advantageous. This changed manner in which funds will be managed across the eurobloc will release the long pent-up value in Irish equities.

The euro will thus cause a rerating of individual Irish equities relative to their sector peers in euroland. The rationale for such a concentrated holding by the Irish fund management community will dissipate in tandem. Irish fund managers will be net sellers of Irish equities, using the proceeds to realign their portfolios to achieve a greater diversification by stock, sector, and business cycle, while maintaining assets denominated in the (new) domestic currency. The conjectured portfolio shift is expected to be largely completed within three years.

The run-down of Irish equities to 10% or so of Irish pension fund exposures leaves just 15% with a specifically Irish orientation, the rest being largely Irish property. This is not much of a difference from long-term portfolios managed elsewhere. The more remarkable fact will be that long-term portfolios will be almost identically aligned across euroland. This sets the stage for integration of the fund management industry in Europe.

The arguments advanced in Part I lead to the conclusion that long-term Irish portfolios will gradually evolve into being similarly distributed to long term euro portfolios managed anywhere else in Europe. Gone will be the uniqueness that have characterised our portfolio orientations to date. All differences will be swept away by the integration of asset markets in euroland.

This implies that Irish investors will be free to choose between any manager located anywhere in euroland and get essentially the same service. In particular, the dominant and exacting pension fund mandates will demand full pan-euro investment capabilities of their managers. For if it is accepted that a firm’s domestic competitors are from the same currency region then it follows that the appropriate peer group comparison for labour costs is across the single currency region. Irish pension costs, forming part of total labour costs, should accordingly be analysed relative to our euroland peers. This entails, in turn, that relative investment performance should be compared across all euroland pension portfolios, as outperformance of pension assets is a meaningful method of stealing a competitive advantage against one’s peers. Irish fund managers will be thus directly compared with euro fund managers.

Is our fledgling investment industry capable of offering this pan-euro service? The table overleaf breaks down the Irish fund management industry by size of funds under management. But size, let us hope, is not that important. The IR£25 billion under management of Ireland’s largest fund management group (almost three times the size of its nearest rival) falls within a rounding error of total funds in the brave new euroland. Accordingly, I also set out two other attributes that will be important for the future development of our industry - whether the firm currently manages non-Irish equities from Ireland and whether the firm has a parent with a larger investment operation elsewhere in Europe. Unfortunately, some of the companies in the reference survey withheld consent for publication of the information so they have to be identified by number rather than by name.

Twenty years on, the same three groups that figured prominently back in 1979 remain in the top three slots with, between them, two-thirds the total funds under management. The numbers in the industry have broadened out, though, helped by the establishment of local operations of foreign-owned firms so they can manage locally the high exposure to Irish assets. Notably, six of the 14 have an expertise only in managing Irish assets. Over the next few years they will have to grow the capability of managing pan-euro assets or wither away as existing funds leak overseas and new mandates become impossible to find. The kind way of phrasing this is to say that the euro poses a challenge for them.

The final column is intended to capture an anomaly in the existing structure of the firm’s organisation which will be exposed by the euro. That is, there is a duplication of effort in the organisation with different subsidiaries performing what will become essentially the same function. Those organisations identified with a ‘Yes’ have at least two investment divisions within Europe and the Irish one is not the largest. It is easy to envisage that should one investment division come under pressure - say by slipping relative performance (and hence potential profits) - then commercial logic will be ruthless in its response. One division will be closed down. This internal anomaly affects half the firms in Ireland and its resolution must impair our industry.

The combination of those facing the challenge of growing dramatically or the dilemma posed by being in bed with an elephant affects nine of the 14. Four are faced with the double-whammy.

The table captures well the fledgling nature of our industry. The discussion could take a theoretical bent now as we apply some insights of development economics. But there is no need to dwell here on the increasing economies to scale of our industry and the benefits accorded when there is a critical mass in one small area. Those economic forces are well understood by this audience. Anyway, economic geography spoils the ending: there are no fund managers in Donegal.

My night fears can now be encapsulated in a nightmare. It always begins the same way. For some reason that is never quite clear, Irish fund managers underperform their peers in London or Frankfurt in the early years of the euro. Maybe it proves impossible to organise an orderly portfolio restructuring of Irish funds. The dynamics were always difficult to envisage. We have a dozen identified big sellers in a small market but only vague and diffuse buyers. Maybe the sellers prove more eager than the buyers and the Irish market systematically underperforms other euro equity markets over the next few years. The Irish equity exposure, so long beneficial, suddenly becomes a liability. In any event, Irish fund managers, because of their higher exposure to an underperforming asset class, slip in their performance ranking relative to other European fund managers.

Glib talk will be heard among pension trustees that Irish fund managers do not measure up in the new order of things. The loose remark that half of the industry know only how to manage Irish assets will be developed into the theory that a conflict of interest inhibits Irish fund managers from selling Irish equities - by holding them they are protecting their jobs and not looking after the best interests of their clients. Arguments put forward that Irish equities do indeed represent fundamental good value will be dismissed with the impatience reserved for a sophist. The bald fact that, as a group, Irish fund managers underperform will be enough for most. Nobody will care for what reason.

Pension funds will begin to appoint overseas managers. These managers immediately restructure the portfolio, compounding the problem by selling down the cheap Irish equities further. Eventually, the larger European investment division of half the Irish firms take over the management of the portfolios to stem the haemorrhaging of profits. Their Irish operation will be turned from a managing operation into a servicing operation. The industry, halved in number, is critically weakened.

Does it matter where the hammer blow comes from that snuffs out the struggling Irish industry? Maybe, one or two of the largest fund managers decide to relocate to be closer to the centre of action in euroland. Maybe it will be because of a take-over of a domestic player by a larger financial services provider, or a merger of existing operations, that promptly closes a redundant Irish investment department. In any event, the Irish fund management industry no longer has critical mass. The few remaining operations no longer have common interests that need organisations such as the Society of Investment Analysts in Ireland (founded in 1985) or the Irish Association of Investment Managers (founded in 1986). When these two institutions are disbanded then what could reasonably be termed a fund management industry in Ireland no longer exists.

This is not the end. Posterity has reserved an unkind epitaph. For should a future generation ask why there is no fund management industry in Ireland, the records will show only the relative underperformance in its last few years. The erroneous answer will prevail. There is no industry in Ireland because, when there was, it was no good.