Rising markets mean good times (for most)

In the final years of the pre-crash equity market boom, their stock prices raised upwards, only to fall below the market after it collapsed. After the equity market doldrums of the second half of 2011, stock markets have steadily recovered and London-listed asset managers have made up the ground they had lost against the other public equities. Indeed, on a 10-year view, you might as well have bought the index.

At a company level, investor sentiment towards a certain sector or style is a large determinant of change in assets under management (AUM), or 'flows'. "Flows determine quite a lot of what the share price does," says Arun Melmane, equity analyst at Canaccord Genuity.

Emerging markets have been a particular focus of investor scorn since 2013's 'taper tantrum', where signals that the US would reduce its quantitative easing programme triggered a sell-off that spread quickly to the developing economies. Concern continues that when the US does begin to raise interest rates, further pain will be inflicted on emerging markets.

Ashmore (ASH) is the well-cited example of a manager whose fate has suffered at the hands of the US Federal Reserve. Aberdeen Asset Management (ADN) also continues to endure investor ire due to its bias to EM strategies - the fund house's half-year results revealed net outflows of £11.3bn.

The Aim-listed Polar Capital (AIM:POLR), which has substantial client assets in Japan-targeted investment funds, has also suffered stock price falls on outflows from the country's equities.

Any stock picker that can call the return of sentiment, and crucially flows, to these out-of-favour asset classes can reap rewards as the manager re-rates - but it requires a major call on the market.

Spreading your bets

The growth story of the year has been European equity markets, inflated by the cheap money injected by the European Central Bank's quantitative easing programme.

The assets that flowed from the emerging markets to the US last year have since migrated to Europe, with Henderson Group (HGG) a key beneficiary. A net £3.6bn in client assets flowed into the manager's stewardship in the first quarter, with the biggest contributor being client demand for European equities, one of its core proficiencies.

"If you are in European equities and you have seen some decent performance, you are doing very well," says Pras Jeyanandhan, equity analyst at Berenberg.

Diversification has long been a buzzword for managers to explain how their investment strategies protect their clients from the worst of market falls. But this spread is equally successful in protecting managers themselves against swings in market sentiment.

Aberdeen's purchase of Scottish Widows Investment Partnership from Lloyds Banking Group was a clear effort to diversify its business. While this tactic has not yet saved it from the emerging market backlash, analysts welcome the longer-term strategy to spread its bets.

One manager that has benefited from the spread of its assets is Schroders (SDR) - with less emerging market exposure, and a bias towards developed market equities, the manager has surfed a wave of positive sentiment. Schroders has approximately a quarter of its assets in multi-asset - an investment style that is particularly popular with institutions looking for less volatile returns.

Regulation

Asset managers are fee-based businesses, and a key indicator of performance is the net management fee margin: that is, the proportion of the average AUM over the period that is generated in net fees for investing client assets. The main pressure to these margins comes from regulation, past and present.

Following the implementation of the retail distribution review - which led fund management fees to be unbundled from advisory charges - analysts are especially vigilant about margin pressure in retail investment management.

As clients are able to better compare the price of funds on platforms, unsullied by commission fees, analysts believe managers at the mercy of those platforms could suffer.

So those fund houses with bigger retail businesses, such as Jupiter Fund Management (JUP) are under the microscope from market-watchers to see how its margins are affected - while even Schroders has a substantial retail business that could see pressure.

"The retail businesses are probably facing the most pressure but even institutional clients are driving down prices," says Mr Jeyanandhan. Pressure has been growing for some years from the larger institutions to push down management fees, coupled with growing cynicism of the value of active management in current markets.

A more subtle coming reform is buried in the latest version of the Markets in Financial Instruments Directive, or MIFID. This will stop managers paying for research out of clients funds, and is seen as potentially destructive for the smaller players, who will have to put these costs on their consolidated income statement for the first time.

Much of the detail on this has yet to be thrashed out, as the industry lobbies hard against a regulation that has manifest potential consequences for their profitability.

What is clear is that managers, like Aberdeen, which have a bigger internal research function would be less affected by such a measure, while the future is less certain for those who are more reliant on external research.

Analysts at Berenberg argue that the higher proportion of hedge fund assets at Henderson and Man Group (EMG) means higher portfolio turnover than long-only focused managers, and therefore more research costs.

IC VIEW:

The growth story for asset managers since the financial crisis has surrounded multi-asset strategies and 'alternative' assets - that is, alternative to the mainstream asset classes of equities, fixed income and property. But it must be added that sentiment to certain asset classes and market performance remain the overriding factors in a recovering global economy, over and above these longer-term challenges.

Favourites

Due to the outperformance of this sector in bullish markets, readers will not be surprised that there is no obvious undervalued equity to be picked off, without making a big market call. Shares in our buy tip Jupiter were trading at 13 times consensus forward earnings when we pointed to its long-term growth prospects in February last year. Having been boosted by demand for its bond and European equity strategies, shares are up a fifth and are now trading at 15 times, but we think there is still some value there given the ongoing support for European markets. Buy.

We have intentionally cast a wide net in this sector review to include companies that have a substantial leaning towards asset management, and our buy tip in South African asset manager and bank Investec (INVP) is also up a fifth since we recommended it last year - with business boosted in the last financial year by higher AUM in its wealth management and fund management divisions. We maintain our buy advice.

Outsiders

We remain sceptical on the prospects of Man Group. The manager did grow its funds under management by 7 per cent in the first quarter, but its chief executive reiterated its "degree of caution" over first-half flows, as well as its "reasonable pipeline". Until signs look up, we keep our sell recommendation.