Times are changing for asset managers

A change in the investment climate and greater competition suggests that next year will see sources of higher fee-generating business decline, according to Fitch Ratings. Product numbers are expected to fall as managers try to offset the squeeze on margins by reducing costs. This is a trend that has already started, because average margins on European fund managers' assets under management slipped 44 basis points from 2010 to 2012. This decline has been accompanied by a general shift among institutional investors away from high-fee equity products and into passive, low-fee, low-risk investments. Furthermore, Fitch believes that the trend is structural, and is deflected only on a temporary basis by renewed investor interest in equities. In an attempt to preserve margins, or at least to slow the rate of decline, fund managers are likely to adopt a combination of three potential strategies. The first is to develop lower cost products and make up for the drop in fee income by competing on volume. The alternative is to develop niche products that can support a higher fee environment. But, perhaps, most important of all is the ability to build multi-asset capabilities, as the price of accessing individual asset classes declines.

Indeed, further rationalisation seems inevitable as companies move towards managing fewer, bigger funds. In 2012, around 1,000 funds were wound up, and a similar number are likely to go this year. True, 1,000 funds represent just 3 per cent of the total, but it's worth pointing out that around 65 per cent of cross-border funds do not have a single flagship fund with assets of over €1bn (£860m). However, while consolidation will be one of the major factors in the asset management sector, there is also likely to be a degree of fragmentation, as asset managers leave larger companies to set up boutique firms specialising in niche asset classes.

The overall outlook for the coming year is one of more growth as investor confidence and macro-economic trends remain positive. Inevitably, though, some fund managers will do better than others. Indeed, half of European managers had no fund inflows in the three years to the end of July this year, and the top 10 asset managers pulled in half of the bond inflows and three-quarters of equity fund inflows.

On the competition front, Europe is also more open to competition from overseas players. US managers are already here, but there is also growing interest from Asian and Latin American-based managers. Furthermore, margins are relatively weak in the captive institutional segment, where a bulk of the assets is managed for parent insurance companies. And there are also question marks over whether London will maintain its current stance as the world's largest centre for the fund management industry. Research by international law firm Nabarro showed that 90 per cent of asset managers believe London will retain its status for the next three years. However, this figure drops to 60 per cent when looking 10 years ahead, with Shanghai, Dubai, Sᾶo Paulo and Mumbai all forecast to gain market share. While London has the language advantage, the tax regime is likely to act as a deterrent, and where cost pressures are likely to be a major consideration, this puts London's prospects on slightly more shaky ground.

Asset managers also have to monitor relationships with investors. Nearly half of the respondents asked by Nabarro expect managed accounts, where there is greater interaction between the manager and the customer, to become more popular, along with discretionary management mandates. It's also crucial to understand how investors are thinking, given the changing trends in macro economic activity. Indeed, the debate between active and passive investment strategies remains. At the moment, given the relatively high level of volatility, risk aversion favours a more passive investment stance, but as conditions normalise in the wake of the financial crash, investors are more likely to adopt a more active investment position.

Source: Numis Securities

It's also worth pointing out that a bulk of assets under management in the UK in some way or other come under the pensions umbrella. In the latest survey conducted by the asset management trade body, the Investment Management Association, around 38 per cent of funds held by asset managers were held explicitly by pension funds. A further 24 per cent were held by life insurance companies, and another 17 per cent by corporate bodies and the public sector, a significant proportion of which can reasonably be expected to be held for retirement purposes. Finally, around 18 per cent are held by retail investors where there is also likely to be a high percentage of pension money. In fact, Numis Securities believes that two-thirds of funds under management are related to pensions.

However, a shift in the pension make-up primarily away from defined benefit (DB) to defined contribution schemes suggests that individuals are likely to take a greater interest in their own pension funds. According to professional services group Towers Watson, around 97 per cent of UK pension assets under management were related to a defined benefit scheme in 2000. However, a combination of factors including increased longevity, poor management and weak investment performances led to most of these schemes being closed to new entrants. New defined contribution schemes were employed instead, where the investment risk is passed to the person saving up for a pension. As a result, funds relating to a DB scheme had fallen to 61 per cent of assets under management by 2012. And this trend will continue as DB schemes are wound down further. The shift away from large institutional mandates is crucial, because some asset managers are much further down the road than others in addressing the needs of individuals, whether it be through a self-invested personal pension (Sipp) and/or through a personal investment adviser. Although the new rules abolishing direct commission payments to independent financial advisers could mean that people with smaller pension pots find it unrealistic to opt for the alternative system of paying for advice, and may go it alone by managing their own Sipp.

IC VIEW:

Asset managers will overcome all the potential pitfalls outlined as long as investment markets continue to perform well. And the macro-economic outlook suggests that, for the short term at least, this will prove to be the case as the global economy slowly recovers momentum. Some will, however, do better than others, with success measured by the ability to adapt to changing trends in investment and investors by offering attractive products.

THE BROKER'S VIEW:

Sir John Templeton once quipped: "Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria". In May of this year, I wrote in these pages about Heisenberg and his Uncertainty Principle with reference to the UK asset management sector. Since then, the FTSE 100 has risen by just 2 per cent and the FTSE All-Share by 3 per cent. However, the share prices of the UK asset managers - particularly Henderson Group, Schroders and Jupiter - have risen by much more.

Recent UK economic data have been encouraging, buoyed by other keenly watched indicators from the US and China. It seems as if optimism is starting to proliferate. Nasdaq Shas recently powered through its pre-crisis high and now trades on circa 25 times prospective earnings, with little in the way of a yield to talk about, and the S&P 500 has risen by nearly 30 per cent this year. Earnings upgrades have been limited, so the recent rally has been an exercise of pure multiple expansion, as opposed to being earnings-driven.

Global markets reacted badly in June when Fed chairman Bernanke first dared to mention the prospect of no more 'free money', with emerging markets (EM) feeling the brunt of it. It is no fluke that Aberdeen Asset Management's relative underperformance to the sector coincided with a period of significant upheaval in EM equities and economies. Before its recent takeover of the Scottish Widows Investment Partnership, EM, including Asia-Pacific, accounted for 65 per cent of its equities business with a further 16 per cent held in EM debt.

Fed tapering is now a question of 'when' and 'by how much' rather than 'if'. We look to next year with an element of caution, as we did to 2013, fearing the consequences of overt optimism in equity markets.

Owen Jones, analyst at Shore Capital Stockbrokers