The US fund management sector experienced a generally cautious earnings season as the slowdown in fund inflows towards the end of last year manifested itself in lower profits. In fact, according to S&P Global research, all but two of the top 14 US-listed asset managers recorded year-on-year falls in their profits.
In addition to cautious investors, negative market movements meant a dearth of ad valorem fees. However, with the US economy still looking resilient, the asset managers are positioning themselves to take advantage of a softer landing. The question now is how much benefit there will be for managers who are relying on the stock market to lift their assets, when other asset classes might outperform on the back of rising rates.
The great bond rotation
Behemoths such as BlackRock (US:BLK), which now has $8.6tn (£7.1tn) of assets under management, sounded a cautiously optimistic note, reflected in the upbeat briefing from its chief executive, Larry Fink. He said the long-term investing outlook now looks brighter than this time last year, thanks to the effect that higher lending rates are having on fixed-income assets – the higher rates go, the wider the yield on corporate and government bonds. That means that investors, who generally shunned the skinny yields on bonds over the past decade are starting to come back in search of bargains.
This means that BlackRock, which has about $2.5tn of fixed-income assets under managementcan still benefit from a general rotation away from equities.
It is a well-established fact that higher interest rates tend to keep investors in cash and bonds, rather than equities, with the exception being periods of high inflation. If the assumption is that inflation has now peaked, then the equities rally could start to run out of steam towards the end of the quarter as investors re-price the risk, hence BlackRock’s emphasis on bonds for the year.
This seems to be a tacit admission that BlackRock left itself too exposed to equities last year, hence its general underperformance in relation to its peers. However, it should be noted that the fund manager’s sheer size often makes it a market proxy no matter how judicious the underlying asset allocation strategy is.
It is as investments in themselves that the asset managers are drawing the more negative commentary for the year ahead. Investor services company Moody’s recently changed its rating for the sector from stable to negative, both for its outlook and debt profile.
While most causes of market volatility are generically like 2022 – conflict, inflation, energy prices and fragile investor sentiment – Moody’s reckons that, in addition, the asset pile that managers are competing to manage will struggle to grow this year as investors hold back funds or simply move assets into cash to take advantage of rising rates. In this scenario, the managers with large positions in active management will suffer the most from shrinking market share. Therefore, further consolidation within the sector cannot be ruled out, although smaller deals that swallow the subscale managers are more likely than big debt-fuelled M&A, Moody’s said.
The ratings agency predicts that what asset growth there is is likely to flow into exchange traded funds, private asset classes and ESG investments. In this case, BlackRock would benefit the most from a move into passive investing given its iShares division, with its closest listed rival Invesco (US:IVZ) a few rungs down the ladder. In fact, the largest passive fund manager, aside from BlackRock, is the privately-owned Vanguard.
Uncertainty and private credit
One positive for the US asset management industry is that it isn’t based in Europe, where a raging war on its near frontier will continue to put considerable strain on investor confidence, as well as contributing to a difference in interest rates that favours managers in the US. In addition, despite generally muted activity in private equity (PE) markets, the US should still see a regular flow of exits for PE funds at the sub-$1bn level, which seems to be trickier for their European equivalents where valuations for PE firms are under greater scrutiny.
The other area to watch this year is how the private credit market grows and which asset managers are likely to benefit from this. According to Bloomberg data, the private credit market is one of the fastest-growing financial asset areas. Starting out from around $500bn in 2015, the number of assets under management is now closer to $1.4tn. The business has essentially become an alternative form of banking, with asset managers lending out client money at better interest rates to corporate customers who tend to use it to finance M&A.
This is yet another area where Blackstone (US:BX) has a large presence, but other funds such as Apollo Global Management (US:APO) and Ares (US:ARES) are significant players. The asset class’s ability in recent years to outperform traditional fixed income was part of its attraction – by some measures it returned 4 percentage points over bonds last year. However, with almost no oversight and the barest of regulatory disclosures, it carries considerable hidden risk, particularly at a time when rising interest rates are changing investors’ priorities.
