The market didn't wait for the latest round of quarterly updates to mark-down shares in the UK’s wealth managers. Given the rapid deterioration in equity markets – which has provided a hefty boost to funds under management – during the latter half of 2018, that's unsurprising. However, a slowdown in new business, coupled with market losses, meant the fall in funds was worse than expected.
That's led to another round of earnings downgrades across the sector for the year ahead. All FTSE 350 wealth managers have underperformed the wider index over the past 12 months, while the MSCI Private Investor Balanced Index declined by 7.9 per cent during the last calendar quarter of 2018 alone.
Fluctuating markets may have provided the biggest dent to funds under management, but net inflows are weaker, too. Wealth managers have shifted their businesses towards the discretionary model – where clients hand over the day-to-day management of their portfolio rather than signing off individual investment decisions – in the hope of improving fund retention.
To some extent the more defensive qualities of that model – as opposed to an advised-only approach – have shone through. The slowing rate of growth in net inflows during the closing months of 2018 was predominately the result of a reduction in new business, rather than an acceleration in existing clients pulling their cash. Still, that doesn't bode well for earnings growth, given management fees – charged as a percentage of funds under management – are the biggest contributor to revenue.
For example, discretionary inflows were £0.6bn for Brewin Dolphin (BRW) during its first financial quarter – short of the £0.8bn generated this time last year. Meanwhile, increased client circumspection meant new business generated via intermediaries accounted for just a third of the total, down from around half.
Even wealth management heavyweight St James’s Place (STJ) – which is classified by the London Stock Exchange as a life insurer but has discretionary fund management operations – has been adversely affected by low client confidence in markets. The group may have earned £2.6bn in net inflows during its fourth quarter, but that was behind the £2.9bn reported this time last year, while new business flows missed consensus expectations by 2.5 per cent.
A temporary phenomenon?
Credit Suisse’s Abid Hussain believes average growth of 9 per cent between 2019 and 2022 is more likely for St James's Place: "We believe the growth rate in net flows will be lower than the 15 per cent [target] due to slower asset inflation and lower amounts of assets transferring from defined benefit (DB) to defined contribution (DC)," he says. DB to DC pension consolidation is also likely to face obstacles as individuals become increasingly aware of SJP's high-end fees relative to some advice-based peers and self-investment options, he adds.
St James's Place chief executive Andrew Croft attributes the downturn not only to rocky market conditions, but also a strong comparative performance in 2017. However, there could be further tumult to come for the wealth manager.
"If we continue to experience market volatility and Brexit uncertainty, then investors will continue to be nervous," says Mr Croft. That is part of the reason the board expects gross inflows this year to rise at a compound rate of just 15 per cent – behind the 18 per cent achieved over the past two, five and 10 years.
For wealth managers, a predominantly fixed cost base means any drop in assets under management feeds directly through to revenue and profitability, says Shore Capital analyst Paul McGinnis. "There's a bit of operational gearing with these models," he adds.
Some wealth managers have pursued efficiency improvements to combat more volatile new business flows and markets. In January, Brooks Macdonald (BRK) unveiled plans to materially reduce the number of IT and administration staff, which could save an annual £4m.
An overreaction?
The question is whether the heavy sell-off in wealth management shares has more than priced in this potential for lower new business volumes.
One of the metrics that investors use to value wealth management shares is enterprise value as a percentage of the total assets managed, says Mr McGinnis. "If these metrics fall much below 2 per cent, that’s well below the level at which corporate transactions have taken place in the sector," he says.
Wealth managers have also benefited from rising transfers of defined benefit (DB) pension funds to defined contribution (DC) schemes since 2015, spurred by members wanting to take advantage of the pensions freedom changes introduced in 2015. The amount of DB assets transferred rose more than sixfold during the two years to March 2018, according to data from the Financial Conduct Authority (FCA). However, the rate of those flows may now ease off. In October, the FCA unveiled more stringent rules on providing transfer advice, which could discourage DB members from switching.
Historically low interest rates pushed the value of DB pension scheme deficits up, providing greater incentives for pension scheme trustees to encourage members to move to a DC scheme. "Therefore, trustees were giving enhanced transfer values for members to transfer out of DB schemes," Mr Croft says. As interest rates rise, that is likely to peter out, he adds. St James’s Place expects the level of DB to DC transfers to be flat on last year.
