Asset managers count the cost of the big squeeze on fees

Date published: 01 February 2019

Richard Henderson and Robin Wigglesworth

If investors in asset managers were hoping for some relief this week, they did not get it. A string of lacklustre results from some of the world’s biggest asset-management firms highlighted the big squeeze on fees across the $89tn investment industry.

Franklin Templeton, the $650bn-in-assets fund house, lost about 6 per cent of its market value this week after releasing gloomy fourth-quarter results that echoed weak figures from T Rowe Price and Invesco. As a whole, US-listed asset managers saw 1 per cent trimmed off their stocks this week, even as the S&P 500 climbed back to its early-December level. European asset managers have also seen their shares sag again.

“It was a very challenging year, which culminated in an extraordinarily difficult fourth quarter,” Joe Sullivan, the chief executive of Legg Mason, told the FT. The $727bn Baltimore-based investment group reports its full results on Monday, but speaking of other reports, he said: “Analyst estimates were wildly off, and that shows just how devastating the period was.”

Global equity markets suffered their worst quarter in seven years in the last three months of 2018, with the US stock market alone suffering its worst December since 1931. That weighed heavily on revenues for fund managers, which are tied to the dollar value of assets they oversee, while triggering a big surge in outflows. Shares in the fund managers lost 26 per cent over the year — the worst annual decline since the financial crisis.

December in particular became ‘Flowmageddon’ for the industry. Traditional, actively-managed global equity funds saw almost $160bn yanked out last month — the worst burst of outflows on record, according to data provider EPFR. Bond funds, meanwhile, saw $86bn of withdrawals in December, the biggest since the 2013 “taper tantrum” triggered by the Federal Reserve’s plans to wind down its quantitative easing programme.

“It’s been a risk-off environment like you can’t imagine,” Martin Flanagan, chief executive of Invesco, lamented on a Wednesday earnings call.

The market turbulence that erupted last year was particularly problematic for asset managers, as the post-crisis bull market has masked the severity of a secular shift away from pricier active investment funds to cheaper “passive” funds. While indices have risen revenues have climbed too, keeping profit margins juicy even as many groups have seen big outflows from their higher-fee funds.

“Despite what were rising equity markets, there were a bunch of firms that were experiencing flat or declining asset levels because of outflows,” says Rob Lee, an analyst at Keefe, Bruyette & Woods. “It’s going to stay a pretty challenging environment.”

Indeed, investors are growing increasingly skittish that fund managers can adapt to this radically changed environment. Last year passive equity funds sucked in another $472bn, while active ones shed $488bn, according to EPFR.

“It is bad and it’s gotten progressively worse over the last few years,” says Matt Harris, partner at Bain Capital Ventures. “They’re going to lose with every dollar that goes into passive.”

Fund managers have clipped fees to stay competitive, and many rushed to launch index-based strategies and offer bargain-priced exchange traded funds. These businesses operate on thin margins and require scale to draw profit, especially as index funds themselves are now feeling the heat of a ferocious price war. Fidelity sent shockwaves through the industry last summer after launching a zero-fee index fund to gain market share.

There are some bright spots for asset managers. Hopes are high that new markets like China will provide rich pickings. Meanwhile, strong demand for some hedge fund strategies and private equity — which claim to deliver high returns uncorrelated to the stock and bond markets — is offering fund managers a lifeline.

Asset managers that do not have these products are scrambling to acquire them. Franklin Resources, for example, last autumn bought a $26bn-in-assets private debt investment group, Benefit Street Partners.

Larry Fink, chief executive of BlackRock, argues that there is a “bar-belling” effect under way, as investors flock into cheap, passive investment products or expensive, high-end alternative ones, with most of the pressure being felt in the middle. Unfortunately for many asset managers, that is where most of their products are.

The relentless pressures facing fund managers should spur further consolidation in the industry, which has already seen a rash of big deals.

Invesco last year announced a $5.7bn deal to purchase rival OppenheimerFunds from insurer MassMutual — a deal that promised to lift it into the elite club of fund managers with assets above $1tn, while yielding $475m of cost savings. The merger was the largest among traditional asset managers last year, when the $7.5bn in M&A volume reached the highest point since 2014, according to PwC data.

Investors have been left cold by many of these combinations. The stock of Invesco, Janus Henderson, Standard Life Aberdeen and Amundi — which have all done big deals in recent years — are all down 30-50 per cent since their 2018 peaks. Nonetheless, most people in the industry say further consolidation is inevitable.

Greg Peterson, US financial services deals leader for PwC, said the bulk of tie-ups would probably be between small and medium-sized fund managers. But bigger deals will probably occur too, as all investment groups are pinched by secular and now also cyclical forces.

“Traditional asset managers are either looking ahead because they’re hunting or looking over their shoulder because someone is hunting them,” Mr Peterson says.

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