By Hugh Elwes, managing director at Stephens
Asset managers are confronted with a perfect storm about one year every decade where everything seems to simultaneously go wrong.
Macroeconomic pressures are continuing to reverberate across the industry as asset managers look to overcome persistent cost pressures and ongoing regulatory change – all while navigating through turbulent markets to deliver above-benchmark performance.
In terms of business models, pressure on active fees continues and passive strategies are still growing in popularity, but fee pressure on the better-performing managers seems to have stabilised. Globally, average fee rates for asset managers are lower than they were in 2010 across all asset classes. In the UK, average fee rates for equity and allocation funds are around 83%, which is still a profitable and attractive business model. Nevertheless, retail turnover and costs have grown, increasing the need for scale.
As for regulation, the burden continues to grow. In the UK, for instance, the senior manager regime and the new Consumer Duty regulations are changing the industry, and the full effect of these changes is yet to be felt. Many managers are still behind the curve in fully thinking through their responses.
But one thing is for certain – the costs associated with these changes will keep increasing and in turn sharpen investor focus on value for money, facilitated by increased fee disclosure. The industry has relatively high operating leverage – BCG estimates about 60% of costs are fixed – which means it may be a case of having to run faster to stand still, as costs associated with increased regulation and inflation feed through.
Positivity as investor preferences shift
However, there are now more positive signs for the industry in 2024. If we are at or near the peak of the interest rate cycle and a hard landing can be avoided in developed markets, the renewed ‘risk on’ appetite could continue and with it, a significant reallocation back into equities and other ‘risky’ asset classes.
We hear from asset managers their desire for increased longevity of capital, which has been a key driver of the convergence between insurance companies and asset managers in the US. This is happening in both directions, with asset managers seeking to buy or build insurance capabilities and insurers bringing in specialist capabilities to manage insurance assets in-house or nearby.
Investor preferences are also shifting. Private markets and alternative asset categories are in strong demand, so larger groups are looking to fill product shelves as investors allocate to smaller numbers of managers. This is driving corporate demand to add expertise in these areas, acquiring teams or smaller businesses.
As for ESG, the attraction continues despite the recent backlash. For managers, there is a risk of doing nothing, but also a risk of doing it badly. Having a credible ESG proposition is now a must-have for asset managers, with investors demanding better performance and disclosure. More sophisticated models to service this area will emerge.
A considerable scope for consolidation
Overall, we see both winners and losers in this highly fragmented industry. The top five global asset managers represent only 10% of global revenues, versus more than 30% in investment banking. This means there is still considerable scope for consolidation, and the constant rhythm of spinouts to gain independence and acquisitions to bolt-on capabilities will continue in the industry.
Winning business models have been the larger managers with true scale, as well as groups embracing the growth of passive strategies, multi-boutiques, and integrated specialists. On the flip side, sub-scale, undifferentiated managers have struggled in the tough climate and will continue to do so.
There is a long tail of smaller managers, only some of which will thrive as fully or semi-independent boutiques. The boutique remains a good business model, but it needs to stay focused and perform well. However, there are challenges, namely the need for succession. In the UK, many key managers who set up boutiques during the ‘big bang’ of the late 90s and early 2000s are now at retirement age. In addition, distribution is also more difficult and expensive than ever. Some problems can be handled internally – for others, corporate activity can be an attractive solution.
In terms of corporate activity, large managers are still adding alternative capabilities, which are generally higher-fee businesses. Reflecting slower growth rates, valuations of alternative businesses have come down and now trade closer to their traditional peers, making transactions more palatable for purchasers. Despite challenges, the industry remains resilient, and better times are anticipated on the horizon.
