The five chief threats to the asset management business and the changes they could wreak on the industry in the years ahead. Just what do asset managers have to do to survive?
Part 2: A blow upon a bruise
In my last blog I gave a highly sentimentalised account of the ghost of asset-management past. If you’re a fund manager over the age of 50 then those times could be defined as your safe space. Long on lunches and short on regulation - plus all those lovely fat fees lapping gently in like a regular tide.
Not so today. The industry has changed beyond all recognition. Bigger players have gobbled up smaller ones, the sector is strait-jacketed by regulation, fees are shrinking, costs are rising and technology threatens to make the skills of the traditional active manager – dare I say it - redundant. And on top of these difficulties, like a blow upon a bruise*, there has been a major erosion in trust from the wider public – based largely on weak recent performance and transparency over fees.
It doesn’t help that the former garlanded scions of the industry - the star managers - have struggled to replicate their past alpha glories. “Just what do we pay these guys for?” people ask, rightly, when passive funds and indices consistently outperform their manicured portfolios. There’s a feeling that these individuals started to believe their own marketing department’s hype, that they got complacent, that they developed a Midas complex. “You behold a range of exhausted volcanoes,” as Benjamin Disraeli might have said of those star managers today.
A recent survey by the CFA – cited in the FT – showed that only 44% of retail investors said they were satisfied that investment managers generated returns similar to or better than a target benchmark. And they were also largely unhappy about disclosure of fees and other costs.
But it’s not all doom and gloom for the sector. Every market yin has its yang. In this case it is the many billions of dollars from savers all across the world that will need to be invested over the next few decades. From pensioners in Europe and the US, to a surging middle class in China and yield-hungry sovereign wealth funds – opportunity knocks for asset managers. But which managers will be around to benefit from this fees gold rush? It will be those firms that are resilient to the five major forces buffeting the sector.
In no particular order, these forces are:
- Falling fees: in a world of passive funds and easy execution it’s hard to see how active managers can justify their fees to an increasingly sceptical public – both ordinary investors and the institutional kind. Especially when they don’t deliver on their promises. (And mitigating poor returns by saying: “but we invest for the long term” is wearing as thin as the Downing Street doormat.)
- Rising costs: As fees are shrinking, so costs are rising. These rising costs come in three broad categories: first, the cost of coping with new regulation and reporting standards, second, the cost of implementing new technology and data storage and security, third, the cost of competing with richer global rivals. If you are a smaller or medium-sized manager contemplating the future, then it is hard to find much to be cheerful about. And you certainly can’t put up your fees!
- Tighter regulations: Governments and regulators have fixed their gaze on asset managers – and they won’t be looking away anytime soon. Whether it is the retail distribution review, Mifid 2, or new laws about data storage and security or OTC derivatives trading – the authorities are cracking down on every facet of the fund manager’s day job. It is becoming much harder to be a dynamic investor these days, and much more expensive too.
- Diminishing faith: As touched on above, people just don’t believe the hype anymore. And all the marketing platitudes in the world won’t change this. Why pay 1%-2% to an active manager when you can invest in a passive fund for half the price, or execute your own trades for next to nothing, online. Active managers must truly prove their worth to a sceptical public.
- Advancing technology: Artificial intelligence, machine learning, big data, and analytics. These advances will revolutionise investing – helping to drive efficiencies, maximise returns and boost margins. But technology doesn’t come cheap. It’s no longer a ‘nice-to-have’ but a ‘can’t-survive-without’. Not only that, but AI raises uncomfortable existential questions for active managers: could a robot do my job? It is unlikely a computer will replace the very best investment managers, but a large swathe of the mediocre ones should be getting nervous.
Survival of the fattest
What will it take to survive and thrive against this troubling backdrop? I’m too inexperienced to say. But after chatting to one or two people whose judgement I trust – and reading a few cerebral reports - four answers present themselves:
- Make a big investment in technology
- Create economies of scale via M&A and partnerships
- Break into emerging markets, especially China
- Automate processes and use third parties to slash costs
- Win back the trust of investors via fee transparency and better performance
Ultimately, however, scale will win the day. It will be the deep-pocketed behemoths who can capitalise on the new markets in China and beyond. With trillions under management, these big berthas – these mega-managers who are ‘too big to fail’ - will offer a commoditised service at low cost.
The very best individual managers will do what they have always done, put in a few years’ service at a big brand and then slip off to open their own niche fund – charging wealthy people fat fees. These funds will be administered by a third party and have a strict investment limit. It’s the medium-sized operators who will disappear.
*With thanks to Evelyn Waugh