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INDUSTRY HEALTH CHECK: prospects for recovery

We may be over the worst of the crisis, but profitability levels are a long way off their peak for most companies and the outlook is generally downbeat. Angèle Spiteri Paris considers who will prosper in this new environment...

stethoscopeYou could joke that when ratings agencies are not hammering down credit scores on Greece, they are kicking the fund management industry instead. Fund managers have come a long way from the woes in late 2008, but a recent report from Moody’s, a ratings agency, declared a negative outlook for the industry with earnings strength still 25% lower than at its peak. Fitch Ratings manages to give a ‘cautious’ outlook.

A brief poll of senior executives in fund management shows a similarly downbeat mood.

Jon Little, vice chairman of BNY Mellon Asset Management, says: “Although I wouldn’t say the outlook for the asset management industry is negative overall, it’s not as positive as some managers seem to think.

“Recapturing earnings strength largely depends on good market performance.”

Elizabeth Corley, CEO of Allianz Global Investors Europe, says: “I would hesitate to say that industry profitability levels will be back to what  they were two years ago because the whole structure of the market has changed and therefore things cannot be the same.

“It is brave to say that the industry will see profitability improve in one or two years because it largely depends on markets, which are very unpredictable.”

However, Jean François Boulier, CEO of Aviva Investors France, says: “A number of market players were able to withstand the crisis, because they weren’t exposed to leveraged instruments and similar assets. They were considered to be lame ducks before the crisis, because they didn’t follow trends. But they’ve since had their revenge as the market is now seeing a greater focus on long-term investing and traditional instruments.”

According to the Moody’s report, a number of changes are needed – both within the industry and the global economy – before a stable outlook is reached.

Dagmar Silva, a vice president and senior analyst with Moody’s, says: “Moody’s outlook for the global asset management sector moving from negative to stable depends on the pace of economic recovery, capital market prices, the level of investors’ discretionary income and relative investment performance. If the recovery is faster than anticipated then it could result in more flows to asset managers but if it lags, then this will drag on the industry.”

Total European assets rose 15.6% last year to €7bn – but little of this increase was due to inflows. In fact, assets under management (AuM) are still 14% below their peak levels.

Market performance was the main driver behind the relative improvement in the asset management industry over the past year.

Manuel Arrive, senior director at Fitch Ratings, says: “Eighty percent of last year’s growth was due to market appreciation while 20% could be attributed to inflows.” He compares this to the situation after the tech bubble, when 65% of asset growth came from inflows. He adds that profitability is unlikely to go back to pre-crisis levels over the coming year.

Little, of BNY Mellon, says: “As long as there’s no crash, then the asset management industry will be on route to regaining its profitability.”

According to Fitch Ratings, operating margins were down to 27% on average in 2009 compared to 35% in 2007. But the agency says the profitability of the asset management industry is still healthy, in spite of being reduced.

Side effects
The strong equity market performance that began in March last year may have boosted the profitability of the asset management industry, but this could have had negative side effects that were destined to come to light when markets stabilise.

Little says: “If your costs were too high pre-crisis, then the strong market performance of 2009 rescued you. Once you started making money again, you thought you would be out of the woods. Actually, the rally masked the structural problems inherent in some badly run asset management businesses.”

He says the firms with such issues are the middle-of-the-road players with too many products.

Arrive, of Fitch, says: “The crisis revealed a lack of business focus. The innovation was more about launching the ‘flavour of the month’ fund than creating economies of scale in core markets.”

Corley, of Allianz, says: “The crisis is punishing the weak and benefiting the strong.”

Although mid-sized firms with between US$30bn (€23bn) and $100bn in AuM were highlighted as the ones in this category, Boulier, of Aviva Investors, says: “It’s not necessarily a question of size, it’s more that some managers were doing too much with too little means.”

Horacio Valerias, CIO of Allianz Global Investors Capital, says: “The equity rally helped, but I don’t think it saved anybody. The firms that were caught in the middle before the crisis are still caught in the middle now and are struggling to survive. The normalisation of markets created an opportunity that helped bail some people out. But now they have to deliver performance.”

Corley, of Allianz, says: “Although the recovery has boosted industry revenue levels, our view is that we cannot afford to slacken the development programmes we have. Managers cannot rely on rising markets to bail out average financial performance.”

Fred Ponzo, managing partner at GreySpark Partners, says: “Fund managers need to update their business models. They need to gain more economies of scale, which will be more of a struggle for smaller firms than the giants. Being average isn’t going to cut it anymore.”

Arrive, of Fitch, says: “We’re seeing a streamlining of businesses process and a reshuffling of product ranges. Some fund managers will be getting rid of certain products and moving towards true innovation.”

In its report, Moody’s said: “Our asset manager outlook for 2010 and 2011 is a mix of broadly unfavourable market and macro uncertainties, downward pressures on revenue yields driven by investor demands, the rise of passive investment and the rising strength of distribution platforms.”

Investors’ asset mix has changed and since flows into equity funds have not recovered, margins are still low.

For example, Goldman Sachs’ annual report for 2009 shows that net revenues in asset management decreased significantly compared to 2008, reflecting lower net revenues in asset management.

Asset management net revenues for 2009 were of $3.97bn, a decrease of 13% over 2008. The firm says this primarily reflected the impact of changes in the composition of assets managed, principally due to equity market depreciation during the fourth quarter of 2008, as well as lower incentive fees.

Market positioning
Being conservative going into the crisis helped F&C Asset Management get through it, but this also means the firm did not benefit from last year’s rally as much as it could have.

In its annual report for 2009 the firm says: “We were relatively defensively positioned during the sharp equity market declines in 2008, and thus were more limited in our participation in the equity recovery during 2009.  We ended the year with assets under management of £97.8bn [€112.6bn], broadly flat on the year, compared to £98.6bn in 2008.”

F&C’s net revenues also remained relatively stable at £225m, compared to £230m in 2008. When it came to fees, the firm saw a decline in investment management fees, which were £18.6m lower than the year before, but an increase of £10.8bn in performance fees on the back of strong investment performance.

Another giant, BNY Mellon AM, saw its results buoyed by its acquisition of Insight Investment in August last year. In its annual report, the firm said: “Assets under management were $1.1 trillion at 31 December 2009, an increase of 20% compared with $928bn in December 2008. The increase primarily reflects the Insight acquisition and market depreciation, offset in part by money market outflows.”

BNY Mellon AM’s first quarter results have not yet been released, but Little says: “We did well in the second half of 2009, although it was a year of differences. We’re pleased with the way things are going in 2010.”

Valeiras, of Allianz, says: “Profitability has been hit but if you’re positioned well, you can pick up market share in times like these. Our profitability is actually improving, but it’s still not what it had been at the peak of the market. We’ve kept our revenues up by being in the right product.”

Boulier, of Aviva Investors, says: “In France, inflows are very large since a lot of people are investing in insurance company products, who in turn, hand their money over to be managed by asset managers. At Aviva Investors France we had almost no outflows in 2008 and saw €2.1bn of new money from third-party clients coming in. We’re convinced we’re in a good position to make the most of the current situation.”

Greg Johnson, president & CEO of Franklin Templeton Investments, says: “Franklin Templeton’s assets under management were almost $587bn  at March 31, 2010, and we finished calendar 2009 with two of our best quarters ever in terms of net new flows.  Our improved sales momentum has been positive for our earnings.”

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