Trillion-dollar global
fund industry faces pressure to tighten belt
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[September 21, 2016]
By Simon Jessop, Sinead Cruise and Trevor Hunnicutt
LONDON/NEW YORK (Reuters) - Home to trillions of dollars of
global wealth, mutual fund firms face an unfamiliar round of
belt-tightening as changes in the way people invest and rising costs
chip away at rich margins.
After years of underwhelming returns in a low-interest rate environment,
savers are dumping high-fee funds in favor of cheaper investment
products, forcing asset managers to look more closely at the balance
between income and costs.
Increased regulation after the global financial crisis is pushing up the
cost of doing business for the established players while nimble
technology-driven rivals are springing up to offer alternative
investment products at a lower price.
"Strong inflows over a number of years have mitigated the need to make
hard, cost-cutting decisions," said Alastair Sewell, regional head for
Europe, the Middle East, Africa and Asia-Pacific in the fund and asset
manager group at Fitch.
While the first signs of pressure are already being felt, Sewell said
the biggest hits would likely come if an economic downturn prompted more
investors to move their money.
"When the cycle turns, and we start to see a trend toward outflows --
that is when the cost-cutting question will start to bite," he added.
Firms could respond by cutting jobs, particularly among back-office
staff, streamlining product ranges and making greater use of technology.
More takeovers of the thousands of small firms operating globally could
be another consequence.
A Reuters analysis of the annual reports of the world's biggest listed,
standalone asset managers between 2005/6 and 2015 showed the strain is
already being felt. While some operations have been trimmed, more cuts
may be on the way.
The average firm analyzed increased assets by more than 200 percent in
the decade to end-2015 but just five out of the 11 firms managed last
year to grow their assets under management -- the primary driver of
revenues.
Eight firms posted a fall in the revenue generated by each employee
between 2014 and 2015, while the four firms which broke out their
management fee margin -- the ratio of net fees earned to average assets
under management -- all showed a fall.
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While nine still managed to raise their operating margins in 2015, for
example by growing their asset base or moving to a more profitable mix
of products, just one firm -- Swiss-based GAM Holding - cut staff, the
biggest cost.
Despite that, bosses of some of the firms chalked up a bumper year
personally. BlackRock's Larry Fink, for example, pocketed $25.8 million
in compensation, up 8 percent from 2014, a filing showed.
This year, though, BlackRock, the world's biggest asset manager, and
Pimco, the U.S.-based bond house owned by German insurer Allianz, have
both launched plans to shed 3 percent of staff, sources said.
CHANGING FLOW
Consultants PwC suggested total assets managed by the global funds
industry would grow to $100 trillion by 2020 although they said rising
costs were expected to weigh on profits.
And within that figure, global demand for cheap exchange-traded funds (ETFs)
would also rise, following the lead of the United States, where ETFs
account for 17 percent of total industry assets, trade body Investment
Company Institute (ICI) said.
Between 2012 and 2020, passively invested mutual fund assets are
expected to grow from $3.4 trillion to $10.5 trillion, while passively
invested institutional mandates are set to grow from $3.9 trillion to
$12.2 trillion, PwC said.
The biggest fund firms in the industry are taking notice.
"There are fixed costs to managing funds. Asset managers must either
bring those costs down, or find another way to pass the cost on to
investors," said Bill McNabb, chief executive of Vanguard, whose firm
manages $3 trillion across both passive and active funds.
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"There's no free lunch", he said.
As a result, average fees were already starting to fall. Equity investors in the
United States, for example, have seen their yearly costs drop from 1 percent of
assets at the turn of the century to 0.68 percent last year, the ICI said.
Fees paid by European investors have fallen 8 percent over the last three years,
industry data tracker Morningstar said.
Changing investor habits were already being seen elsewhere in Europe, where
households were investing more into pensions and life insurance products,
resulting in large, but lower-margin mandates for asset managers, Fitch's Sewell
said.
And in the United States, new Department of Labor rules covering retirement
accounts are expected to push assets to fewer providers and lower-cost funds.
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At the same time, regulators have ramped up rules for disclosure and
transparency, which carry a hefty price tag to meet, including in hiring staff
to ensure compliance.
OVERHAUL BEGINS
European firms are likely to save some costs by cutting out fees paid to the
intermediaries who sell their products to 'mom and pop' retail investors, but
bigger overhauls of fund ranges and headcount will be needed to buoy margins.
This could involve reducing the number of share classes in each fund, merging
products and using technology such as BlockChain to make custody and trade
reconciliation processes cheaper.
A mass cull of front-office staff is unlikely but sales, distribution and
trading jobs are at risk, industry analysts say, with the latter replaced by
algorithmic trading.
BlackRock, which employs more than 13,000 people, already uses data to pinpoint
which financial advisers are most likely to recommend its funds for clients,
while Franklin Templeton now uses software to part-write fund commentaries.
Some asset managers are also exploring ways to use so-called 'robo advice' to
sell funds more cheaply online, and have plans to use artificial intelligence to
improve stock picks.
"We've been able to invest in new technologies to streamline our global trading
operations, resulting in greater efficiencies," said Vanguard's McNabb.
"We certainly believe that those who wish to remain relevant must continue to
seek out and leverage new technology. A manager can rein in costs by operating a
lean shop but that will only get you so far."
And while nine of the firms analyzed maintained or grew their dividends in 2015,
Reuters data showed a weakening in other measures of shareholder returns, with
six posting a weaker return on equity and return on invested capital.
This strengthens the case for industry consolidation as the world's 7,723 fund
firms and 284,422 individual funds tracked by Thomson Reuters Lipper search for
the best way to survive.
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Smaller funds could look for shelter in the arms of a larger rival better able
to cope with the increased regulatory expenses, a fall in sales of higher-fee
products and increased competition from upstart tech firms.
"You can run a cheaper cost base just because you're bigger," said Detlef Glow,
head of Lipper research in Europe, the Middle East and Africa. "Size matters."
(Editing by Keith Weir)
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