Fund managers struggle to dodge hazards

It is tough managing a long-only fund when markets are this erratic.

"Everything is turning in the blink of an eye. You can't trade in markets like this," says Alan Brown, chief investment officer at Schroders. "Derivatives are leading the cash markets."

The head of equities at another fund management group agrees. "It is a mix of elation and despair," he says. "We wanted to put money into the market but there is no liquidity. In two days I managed to complete half of a buy-order for a FTSE 100 company. It has felt like a casino."

A third manager, this time of a small cap fund, says: "The hedge funds have completely disoriented the long-only fund managers, moving markets so aggressively that long-only managers are like the proverbial bunnies in the headlights."

Morale within the fund management community is not only affected by the falling values of funds, but the impact on their own employers.

The UK's asset management sector has been among the worst performers in the FTSE recently, with market declines having an immediate impact on profit. The industry agrees broadly that a 1 per cent fall in the stock market translates into at least a 2 per cent drop in profits as performance fees suffer, fees charged on assets under management drop and outflows from funds rise.

The cost of managers' salaries and bonuses are, inevitably, much slower to fall.

Last week, New Star Asset Management announced more than £500m of outflows from its funds and a 6.5 per cent fall in assets under management to £23bn.

The former darling of retail investment has been hit by its exposure to property and the poor performance of some flagship retail funds.

Shares in Aberdeen Asset Management and Henderson have been hit badly, too.

"Any asset manager with a strong retail and/or property fund business is being kicked," says one analyst who did not want to be named.

Even Schroders, the UK's largest listed fund manager with more than £140bn under management, has not escaped despite making about 10 per cent of its profits from private banking and deriving two-thirds of its revenues outside the UK.

Selling funds to private investors is an advantage when economic conditions are benign and stock markets are rising. Fees and margins on funds sold to retail investors are higher than on institutional funds.

However, insurers and pension funds will invest with one manager for up to eight years, on average. Private investors and their independent financial advisers are much quicker to sell - particularly when markets are turbulent.

"Retail investors do tend to panic," says Mr Brown.

A decline in private investor confidence began last year as it emerged that active managers were struggling to perform better than cheaper index trackers.

In November, retail investors became net sellers of investment funds for the first time in 15 years, according to the Investment Management Association. December's numbers, due next week, are also expected to be weak.

The UK sector's woes are in sharp contrast to the likes of BlackRock, the largest listed asset manager in the US with $1,357bn (£687bn) in funds under management. Last week it revealed earnings had nearly doubled in a year and assets under management in the fourth quarter had risen $57bn on net new business of $30bn.

In an interview with the FT, Larry Fink, BlackRock's founder and chief executive, says this is due in part to its size and diversity - geographically and in products and clients. Having acquired Merrill Lynch's investment funds arm in 2006, the business stretches from the US to Asia and is split between money market funds, bond funds and equities sold to both institutions and private investors.

Other big international asset managers, with close to $1,000bn under management, also claim they have a diversity of product, client and geography that should allow them to weather the worst the markets can throw at them. By comparison, most UK asset managers are smaller and more focused.

Mr Fink says price falls could trigger some consolidation in the sector, flushing out distressed sellers and attracting opportunistic buyers. Banks and insurers with a low rating may be spurred to spin off or sell asset management arms, hoping that an independent asset manager would be valued more highly.

Already, Friends Provident, the struggling assurer, is thought to be looking for a buyer of its 53 per cent stake in F&C Asset Management.

Several big asset managers say they been approached by small firms of investment managers and hedge fund managers, worried that they have limited capacity to withstand the market's buffeting independently.

Speculation is mounting that New Star, after its shares have fallen from 400p to 100p in a year, will attract a buyer. Aberdeen is thought to want to bulk up its retail funds.

However, the difficulties of merging asset managers are well known. As Mr Fink says: "Most mergers don't work. Asset managers are just a bunch of people. We have seen 200 companies in 20 years and done just four transactions."