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Toughest time yet for asset managers

Date: Tuesday, February 17, 2009
Author: Pauline Skypala, FT.com

Asset managers face tough times – not as tough as banks perhaps but challenging nonetheless. Assets under management have fallen, outflows have been high, and the change in fortunes has happened too quickly for managers to adjust cost structures to cope.

Moreover, according to research by Barclays Capital, managers are reluctant to cut costs by shedding expensive investment staff because of the difficulties of replacing them quickly if markets turn round within months. That puts pressure on margins, leading to lower earnings.

Managers experienced similar problems in the last market downturn. The five US managers Barclays covers in its research (BlackRock, Invesco, Janus, Legg Mason and T Rowe Price) saw revenue fall by an average of 7 per cent over 2001 and 2002 and operating margin by 6 per cent.

Those figures were pulled up, though, by BlackRock, which showed positive growth in assets under management, revenue and operating margin over the period due to its fixed-interest focus (before the merger with Merrill Lynch Asset Management increased its equity exposure).

More representative, perhaps were the revenue reductions of 17 per cent and 25 per cent experienced respectively by Invesco and T Rowe Price.

Barclays expects things to be significantly worse this time around. It is forecasting a drop of more than a third in average revenue over the two years of 2008 and 2009, with the bulk of that to come this year, and a 7 per cent fall in operating margin. It expects earnings per share to fall by 65 per cent.

BlackRock is expected to perform better than its rivals due to its diversified asset and revenue mix and its international reach. “Greater diversity makes an asset manager more resilient in different types of market environments and allows for a more predictable earnings stream,” the report comments.

BarCap’s view of the business model best able to cope with the downturn may provide comfort for other managers. John Hailer, chief executive of Natixis Global Asset Management, US and Asia, says the analysis “covers why firms like ours will do well”.

Natixis is a $628bn (£436bn, €488bn) multi-boutique with a range of investment styles and asset classes on offer. In January it had its best month for gross and net sales over the past 10 years, with flows into corporate bond and value equity products. Its Gateway fund, which aims to provide equity-like returns with bond-like volatility, also did well.

“We have three things that are selling and 10 that aren’t, but we are remaining relevant to clients,” says Mr Hailer.

The firm has also kept a grip on costs, he says, achieving $120bn of gross sales in the US last year with fewer than 100 salespeople. Mr Hailer does not deal directly with managing investment costs as these are a matter for individual boutiques, but says fund managers get paid on the basis of performance. “Having managers paid on three to five-year performance will be critical for the industry.”

The CFA Institute says short termism was the problem on the risk management front, rather than too great a reliance on flawed models. Models are just tools and it is how they are used that is important.

But the organisation, which has a membership of 100,000 in 55 countries, is not about to demand change, suggesting all it can do is “remind investors about short-termism”.

John Rogers, newly installed president and chief executive, says the market is the best clearing mechanism. “In the absence of signals from market participants, the market should clear to a more appropriate level of pricing based on a longer term perspective of risk.” He acknowledges that might involve “a lot of pain” in the meantime.

He takes a similar view on the issue of investment manager compensation: the market will set the appropriate level. It is doing so on hedge fund pricing. “I think few are signing up to put money in 2 and 20 products, or conduits that charge 2 and 20 on top of 2 and 20,” he says.

Market forces, in the shape of fund flows, may drive change in the fund industry on pricing. But whether they will force a longer-term perspective when it comes to setting compensation is questionable.

Fund managers were quick to resume business as normal after the last market downturn, although the experience did lead to reform at fund houses hit hardest.

If Barclays Capital’s forecasts are correct, managers will be hit harder this time. Chief executives keen to retain investment talent but needing to cut costs may find the time is right to change the compensation culture.