Analysts warn of continuing pressures on asset managers as flows hit

Analysts have warned asset managers face stronger headwinds this year as market uncertainties and regulatory pressures continue.

Aberdeen, Jupiter, Axa Investment Managers, Standard Life Investments, Rathbones and Architas are among the asset management firms whose recently published financial results reveal a mixed, but not particularly positive picture.

While profits generally remain high for asset management groups, events from 2016, especially political, have largely weighed on flows and general investment appetite.

Hargreaves Lansdown senior analyst Laith Khalaf says 2016 was “a strange year” in terms of flows, with very low investor confidence and a weak take-up of core funds in the UK equity space.

However, Architas investment director Adrian Lowcock points out 2016 was a tale of two halves, and interest in funds rebounded after Brexit.

He says: “Investors have been attracted to multi-asset solutions as the political landscape made investment decisions tricky, with the situation not improving this year.

“The property market’s freeze lead to outflows, however the sector tends to include funds from the larger management groups so it is unlikely to have a big impact on profits overall.”

Last year proved more challenging for some groups, such as Aberdeen Asset Management, than others.

To the end of 2016, Aberdeen saw its assets under management drop as a sovereign wealth funds and UK wealth managers led outflows of £10.5bn over the last quarter of 2016. Over £100bn has left the emerging market-focused group in the past four years.

Chief executive Martin Gilbert says despite the large redemptions from two clients withdrawing a combined £4.2bn from active equity strategies, he is “encouraged” by the progress being made by the firm, while adding the “growing interest” in a number of Aberdeen’s strategies were being “masked” in the short term.

Writing ahead of the Aberdeen/Standard Life merger announcement, Justin Bates, equity research analyst at brokerage Liberum, claims Aberdeen’s large outflows would make it difficult for it to acquire other firms, despite continued interest from US-based potential buyers.

He says: “Aberdeen salesmen have been out of the door in the last six months although they say it is not the case. Aberdeen can’t buy anything meaningful because they find it difficult raising equities and the regulatory capital position is very tight.”

That may have contributed to the recent deal being structured in the way it has been.

Standard Life posted a pre-tax profit of £723m for 2016, up 9 per cent from £665m the previous year. However, demand for the firm’s £25bn Global Absolute Return Strategies dropped, with flows falling from £17bn in 2015 to £10.2bn in 2016.

Lowcock argues given the “sheer size” of the fund, outflows and weak performance will impact the group overall.

Market commentators suggest profits and margins at asset managers are not only going to be challenged by market movements. Analysts agree some firms are more exposed than others to the outcomes of the FCA asset management study, which could put in place some drastic measures for the industry, including a potential ‘all-in fee’ solution that would include transaction fees in the total cost paid to managers.

Bates names Jupiter as one of the firms that could be hit hardest by a more rigorous regulatory approach.

He says: “People have concerns about Jupiter; that their distribution is not very good. They don’t use platforms and because their revenue margins are very high, people think they might be hit more than anyone by the FCA’s asset management study. They have added pressure on profit margins but they make 40 or 50 per cent margins, and the FCA thinks that is too high.”

Bates adds Jupiter is often mentioned for being susceptible to price reductions because box profits make a substantial percentage of their revenues. The FCA is concerned box profits are opaque and are not passed through to investors.

Box profits generated £12.8m in 2016 for the firm, which represents 3.6 per cent of net revenue, Liberum notes. However, Jupiter has announced in its results it will move to single pricing for buying and selling fund units, which will remove box profits from its 2018 income.

Jupiter will also take the cost of research through its accounts with no change in management fees, saying it will add around £5m of costs from 2018. Liberum expects the combined impact of the removal of box profits and additional research costs to amount to an 8.5 per cent negative impact to its current 2018 adjusted profits forecast of £210.2m.

In terms of flows, Jupiter has seen net inflows of £1bn in 2016 as international diversification compensated for “a tough year in the UK”. Profits before tax saw a “healthy growth” of 4 per cent to £171.4bn from £164.6bn in 2015.

However, inflows came from the firm’s international distribution, which contributed to half of gross inflows and 100 per cent of net inflows. For 2016, the group attributed positive flows to its neutral and total return strategies as well as lower sterling movements. Inflows at the firm halved from 2015 when they were closer to £2bn.

Khalaf says: “The different ranges and distribution networks have been the key determinant of how fund firms did in 2016. If you were purely focused in UK equity, 2016 wasn’t a great year for you.”

Shore Capital analyst Paul McGinnis predicts that in the whole investment chain – including IFAs, platforms, DFMs and fund management firms – pure asset managers have the bitterest piece to bite. He says: “The pure asset managers are seeing the biggest fee deflation, the highest level of growth in inflows and outflows in terms of non-stickiness of the assets and the increasing threat of passives in continuing to take share.”

Firms including Lindsell Train, Vanguard, Royal Bank of Canada and Investec have some of the largest amounts invested in the top 10 listed asset management firms by market cap in the UK, according to Morningstar.

The £3.2bn CF Lindsell Train UK Equity fund, for example, has more than £431m invested in asset managers including Schro-ders, Hargreaves, Investec and Aberdeen among others.

However, out of 30 funds holding the largest amount of asset managers, only five are UK equity funds while most of them are European or Global funds or non-UK-domiciled funds, and four are passive funds.

Dan Brocklebank, UK head of boutique asset manager Orbis Investments, says the firm doesn’t own any pure asset manager companies in their portfolios, but holds some financials and banks, which sometimes have asset management units.

He says the reason he is not holding asset manager firms is because “there are better opportunities out there”.

Brocklebank says: “Within the broader financials group, we have generally found that many of the banks around the world are trading at a discount to intrinsic value, particularly in emerging markets. While we don’t think their profitability, specifically returns on equity, will get back to pre-crisis highs, there is scope for it to recover somewhat.

“By contrast asset managers out there face global equity markets which are reasonably fully valued. Asset managers typically show negative operating leverage when markets draw down so profits can decline significantly if markets decline. Similarly, active managers are under considerable margin pressure over fees and from passive competitors.

“Unless you want to make a bet that a particular manager is going to see a sharp uptick in net inflows, which is hard to get conviction on, we don’t think it’s an area full of opportunities.”

However, asset managers should continue to see growth in their businesses thanks to the opportunities brought by pension auto-enrolment as well as the pension freedoms. He says: “Asset managers will benefit from pension auto-enrolment, especially for those groups following a passive strategy, and the pension freedoms should bring more money in, including insurers like Aviva and Standard Life. Pension freedoms in particular, will be good for active management and income-focused groups.”

Lowcock adds: “Boutiques of star managers continue to do well, even if there was a dip in their performance relative to their benchmarks in 2016. Fundsmith and Woodford Investment Management continue to enjoy their moment in the sun.”