JP Morgan Asset Management’s CEO EMEA has warned that asset managers’ profitability will decline in coming years despite growth in assets, and the industry needs to prepare for a more hostile market environment and the impact of falling fees.
Mike O’Brien, who is also co-head of global investment solutions, says the golden era for markets over the past 30 years is a historical anomaly that cannot continue. Over the next 20 years US and Western European equities will deliver between 1.5 per cent and 4 per cent less per annum than over the past 30 years, while fixed income will return 3-5 per cent less, he adds.
“The industry has been fortuitous, it has been buoyed over the years by strong market returns,” O’Brien says. “I think this will change. The industry will need to be more thoughtful about how it’s going to face the future without the rising tide lifting all boats.”
Asset managers will continue to see flows thanks to the global trend of ageing demographics – by 2030 almost 20 per cent of the world’s population will be over 60 – meaning the $80trn industry is predicted to be $100trn by 2020, O’Brien says. However, this is unlikely to boost profits, largely due to falling fees.
“With that growth in assets you would expect continued profitability in the industry – which is about the highest among industries with a margin of 30 per cent – but that is not sustainable. The asset management industry will be less profitable,” O’Brien says.
“Since 2009 the S&P is up over 350 per cent but we have seen the profitability of the industry fall from 35 per cent pre crisis to about 27 per cent today. The key driver of the reduction in profitability has been falling charges. In aggregate across the industry pre-crisis profitability was about 34 basis points but today it is closer to 26 basis points.”
The three main drivers pushing down fees have been the growth of indexation putting price pressure on the industry; the shift from equities to fixed income mandates where fees are significantly lower and the compression effect on fees for underperforming managers, O’Brien says.
These factors are set to remain, he adds, with investors likely to move to fixed income in a higher rate environment and the “perceived disappointment with active management [continuing] to put pressure on fees”.
Furthermore, the shift to indexation is “a structural and permanent fixture of the industry”, O’Brien says.
“Between 2008 and 2016 40 per cent of active US large-cap equities moved out of that space, about a $2.4trn shift. About $1trn of that went to indexation.
“Currently 50 per cent of developed market equities are now indexed worldwide, and 55 per cent of all equity flows are going to indexation.”
However, while the performance of active equity mandates has been a major driver in the shift to indexation, O’Brien says this has been cyclical rather than structural.
“If you look at the environment since 2008 it has been characterised by strong market returns, low volatility, a high correlation between stocks and sectors and – as a result of quantitative easing – a dislocation between fundamental value and price. In that environment active management is going to find it difficult to deliver performance.”
While index funds are a mainstay of asset management, O’Brien is optimistic on the outlook for active mandates.
“Over the next five to six years we’ll have higher volatility, we’ll see lower correlation and we’ll see a wider dispersion of returns across stocks and sectors. And with QE unwinding a reversal back in that the link between fundamental value and price will reconnect, and in that environment active management will perform.
“In Q2 this year, of the 4,000 funds in Europe, 55 per cent of active managers outperformed, a big step forward from Q1 2016 when less than 25 per cent of active managers outperformed.”