For the first time since April 2008, when markets were buffeted by the worst financial crisis in over 70 years, Moody’s Investors Service has adopted a negative outlook for global asset managers.
Asset managers are under pressure from declining management fees, technological changes that make it easier to build portfolios but harder to generate excess returns from individual securities and government regulations, which involve hefty compliance costs and in the case of the Department of Labor fiduciary rule, more fee-based advisory services, according to Moody’s analysts.
“Markets are at all-time highs but business conditions are at an all-time low,” said Marc Pinto, managing director of the Financial Institutions Group at Moody’s at a meeting with financial reporters. “The sky is not falling but fees are.”
The Pressure From Declining Fees
The average fee for actively managed equity funds is 84 basis points – almost eight times the 11 basis point average for passive funds. Among bond funds, the equivalent comparison is 60 basis points compared with 10 basis points, according to Moody’s.
In the current low-return environment, investors are more aware of management fees and these differentials, according to Neal Epstein, vice president and senior credit Officer at Moody’s. But even before fees, he noted, there is evidence of underperformance of actively managed funds in some markets.
The result is money flowing out of actively managed funds and into passive funds — both index mutual funds and ETFs but primarily the latter — and increased ETF activity in “less penetrated” markets such as fixed income and “less penetrated” channels such as retirement.
“If asset management is boiled down to the products it sells — financial products — customers are not buying the traditional products but low-cost products,” said Moody’s Senior Analyst Stephen Tu.
The competition around fees is not just between active and passive asset managers but also among passive managers.
Even the three big players in the passive asset management space – BlackRock, Vanguard and State Street – are subject to price wars, said Epstein. BlackRock, the world’s largest asset manager, for example, has seen revenues fall while assets rise.
According to its third-quarter earnings report, revenues fell 1.612% to $5.678 trillion while assets rose 14% to $5.117 trillion in the third quarter of 2015. In October, BlackRock cut fees for 15 of its exchange-traded funds in order to better compete against Vanguard and State Street. Moody’s expects fees will continue to decline for both passive and active fund managers in retail and institutional markets. It expects more fund distributors in the retail market will adopt an advisory model, selling advisor class shares, whereby fees are based on client assets rather than on distribution fees, like 12b-1, based on products. And it expects continued competition among passive managers to lower costs.
Looking toward a future with additional regulation — beyond the DOL fiduciary rule are the SEC’s mutual fund liquidity rules, effective 2018 — and potentially more volatile markets, Moody’s expects the most successful asset management firms will be firms that have the most assets, sell products that in Pinto’s words “don’t hug the benchmarks” or firms that acquire others.
Size, Products and Acquisitions Matter
“Bigger is better more than ever, especially in the retail market,” said Rory Callagy, a senior credit officer at Moody’s. “The institutional market is not as fast-growing.”
Among active managers, Moody’s analysts see the potential for firms to differentiate themselves by offering products such as smart beta, multi-asset markets, global markets, including emerging markets, ESG and fixed income. But “not all such managers “will be successful,” said Callagy.
They expect more consolidation among asset managers, including strategic acquisitions such as Legg Mason’s purchase of Clarion Partners, a real estate investment firm, as well as acquisitions of American firms by Asian and European firms. Acquisitions have been key to asset growth of domestic firms such as AMG and Invesco, according to Moody’s.
Despite the firm’s negative outlook for asset managers in 2017, its long-term view is more positive. “Demand for asset management services will grow because the retirement burden is moving to individuals,” said Pinto.
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