LONDON: Home to trillions of dollars of global wealth, mutual fund firms face an unfamiliar round of belt-tightening as changes in the way people invest and rising costs chip away at rich margins.
After years of underwhelming returns in a low-interest rate environment, savers are dumping high-fee funds in favour of cheaper investment products, forcing asset managers to look more closely at the balance between income and costs.
Increased regulation after the global financial crisis is pushing up the cost of doing business for the established players while nimble technology-driven rivals are springing up to offer alternative investment products at a lower price.
"Strong inflows over a number of years have mitigated the need to make hard, cost-cutting decisions," said Alastair Sewell, regional head for Europe, the Middle East, Africa and Asia-Pacific in the fund and asset manager group at Fitch.
While the first signs of pressure are already being felt, Sewell said the biggest hits would likely come if an economic downturn prompted more investors to move their money.
"When the cycle turns, and we start to see a trend towards outflows - that is when the cost-cutting question will start to bite," he added.
Firms could respond by cutting jobs, particularly among back-office staff, streamlining product ranges and making greater use of technology. More takeovers of the thousands of small firms operating globally could be another consequence.
A Reuters analysis of the annual reports of the world's biggest listed, standalone asset managers between 2005/06 and 2015 showed the strain is already being felt. While some operations have been trimmed, more cuts may be on the way.
The average firm analysed increased assets by more than 200% in the decade to end-2015 but just five out of the 11 firms managed last year to grow their assets under management - the primary driver of revenues.
Eight firms posted a fall in the revenue generated by each employee between 2014 and 2015, while the four firms which broke out their management fee margin - the ratio of net fees earned to average assets under management - all showed a fall.
While nine still managed to raise their operating margins in 2015, for example by growing their asset base or moving to a more profitable mix of products, just one firm - Swiss-based GAM Holding - cut staff, the biggest cost.
Despite that, bosses of some of the firms chalked up a bumper year personally. BlackRock's Larry Fink, for example, pocketed US$25.8 million in compensation, up 8% from 2014, a filing showed.
This year, though, BlackRock, the world's biggest asset manager, and Pimco, the US-based bond house owned by German insurer Allianz, have both launched plans to shed 3% of staff, sources said.
CHANGING FLOW
Consultants PwC suggested total assets managed by the global funds industry would grow to US$100 trillion by 2020 although they said rising costs were expected to weigh on profits.
And within that figure, global demand for cheap exchange-traded funds (ETFs) would also rise, following the lead of the United States, where ETFs account for 17% of total industry assets, trade body Investment Company Institute (ICI) said.
Between 2012 and 2020, passively invested mutual fund assets are expected to grow from US$3.4 trillion to US$10.5 trillion, while passively invested institutional mandates are set to grow from US$3.9 trillion to US$12.2 trillion, PwC said.
The biggest fund firms in the industry are taking notice.
"There are fixed costs to managing funds. Asset managers must either bring those costs down, or find another way to pass the cost on to investors," said Bill McNabb, chief executive of Vanguard, whose firm manages US$3 trillion across both passive and active funds.
"There's no free lunch", he said. As a result, average fees were already starting to fall.
Equity investors in the United States, for example, have seen their yearly costs drop from 1% of assets at the turn of the century to 0.68% last year, the ICI said.
Fees paid by European investors have fallen 8% over the last three years, industry data tracker Morningstar said.
Changing investor habits were already being seen elsewhere in Europe, where households were investing more into pensions and life insurance products, resulting in large, but lower-margin mandates for asset managers, Fitch's Sewell said.
And in the United States, new Department of Labour rules covering retirement accounts are expected to push assets to fewer providers and lower-cost funds.
At the same time, regulators have ramped up rules for disclosure and transparency, which carry a hefty price tag to meet, including in hiring staff to ensure compliance.
OVERHAUL BEGINS
European firms are likely to save some costs by cutting out fees paid to the intermediaries who sell their products to "mom and pop" retail investors, but bigger overhauls of fund ranges and headcount will be needed to buoy margins.
This could involve reducing the number of share classes in each fund, merging products and using technology such as BlockChain to make custody and trade reconciliation processes cheaper.
A mass cull of front-office staff is unlikely but sales, distribution and trading jobs are at risk, industry analysts say, with the latter replaced by algorithmic trading.
BlackRock, which employs more than 13,000 people, already uses data to pinpoint which financial advisers are most likely to recommend its funds for clients, while Franklin Templeton now uses software to part-write fund commentaries.
Some asset managers are also exploring ways to use so-called "robo advice" to sell funds more cheaply online, and have plans to use artificial intelligence to improve stock picks.
"We've been able to invest in new technologies to streamline our global trading operations, resulting in greater efficiencies," said Vanguard's McNabb. "We certainly believe that those who wish to remain relevant must continue to seek out and leverage new technology. A manager can rein in costs by operating a lean shop but that will only get you so far."
And while nine of the firms analysed maintained or grew their dividends in 2015, Reuters data showed a weakening in other measures of shareholder returns, with six posting a weaker return on equity and return on invested capital.
This strengthens the case for industry consolidation as the world's 7,723 fund firms and 284,422 individual funds tracked by Thomson Reuters Lipper search for the best way to survive.
Smaller funds could look for shelter in the arms of a larger rival better able to cope with the increased regulatory expenses, a fall in sales of higher-fee products and increased competition from upstart tech firms.
"You can run a cheaper cost base just because you're bigger," said Detlef Glow, head of Lipper research in Europe, the Middle East and Africa. "Size matters." - Reuters
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