• Nick Turner

Asset Management's Groundhog Day?



The Financial Conduct Authority (FCA) published their review of the UK asset management industry last week, advocating "radical reform" of the £7tn sector. Their key findings included:

  1. A lack of price competition, especially in retail active funds

  2. Questionable "persistently high" levels of profitability across the industry, with average profit margins of 36%

  3. Neither active nor passive funds on average outperform their own benchmarks after fees

  4. There is no clear relationship in retail active funds between gross performance and fees charged

  5. Virtually all investment risk is taken by the retail investor, who are poorly equipped to select funds and typically chase past performance, which is not a good indicator of future performance (as we all should know!)

  6. A lack of transparency in communication of fund objectives and in some instances (an estimated £109bn) of active funds actually acting as closet trackers (but still charging higher, active fees)

  7. A sharp divergence in the sophistication and awareness between retail and institutional investors, in their ability understand fees and charges

  8. Concerns about the lack of competition and conflicts of interest in the investment consulting market, whose purpose ironically, is to secure a better deal for investors

In short, the asset management industry is painted as being opaque, uncompetitive, customer unfriendly, offering poor value for money and in the round, not achieving their primary purpose, i.e. offering appropriate risk-adjusted returns for the fees charged and enabling investors save for their respective futures. Not exactly a ringing indictment.

And yet, most commentators believe the asset management industry has got away lightly. Many of the harshest remedies that had been flagged in the interim report last November (2016), have been dropped or watered down. The reforms proposed will now be implemented in a number of stages, with some of the measures dependent on the outcome of "further consultation". The investment consulting industry, while depicted as dysfunctional, was not immediately referred to the Competition and Markets Authority (CMA).


So bullet dodged? Well, maybe.


The FCA did acknowledge in their report that there is a deluge of new regulation coming down the pipe that will deliver many of the desired reforms, not least the Markets in Financial Instruments Directive (MiFID II) and the Packaged Retail and Insurance-based Investment Products (PRIIPs). My clients in this sector frequently remind me of the huge increase in regulatory burden placed on their business, resulting in increased headcount and associated costs to respond.


However, despite all the post-crisis regulation, I can't help but be struck by how relatively little has changed in the asset management industry, especially in comparison to the more fundamental shifts imposed on the banking and investment banking sectors.

If I think back fifteen years, while working at Morgan Stanley, I helped to lead a major scenario strategy project exploring the futures of the asset management industry (FoAM). Why then? Primarily, as we were convinced that the combination of both cyclical and structural forces would radically restructure the world of investment and asset management. Those drivers included:

  1. The worst bear market in 60 years and the concern that we might be stuck in a "low return world" for a prolonged period of time

  2. Huge geopolitical uncertainty, particularly around the war in Iraq and subsequent fall out

  3. Resurgent regulation (post the dot com equity market collapse)

  4. A major review of the industry (The Myners Report) had just been published by the the UK government (HMT)

  5. Excess capacity in the industry, implying the need for structural rationalisation

  6. The demographics of investors were increasingly challenging

So not that much has changed in the external environment either!

Using a classic deductive methodology, we build a 2x2 scenario framework around the two most critical uncertainties facing the asset management industry:

  1. The macro uncertainty of future market returns; higher or lower than expected, and;

  2. The nature of investor demand; would investors increasingly seek to "match" their investments to the quantum and duration of their liabilities ("sound and rational") or be more focused on assets only, through traditional benchmark-driven investing, which in the worst case is just chasing the "hot hand" ("irrational and unsound").


Fig 1. The Future(s) of Asset Management 2002 - 2010


We developed implications for all four scenarios as well as a number of overarching conclusions, irrespective of which future played out, the latter included:

  • Investors need to "move to the right", with a greater focus on investing to match their respective liabilities, if we are to avoid catastrophic failures in society, including addressing the pension time-bomb.

  • However, investing this way is difficult and it was unclear who would advise investors (especially retail). Would asset managers reconfigure their products and services to help? Given the FCA's conclusions, is the investment consultant sector best placed to advise institutional investors?

  • The generation of "alpha" and absolute returns would be increasingly important vs. the more traditional approach of relative (benchmarking) investing, the latter becoming less and less relevant.

  • The asset management industry was likely to bifurcate between large scale "solution providers" and typically smaller and more nimble, "performance generators" - the so-called "barbell" re-distribution of the industry.

Reflecting on the current state of the asset management industry and the FCA report, one has to conclude that many of the expected (and recommended) developments have yet to play out, even 15 years on.


One upside perhaps is that the FCA's report does indeed throw (once again) the "disinfectant of sunlight" on the asset management industry. Even retail investors are increasingly aware of the poor deal many of them receive from their professional investment managers - one of the main drivers surely, of assets flooding to passive and ETF products in recent years.


In my experience, some asset managers are indeed preparing for a very different world (witness the recent flurry of consolidation in the UK market) but many are not; still lulled into a false sense of security by high-margins and a lack of understanding of how their client's and customer's needs are changing.


So what to do?

  1. End the denial. Change is coming and you need to get ready.

  2. Play to your strengths. As the industry continues to bifurcate, make an honest strategic assessment; are you better positioned to be a "performance generator" or a "solutions provider"? Very few, if any, will be good at both.

  3. Recognise those juicy fat margins are (at long last) going away. How do you reconfigure your business, cost and infrastructure model to get ahead of the curve?

  4. Welcome transparency, take the difficult decisions and "do that painful thing" before someone else does it to you!

  5. Stop playing lip-service of "being client centric" and really understand your customer / client and how their needs are shifting. How can you best advise / help them? Move away from being obsessed with "product" - what solutions will meet their needs?

  6. Embrace technology. Note, BlackRock is not only making strategic investments in "robo-advisory" fintech firms, but earlier this year shifted a number of their active equity funds to quant-drive, tech-enabled strategies (lowering their fees in the process).

  7. Build a culture that is increasingly comfortable with change, is forward looking and is genuinely focused on client outcomes.

I hope and anticipate that in 15 years time, through a combination of regulatory scrutiny, customer enlightenment, digital technology and increased competition, we will indeed see a very different asset management industry emerge.

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