The pain is just starting for active management firms

Increasing pressure on profitability at active asset management firms in 2009 is likely to cause considerable changes in the industry and asset owners are urged to prepare accordingly, says new research by Watson Wyatt's Thinking Ahead Group.

According to the firm, active managers are starting the year with revenues between 30 and 50 per cent below 2008 levels that, if the market stays flat, mean even worse earnings for 2009.

Paul Trickett, European head of investment consulting at Watson Wyatt, said: "If returns stabilise now, then for pension funds and other institutional investors the worst of the pain is over but for asset managers the pain is just starting. Earnings for 2008 were down between 10 and 15 per cent from 2007; that is beginning to look attractive for 2009."

According to the research paper, the ad valorem fee basis on which the industry in centred means that profits will remain under pressure as long as market returns and new inflows remain low and while there is little appetite for raised fees. It concludes that asset managers will continue to reduce headcount by around 10 per cent (mainly in non-core roles) and costs (mainly in variable pay) by around 20 per cent in order to return to profitability.

"This is clearly an unstable business environment for active managers and 'people' issues are likely to be superseded by 'business' issues as the principal concern of management and chief among these will be consolidation, regulation and sustainability," said Trickett.

According to the research, pressure on profits can be countered by adding new assets to the existing cost base which will result in increased consolidation in the short term that would continue if markets were to fall further. However, while the merging of entities can make business sense, paying too high a price in a falling market could also damage rather than enhance their sustainability.

"We are expecting the nameplates of existing asset managers to change substantially during the next few years. While in the past there has generally been a bias against change in ownership, we need to consider that some of these changes could be materially positive for the survival of a firm," he added.

In its Defining Moments publication of last year, Watson Wyatt's Thinking Ahead Group predicted that new regulation would materialise in 2009 and that it would be the financial sector's equivalent of Sarbanes-Oxley.
Tim Hodgson, senior investment consultant at Watson Wyatt, said: "While we believe this prediction remains on track, the relatively clean hands of the asset management industry should mean an escape from additional regulation, but there is a chance that it gets caught by regulation aimed at banks. This would be a further blow to the industry as higher compliance costs would further damage margins and challenge their sustainability."

According to the new research, entitled The future of the asset management industry, there is little trustees can do about consolidation in and regulation of the asset management industry, but among the actions they can take to prepare themselves for changes to its sustainability is to revisit whether the current extent of active management remains appropriate for the fund. Other actions are to continue to diversify the manager line-up; renegotiate fees and terms, focus on sustainability issues and think through scenarios where certain eventualities could compromise the future performance of their managers.

Paul Trickett said: "We do believe that pursuing active returns is a worthwhile activity provided that the resources exist to have a competitive advantage in identifying, hiring and terminating active managers. Equally, we believe in the virtues of passive management and continue to advise that this is the more appropriate route for the majority of funds. That said, we are very mindful of the fact that passive management firms are not immune from many of the business issues facing active managers."