Silver lining in the cloudy sector of asset management?



Madame Tussauds will reopen its chamber of horrors later this month. It is expected to include asset management company stock charts alongside Jack the Ripper’s wax statue and Dr. Crippen’s glasses. Because if this year has been horrible for most investors, it has been even worse for most investment managers themselves.

Just watch the stock price performance of listed asset managers – from Schroders and Abrdn in the UK, Amundi and DWS in Europe and even US giants such as BlackRock and Franklin Templeton. In constant currency terms, each significantly underperformed the broader stock market in 2022.

Dollar-denominated declines range from 34% to a stunning 72% for Britain’s Jupiter. And this is not an irrational market crisis. Talk to industry executives and it becomes clear that many insiders are surprisingly glum about their own business.

Nevertheless, asset management remains an industry with enviable profit margins. And some corners are still enjoying strong tailwinds that the current financial turmoil will only interrupt, rather than reverse. For investors fond of volatility, some opportunities are beginning to emerge.

The reason for the poor performance in 2022 is obvious. The post-financial crisis bull market has masked a severe deterioration in the fundamentals of the asset management industry, which is now laid bare as central banks increasingly raise interest rates.

The double rebound in the bond and stock markets since 2009 has inflated the industry’s assets under management and the resulting revenues. This thwarted fierce underlying price pressures, rising costs and even, in many cases, outflows as investors turned to cheaper passive funds.

Consulting firm BCG has estimated that rising stock markets alone will account for 90% of revenue growth for the entire industry between 2005 and 2021. half.

Now that the financial tide is receding, it reveals a host of bad swimmers. The UK fund management industry looks particularly troubled, as even domestic giants such as Schroders struggle to keep pace with asset growth with its biggest US and European rivals. The smaller ones will likely emerge as prey for more powerful rivals, or simply become zombie-like institutions that are too profitable to die but too lifeless to thrive.

The overall picture is grim. Morgan Stanley estimates that after a compound annual growth rate of 11% over the period 2019-2021, the traditional asset management industry will see its revenues decline by 8% and its operating margins will shrink by an average of 4 points. percentage. “We see a less certain growth outlook amid persistent inflation, rising interest rates, growing recession risk and elevated geopolitical risk,” Morgan Stanley analyst Michael Cyprys wrote in a recent report. In effect.

However, like someone with their head in the freezer and their feet in the oven, the average can hide a more nuanced picture.

Some investment managers appear to be in terminal decline, but many will be fine. Morgan Stanley estimates that average operating margins will remain healthy at 38% in 2023, only slightly down from 39% in 2022. These are often companies that may not have great prospects for growth but still generate money.

Even poor investment results can be acceptable, given the regrettable stickiness of investors’ money. Given their inherent bias toward the fate of financial markets, stock price rallies should be powerful once central banks feel at the peak of the inflationary spiral, halt their rate hikes, and markets bottom out.

And a handful will emerge strengthened from the detritus. Clearly, sprawling financial supermarkets like BlackRock that can offer any investor – from ordinary savers to sovereign wealth funds – a panoply of options, and companies that specialize in hotter, higher-fee areas like “private capital” .

Data provider Preqin recently released its semi-annual report on the private equity industry – which invests in non-traded assets such as venture capital, real estate, private equity, direct lending and infrastructure – and estimated it would nearly double in size to over $18 billion by the end of 2027. Of course, Preqin has a natural tendency to look at his own world through rose-tinted glasses. But his aggressive predictions actually seem reasonable to me.

Yes, the next year or two is going to be characterized by a wave of embarrassing markdowns on acquisitions and investments made during more turbulent times, which will turn many buyout, venture capital and real estate funds into duds.

This is one reason why stocks of industry giants like Blackstone, Apollo, Partners Group, Carlyle, Eurazeo, 3i and Brookfield also performed poorly in 2022. In fact, most underperformed the broader stock market, and EQT, Intermediate Capital Group and Carlyle shares have lost more than half their value this year.

I’ve also long feared that the boom has gone a little crazy in recent years. This has led to hidden risks in more opaque private markets – such as rising corporate leverage and an incestuous investor ecosystem where companies invest and lend to each other. And with so much capital flowing through the space, returns will inevitably disappoint many investors.

Nonetheless, the combination of the lack of volatility (private assets that don’t trade on exchanges) and the desperation of many sovereign wealth funds, endowments, pension plans and private banks for at least a semi-plausible promise of above-market returns means that the wind will remain at the back of the private capital industry.

A word of caution, however, regarding mergers and acquisitions in the investment industry itself, and the lofty promises of synergies and growth that often accompany them.

For now, the asset management industry is battening down the hatches. But once the market storm subsides, there will be a new wave of consolidation among fund managers, as the stronger companies hunt down the weak and the weak seek solace and hope in each other’s arms. others.

Still, investors should be wary of these consolidation games. Scale will undoubtedly be a huge advantage in the coming era, perhaps even essential. But the history of asset management mergers and acquisitions is bleak. There is only one clear and undisputed success story – BlackRock took over Barclays Global Investors in 2009 – and a litany of career-ending and wealth-destroying failures.

UK investors need look no further than Abrdn and Janus Henderson for powerful examples. So investors should beware of thinking that tying two drunks together will make them walk straighter.

Instead, anyone fancying a punt on something more racy than a cheap index fund could look at the battered stocks of winners from the last investment round, like Blackstone and BlackRock. Maybe they could falter in the next era of higher interest rates, but for now they seem the best of a confusing bunch.

Robin Wigglesworth is editor of FT Alphaville

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