WASHINGTON Recent growth trends in the asset management business indicate that brand and reputation have become increasingly important, as abusive mutual fund trading practices have prompted investors to vote with their feet.
Fund complexes hit with fraud charges in the 18 months after the scandal broke have suffered, on average, a negative growth rate of 24%, while those fund complexes that have emerged unscathed have enjoyed a 15% growth rate on the plus side, said Merrill Lynch Senior Analyst Guy Moszkowski, speaking on a panel of sell-side analysts at the Investment Company Institute general membership meeting here. On an annual basis, the implicated fund shops shrank 16% as compared to 10% annualized growth for the scandal-free firms.
Many of the scandal-plagued firms, with the obvious exception of Strong Capital Management, were among the top 25 fund complexes in terms of assets.
Prior to September 2003, there had been no differentiation between the top fund companies because the prevailing perception was that they were all above reproach. Now, the landscape has changed considerably. Reputation is paramount, Moszkowski told attendees. He also noted that performance is a key driver of inflows and that many of the firms accepted market timing in an effort to compensate for poor performance.
Financial advisers are in the catbird seat, said Burnett Hansen, director and equity analyst at Credit Suisse First Boston, arguing that more and more individuals are turning to the advice channel to buy mutual funds as negative headlines abound, thus giving advisers leverage. In fact, 57% of mutual funds are sold through an adviser, according to data through the end of 2004 provided by Financial Research Corp. of Boston.
Going forward, fund companies will be, to a certain extent, at the mercy of the adviser community.
Hansen believes that asset retention will be the name of the game in the coming years more so than asset growth because the market is already saturated. He noted that the average mutual fund family now has increased to 12 funds from five funds in 1999.
Perhaps even more telling of the product explosion is that there are more mutual funds on the market than stocks traded on the New York Stock Exchange.
Looking ahead, Hansen said that overseas markets will be a key driver of growth. He also sees lifecycle funds and funds-of-funds gaining traction and the insurance business as a dark horse in the race for assets.
Christopher Meyer, asset management analyst at Morgan Stanley, said the industry is likely to slow and has already seen a dramatic reduction in flows.
Market-Share Game
Its a market share game more than anything else, Meyer said. Everybody that wants a mutual fund already owns one. He agreed with Hansen on the notion that the advised channel is the area for growth, noting the massive number of aging investors that have changing needs.
Meyer believes the compensation structure for distribution is likely to change significantly, moving toward greater transparency. Moszkowski pointed to what Charles Schwab has done over the years with its fixed-fee structure. In his opinion, this is the most transparent format on the market and creates a relatively level playing field.
Meyer predicted that it will be harder to get on a platform like Schwab in the new environment, providing further evidence that the barriers to success have gone up even though the barriers to entry may have eased. Moszkowski said it would be prudent for fund complexes to be conservative in making payments for distribution, seeing as new rulemakings and examinations of industry practices have yet to play out.
On the mergers and acquisition front, Meyer said targets cant be a one-trick pony anymore. Instead, they must deliver multiple products across multiple channels.
While consolidation has been the buzzword for the industry in recent years, Hansen doesnt see the big fund houses consolidating. Rather, he sees a number of smaller acquisitions in the coming years. Moszkowski dispelled what he believes to be a myth about consolidation, saying that the industry is more fragmented than anything else as more and more smaller players have gotten into the space with the bigger players having fewer assets under their belt than they did fifteen years ago.
Another topic the panel addressed was the viability of the threat of other investment vehicles such as exchange-traded funds (ETFs), hedge funds and separately managed accounts (SMAs).
Hansen put it matter-of-factly, saying, Mutual funds have the assets to lose, because theyre the ones with the assets. Indeed, at $8.1 trillion, the mutual fund industry is sitting on top, with the rest of the asset management industry nipping at its heels. Still, the combined assets of those alternative vehicles are about $4 trillion, which Hansen characterized as a non-trivial amount. He sees a clear opportunity there.
Given that very real threat, Moszkowski said, the industry needs to be proactive in promoting its format. Meyer advanced the issue by saying that fund managers need to make sure they take a view on their business that goes beyond the allocation of stocks and bonds.
Perhaps one of the biggest challenges the industry is facing is margin compression, as competition for distribution and regulatory scrutiny figure to weigh on their bottom line.
Margin Squeeze
Among the publicly traded asset managers, the average profit margin is roughly 36%, a number some fear could go as low as 27%. While Moszkowski doesnt buy into that wholeheartedly, he believes there are things the industry can do to push back.
For example, a fund complex could rationalize its business so that it has the right number of funds with the right number of assets.
Size is the enemy of performance, Moszkowski said.
Some funds grow so large that it handcuffs the portfolio managers ability to be nimble and flexible. For example, the behemoth $54 billion Fidelity Magellan fund, is essentially an index-hugger that hasnt generated meaningful returns in the last five years.
Ultimately, the winners in the asset management space, the panel surmised, will be the low-beta and cheap alpha providers, the full-product service providers and large players with a proven performance track record. In other words, those that get it right.
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