The global investment management industry faces cyclical and secular threats, with investment performance exposed to late-cycle risks and business models challenged by a shift toward passives, warns Fitch Ratings in a new report.
Fitch says more diverse investment managers are better placed to weather the challenges and adapt as the industry evolves, while smaller firms may be absorbed by larger ones unless they can develop and maintain a niche market position.
The ratings agency notes that passively managed funds have been rapidly taking market share from active players over the past decade due to substantially lower fee rates and largely superior performance, while increased regulatory scrutiny has compounded the pressure on operating margins.
In addition, volatility arising from market uncertainty such as escalating trade war threats negatively affected asset valuations and net flows in 2018, something Fitch expects to persist.
It also expects the customer trend toward passively managed funds to continue. ‘While traditional investment managers argue the case for active management, emphasizing that the rise of passive funds has been linked to rising markets, we believe there are clear secular shifts toward lower-cost passive products,’ notes the report.
By April 2019, the total assets of passive US equity funds had reached parity with those of active US equity funds, according to Morningstar. The performance of passives has been boosted by buoyant stock markets and low fees compared with active managers, notes Fitch, with the trend particularly visible for US and UK large-cap equity funds.
‘To counter the trend, some investment managers have started to focus more on private assets, which are less prone to replication by passives. [But] changes to business models do not guarantee success, and come with execution risk,’ warns the report.
The sensitivity investment managers have to market factors was highlighted in 2018, after a decade of unrelenting asset price growth. ‘Their performance suffered from declining asset values and net inflows due to investors’ heightened risk-aversion,’ notes the report.
Some of the largest traditional investment managers experienced net outflows, and operating margins shrank as a result of reduced assets under management and lower fees. ‘Furthermore, industry-wide fee compression continues unabated as investment managers increasingly compete on price,’ adds the report. In response, several managers launched new low-fee charging structures in 2018.
Yet, despite the trend toward passive funds, active investment managers may still be able to prosper provided they can maintain – or acquire – the scale and diversification to be cost-effective while offering customers an attractive product range that is distinct from passive funds, suggests the report.