Is margin pressure leading firms down the wrong path?

This week Investment Adviser has highlighted that Moody’s, the ratings agency, views passive fund providers’ price cuts as “credit negative” for the entire sector. Given the fact that volume growth should create economies of scale that lower firms’ trading costs, this struck me as quite surprising.

But it is in keeping with a broader pattern. Margins are also under pressure in the active arena, albeit not so much from fee cuts – yet – as rising costs.

The challenge here was highlighted by PricewaterhouseCoopers last week. Total operating costs are “rising and are expected to accelerate”, PwC said, leading to fund groups planning to spend more on technological improvements.

If this really is what’s happening, it’s admirably counter-intuitive. IT spend is often the first thing to go at a time of increasing costs. And let’s be clear, there are plenty of tech improvements that fund houses could get their teeth into, from back office to big data.

But looking at the bigger picture, sometimes I wonder whether acknowledging both margin pressure and the need for tech improvements is leading firms down the wrong path.

More specifically: if I had £1 for every time a fund group said the biggest threat to their business was a Google or an Amazon entering the marketplace, I’d have been compounding at an envious rate in recent years.

What, though, is the real threat from these businesses?

What, though, is the real threat from these businesses? Fund managers are pretty sure it’s not on the product side, placing their faith in financial services’ high and rising barriers to entry.

As the Investment Association’s annual survey of members made clear last month, “it [is] felt that any disruptive capability would be limited to the area of distribution”.

This brings us back to margin pressure. The industry seems intent to respond to this by deepening its own links to the consumer market. Now, a strong brand makes sense whomever distributes products, but, as fatalistic as it sounds, there will simply be no escaping a squeeze if Google does move into this arena.

For a comparison, look at China, where Alibaba and Tencent have raked in billions from ventures where they distribute funds from asset managers. I doubt these fund houses are charging anywhere near their usual rates for the privilege.

That said, I don’t think advisers or wealth managers would need to be overly concerned by this arrival. These distribution agreements would target a mass market that is already uneconomical for most advice.

This widening of the industry is sorely needed on a number of levels, and as these new investors’ pots grow, they may well – in time – take a closer look at both their fund choices and the need for advice. Volume would surely then trump margin pressure once and for all.

Dan Jones is editor of Investment Adviser