The UK asset management industry – the world’s second largest – is in a state of flux. Competition and cost pressures are disrupting the status quo among its 1,840 authorised firms, which collectively manage £7trn of assets and employ 50,000 people. Notably, 10 per cent of those assets are managed in Scotland.
Although uncertainty over Brexit negotiations represents a critical challenge in the short term, not least in relation to future passporting rights and asset managers’ continued ability to sell funds freely across the European Union, broader opportunities remain in the medium to long term. Successful asset management of the future seems likely to favour bigger firms with strong global brands offering a full suite of services alongside small targeted managers with unique product offerings.
Performance levels
Until recently, performance levels have been robust with asset management firms delivering average profit margins of 36 per cent. But fees are under pressure amid the push for greater transparency and comparability from investors, as well as scrutiny by policymakers and regulators. For active managers, the compliance costs of increased reporting standards and burdensome regulation are eroding margins, with MiFID II and undertakings for collective investments in transferable securities (Ucits) being the two most prominent causes.
Meanwhile, the growth of cheaper passive funds continues to threaten active management business by offering investors similar levels of risk and return at a fraction of the cost.
Rising technological and data management advancements are also putting a squeeze on margins. So are commercial costs, as firms grow distribution networks and product manufacturing capabilities to take advantage of opportunities in developing markets.
In response to these diverse pressures, market consolidation has been inevitable to mitigate risks and remain competitive. This is illustrated by the last two years of record mergers and acquisitions activity across the industry, primarily driven by regulation costs and the shift toward passive management.
In October 2016, Anglo-Australian Henderson announced a £4.7bn merger with US rival Janus. This deal ‘of equals’ is anticipated to deliver around $110m £86m) in cost savings by creating one of the world’s top 20 largest independent investment houses with combined assets under management of more than $400bn.
The most recent example is the £11bn mega-merger announced in March between Standard Life and Aberdeen Asset Management (AAM) – a deal that will combine £660bn in assets and make it the largest active investment management firm in the UK and second largest in Europe.
Standard’s virtually nil-premium proposal for taking over AAM is a clear signal of fee pressures, highlighting the importance of reducing costs and achieving scale. Overall synergies from the deal are expected to deliver annual cost savings of £200m – a figure that surpasses £1.3bn when taxed and capitalised.
Consolidation will be fuelled by significant economies of scale. The increasing regulatory burden, particularly acute for smaller asset managers, will create even more compliance costs, putting further strain on industry margins and precipitating more mergers.
Evolution
In their scope of activity, asset managers will continue to evolve. As deleveraging of banks continues, they are expanding their reach into areas dominated by the banks, such as primary lending, secondary debt market trading including distressed and nonperforming loans, primary securitisations and off-balance sheet financing.
Meanwhile, assets under management (AUM) in the core business looks set to benefit from favourable demographic trends: an additional one billion middle-class consumers are expected by 2020 who will accumulate wealth and save more for retirement. And as the world continues to age, retirement and healthcare costs will grow, so asset management clients will need to save more to pay for them.
Other key drivers include a surge in pension funds allied with the increase of defined contribution (DC) pension schemes, many more high net-worth individuals, and the expansion of existing sovereign wealth funds together with the emergence of new ones. This is all against a backdrop of favourable economic conditions, in particular, low interest rates and sustained GDP growth, underpinned by growing urbanisation and cross-border trade.
However, Brexit is overshadowing everything. The UK’s departure from the EU presents a spectrum of risks for asset managers, particularly those whose operations depend on EU market access – asset management exports have represented on average 6 per cent of net service exports over the past decade. Although the issue has yet to be resolved, the rules would mean a loss of managing and marketing passporting rights into the EU. So the outcome of negotiations is keenly awaited.
The competitive landscape is also changing. A potential source of disruption could come from social media or technology firms, which might combine their reach, knowledge and influence with banking alliances to provide compelling asset management propositions.
You only have to look at Silicon Valley’s Tesla, which has jovertaken General Motors to become the biggest US car maker, to see how quickly cutting-edge technology can make a huge impact.
Technological progress
Technological progress is increasingly required in asset management to meet customer and regulators’ demands. This leads to a further escalation in fee pressure. The combination of higher costs and demand for lower fees will intensify the battle for customer relationships, which is likely to be a theme for the UK asset management industry. For most, generating sufficient scale may well be the key to success.
But for those who achieve the right balance – while continuing to deliver consistent returns, increased transparency and strong customer service – the outlook is positive.
Mark Hardwicke is managing partner of Invenio Corporate Finance
Key points
Competition and cost pressures are disrupting the status quo.
Therefore, market consolidation has been inevitable to mitigate risks and remain competitive.
The UK’s imminent departure from the EU presents a spectrum of risks for asset manager.
