I have been questioning the sustainability of the asset management gravy train for the best part of two decades. Fred Schwed was lamenting the lack of satisfactory outcomes for clients way back in 1940 when he wrote Where are the Customers’ Yachts?: or a Good Hard Look at Wall Street (the book is full of wonderful quotes but the title sums up the main argument perfectly).
A brief look at the BRW Rich List or the largest and most profitable Australian companies suggests not much has changed. The big four banks all have wonderfully profitable asset management businesses. Macquarie Group‘s highly successful transition from traditional investment bank to asset manager has been the main driver of its share price appreciation in recent years. And a pure-play fund manager, Magellan Financial Group, has been one of the best performing stocks on the ASX over the past five years.
You could argue, therefore, that it would be a brave man or woman to suggest that the wonderful economics of the industry are about to change. I am going to suggest exactly that, however. It is already changing, but it is going to change a lot more over the next decade.
Three forces at play suggest to me that we are at a tipping point where the competitive nature of the industry changes dramatically.
First is that expected returns on all asset classes are dramatically lower than they have been in the past. Whether it be residential property, government bonds, shares or cash in the bank, exceptionally low interest rates have driven asset prices to levels where implied future returns are very low. From today’s prices, an overall return of 3 to 5 per cent on a balanced portfolio is about the best investors can hope for.
This may not yet be apparent to most investors, but it will become so over the next few years. As expectations change, the impediment of fees is going to take on increasing significance. The average balanced super fund has returned about 8 per cent over the past 20 years. Paying up to 2 per cent of that return in management, platform and advice has a huge impact on final retirement balances, but the end result has still been palatable for most investors.
Focus on fees in low-rate environment
If future returns are closer to 4 per cent than 8 per cent, however, losing half of that return in frictional costs is going to become completely unpalatable. In a world of exceptionally low interest rates, fees are finally going to get the investor attention they deserve.
Secondly, low cost alternatives have proliferated. Index funds, where the provider simply tries to mimic the return on an underlying index and fees on the vanilla options can be less than 0.1 per cent a year, have become widely available. New entrants into the asset management game, with lower cost direct distribution models are offering active management for less than 0.5 per cent a year. In the old days, distribution was so tightly controlled among a few large players that it was impossible for these new players to get any traction.
Finally, and related to the previous point, the ability for investors to bypass gatekeepers and make their own investing decisions has completely changed the landscape. Full administration services for self-managed super funds are now available for less than $1000 per annum. Computers are able to provide simple financial plans – which is all most investors need – for a few hundred dollars. And boutique fund managers are able to communicate directly with potential and existing clients thanks to the internet.
We remain a drop in the ocean, but Forager’s funds management business has grown from nothing to $210 million of funds under management without being accessible via a platform or sold through financial planners. Before the rise of the internet, there was no way our more than 1700 clients would have found us without paying someone a fee.
Given a percentage of the management fee was often kicked back to the financial planner, there was little incentive to apply fee pressure to the fund manager. For investors coming direct, fees are of the utmost importance (that I can tell you from experience).
These forces are combining to place enormous pressure on the industry globally.
According to a recent article in the Financial Times, stockmarket exchange traded funds attracted nearly $US200 billion of net inflows in the past year, while actively managed equity funds lost $US124 billion. Hedge funds – which make the typical retail investment fund look cheap – saw $US15 billion of net outflows in the March quarter of this year, the worst since 2009, according to Bloomberg. Stories abound of active managers cutting their fees dramatically to attract inflows.
Australia likely to follow suit
So far Australia’s highly paid fund managers have escaped relatively unscathed. This could be because interest rates have been relatively high here, property prices have kept rising and attractive, low cost product is not yet as available here as it is overseas. The past 12 months have highlighted how useless the All Ordinaries Index is as a low risk way to access the sharemarket. Its absurdly high weighting to banks and resources companies meant that it underperformed an equal weighted index by some 7 per cent during the past financial year.
There is nothing there that is permanent though. Interest rates are already catching up with the rest of the world and better quality index products are already available to investors.
Whether it is possible to outperform the market with $40 billion of funds under management is a debatable question, but with an excellent track record, strong brand awareness and well-known star investors, the likes of Magellan are unlikely to suffer in the short term. But how does AMP justify its fees in a world where investors have a choice?
This article first appeared in the Australian Financial Review.