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The brave new world of asset management

Golden age of returns is over, creating a new premium for alpha, says JPMorgan Asset Management

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The asset management industry has hit an inflexion point where industry growth spurred by ageing demographics is being tempered by crimping profit margins, a top JPMorgan Asset Management executive told reporters at an international media conference.


THE asset management industry has hit an inflexion point where industry growth spurred by ageing demographics is being tempered by crimping profit margins, a top JPMorgan Asset Management executive told reporters at an international media conference.

And as often heard in the private banking space, the strategy of building scale while offering tailor-made services should likewise be among the top priorities for asset managers, as diverse mid-sized players will struggle to retain market share, said Mike O'Brien, CEO of the Europe, Middle East and Africa (EMEA) region, and global co-head of solutions at JPMorgan Asset Management.

"The industry has no doubt benefitted from a combination of market growth combined with a light touch regulatory environment and strong and continuing flows leading to a profitable environment for managers. But we can foresee this profitability being challenged," he said at the annual media conference held in London.

Mr O'Brien openly cited figures that showed of the challenges ahead for the asset management industry, even as overall assets under management are expected to jump from about US$80 trillion, to more than US$100 trillion by 2020.

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Since the financial crisis, the S&P 500 has increased by over 300 per cent. Yet, over the same period, the profit margin of the asset management industry has fallen from about 35 per cent to approximately 27 per cent today.

A key driver of this reduction has not only been expense growth, but more importantly, a steady fall in fee rates from around 34 basis points (bps) in 2007 to about 26 bps now.

This corresponds with the massive growth of passive investing through indexation - the use of market-cap-weighted indices - which is now a structural trend.

Some US$1 trillion in flows has gone to indexed-managed funds and almost half of developed market equities are now indexed. More money is also going into fixed income, which generates lower fees than that for equities.

"Active management has experienced some underperformance since the crisis - particularly in equities," Mr O'Brien said. "Active management has struggled to stand out and add value in an environment of strong market returns, low volatility, high cross stock and sector correlations and operations like quantitative easing driving prices away from fundamental value."

To be sure, the changing market dynamics today are offering opportunities for active managers to step up their game. Notably, the market returns are being challenged, and correlations across stocks and across markets and sectors are coming down.

In response, active managers have been outperforming. In the second quarter of the year, 55 per cent of active managers out of 3,871 active funds across Europe beat their respective benchmarks.

This is a larger percentage compared with the 52 per cent in the first quarter, and the 28 per cent in the fourth quarter of 2016, that outperformed the market, said Mr O'Brien.

But the times are also a-changing, with Mr O'Brien noting that greater regulation in the areas of transparency, elements of "value for money", and governance, is ahead for the asset management industry.

The rising attention comes as ordinary investors' savings are more closely tied to this trillion-dollar industry than ever before.

He also was plain in accepting that the asset management industry has benefitted tremendously over the past 30 years from strong market returns.

But now, JPMorgan predicts that average annual returns for developed market equities could decline by some 1.5 to four percentage points over the next 20 years, relative to the past three decades. In fixed income, the difference could be even wider, with long-term returns between three and five percentage points lower.

JPMorgan's estimates show that a 60/40 stocks/bonds balanced portfolio back in 2007 would be expected to deliver over 7 per cent per annum over 10 years. Today, that same portfolio is expected to deliver a 10-year return of just 5.5 per cent.

This brings the advantage of scale to the forefront for asset managers, with the numbers showing that over the last five years, the top 10 players by size in the industry have increased their market share by 5 per cent whereas medium sized players have lost over 6 per cent. The balance went to small niche boutiques. Technology also creates a new impetus to scale-up, with Big Data offering ways to improve decision making through new forms of analytics.

"Investor needs are changing as a result of the shifts in the macro environment, and clients are becoming more and more sophisticated and looking further than just investment performance - they want access to partnerships, intellectual capital, fee economies and service," said Mr O'Brien.

In particular, clients are looking for houses that can offer expertise in multi-asset solutions, and that integrate environmental, social and governance (ESG) criteria screening into asset management.

"The return environment of the past 30 years has been a historical anomaly. It was a golden age characterised by declining inflation and interest rates, strong global economic growth fuelled by demographics, productivity and rapid growth in China, and robust corporate profits boosted by access to new markets, low tax rates, and the rise of automation and sophisticated supply chains," said Mr O'Brien.

"The end of this era of exceptional market returns, which have been the primary driver of the asset management industry growth and profitability, will challenge the industry and put a new premium on alpha."

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