Mercer Capital's RIA Valuation Insights


1Q Call Reports

Despite gaining 4% last quarter, publicly traded RIAs are still coping with a low-fee, passive investment environment and continued delays on the Fiduciary Rule implementation.  The proposed DOL rule prohibits compensation models that conflict with the client’s best interests, and is expected to induce active managers to provide lower-cost or passive products and to complete the shift from commission-based to fee-based accounts.  Still, many industry participants see opportunity amidst these headwinds, and the market for these businesses seems to as well.

As we do every quarter, we take a look at some of the earnings commentary of pacemakers in asset management to gain further insight into the challenges and opportunities developing in the industry.

Theme 1: Fees are ultimately determined by investment performance and capital market returns, creating serious challenges for hedge fund managers and other active investors that aren’t delivering alpha on a sustainable basis.

  • There is a greater belief that long-term returns are structurally lower than they were ten and twenty years ago. So if you have an expected long-term return of, let’s say 6%, which many people think that might be high when you look at a balanced portfolio.  Fees take up a lot of that return.  And as long as we believe the world is going to be in a low-return environment, our clients are under a lot of pressure….and so when we talk about fee pressure, fee pressure comes from the real issue of lower expected returns.  And I think this is one of the big issues around hedge funds and why we’re constantly reading about some hedge funds closing, some hedge funds are lowering their fees, because the fee structures are just too large versus the returns on a risk-adjusted basis that they’re achieving. – Larry Fink, BlackRock CEO and Chairman
  • I think fee rates going down are – I think is a reality of what’s happening. Some of that is mix shift.  Some of that is changing regulation in terms of distribution.  Some of that will ultimately – will accrue to the benefit, obviously, of the end client.  I think ultimately, this comes down to our ability to generate sustainable alpha.  I think if we can generate sustainable alpha in a way that, in some ways, kind of captures 3x to 4x the fee over time, I think we’ll be fine.  If we’re in a period of significantly lower returns and lower sustainable alpha, then obviously, I think fee rates are going to have to come down accordingly.  – Gary Shedling, BlackRock CFO and Senior Managing Director

Theme 2: Active managers continue to justify their fees with investment performance on certain products and [the perception of] lower correlation among certain asset classes.

  • I think performance wins in the end. There’s no question about that.  And as we’ve said before, I mean it’s when you have a good quarter or a good year, it may slow redemptions a bit, but it takes a while to build back onto the shelf space.  And we’ve seen, I think the number of 4 and 5-star funds for us has quadrupled here in the last quarter.  So those are the things that really drive sales and shelf space…And that most of the industry that has more brokerage assets, it, as we all know, creates challenges in the transition to more of the advisory mode.  But at the end of the day, if you have performance and you have reasonable fees, you’ll get distribution in that model as well. – Greg Johnson, Franklin Resources CEO and Chairman
  • Outside of the U.S. market, in lesser developed markets, less-efficient markets, more dispersion, less correlation, I think we still feel very strongly in places like Europe and Asia and certain emerging markets, that frankly, the ability to generate sustainable alpha can support higher fees. And I think our performance has certainly showed that over time. – Gary Shedlin

Theme 3: RIAs are still bracing for the DOL’s implementation of the Fiduciary Rule and the Pension Protection Act, which is expected to accelerate assets into passive products.

  • On April 7, the Department of Labor published a 60-day delay of its Fiduciary Rule until June 9. Following that announcement we evaluated the delay in relation to existing projects and the pre-established contingency plans developed in anticipation of the delay.  We are continuing our efforts to complete projects established for full compliance on January 1, 2019…Our efforts associated with the new rule have touched nearly every business unit and required significant lift from our employees and business leaders whose commitment remains strong as we continue to work towards full implementation by early 2018. – Phillip Sanders, Waddell & Reed CEO
  • It’s something that we continue to be very engaged on…So we are very active on that, on the lobbying front. And we’ve been asking that questions, well, what does it mean?  What kind of dollar number are we looking at?  And I think it’s probably too early to say, because it depends just how clients react to the disclosure…But again, when you have that transparency and the questions, we don’t know how far it extends.  And I wouldn’t want to try to extrapolate because we don’t know what that would mean.  I think you’re right in saying there’s still quite a bit of uncertainty on it.  – Greg Johnson
  • The real headwind is in the DOL Pension Protection Act rule.  They created a QDI, or a default option, which is primarily proprietary target date funds.  Our view is that was going to open up and be more open architecture, customized solutions that would include more outside asset managers such as Artisan.  Unfortunately, the litigations have increased the perceived diversification of an all-indexed oriented target date fund, and fee pressure has spurred more and more assets going to the proprietary target date funds, especially if it’s 100% passive.  That has lowered our expectations in the short run of the DC assets turning around.  We still think over the next couple of years you’ll see more and more customized solutions.  But for right now, it just seems the passive solution is the safe approach right now. – Eric Colson, Artisan Partners CEO, Chairman, and President

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