Mercer Capital's RIA Valuation Insights


Q4 Call Reports

Despite gaining 8% last quarter, publicly traded RIAs are still feeling the pressure from the regulatory overhang on the Fiduciary Rule and continued fee compression on most investment products.  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: Continued fee pressure and chronic underperformance have caused many traditional RIAs to consider expense caps or variable fee structures that toggle with performance.

  • There is no doubt that investors have felt more comfortable with what is perceived to be low cost and safe passive investing versus choosing active managers at higher fees and suffering on average, because that’s what the average numbers show, underperformance net of a fee. – Alliance Bernstein’s Peter Kraus
  • I would say, in general, that we are trying to do something different and say to clients, if we don’t perform, we don’t expect to be paid more than five basis points, and if we do perform, subject to all the limitations in those documents, we would expect that clients would be happy to pay us, and that is a pretty competitive offering to the passive world. – ibid
  • That’s something we think can be very useful answer to some of these high pressures around just fees and rationalizing versus passive is only paying on the alpha. And that’s something that we certainly are looking at.  I don’t think we have the same kind of pressure on the retail side, nor do we think it makes a lot of sense certainly on the institutional side.  We think that could be very additive to our overall line-up. – Franklin Resources’s Greg Johnson

Theme 2: The shift from active to passive management is a major headwind for many alpha hunters, but the best in class performers see opportunity for increased market share when the dust settles.

  • Disruption was also a major theme in our industry. Asset flows into passive products continue to accelerate.  The availability of these products and the perception that they are low cost, and in many cases lower risk is impacting all aspects of the investment management industry.  As a high value-added investment manager, we welcome disruption in the industry.  That causes investors to scrutinize their managers and advisors to determine whether value is being added, fees are transparent and rational, and the client’s experience comes first.  We believe we are well positioned to benefit from the ongoing shake-up of the traditional active industry, as well as the increasing frustration of hedge fund investors. –Artisan Partners’s Eric Colson
  • First and foremost, an oversupply of traditional active strategies resulted in too many products hugging indexes and not delivering value. As less expensive passive products came on-line, offering the same exposure at a substantially lower price, a large migration of assets was inevitable… Not all of those investors will go passive.  Our experience over the last several years supports our belief that many of those investors will select managers who offer differentiated strategies with high degrees of investment freedom and strong investment track records. – ibid
  • I think that the headwinds for active management, both long-only and hedged, frankly, remain significant. Relative returns have been largely poor, and fee structures have been high.  We firmly believe for ourselves the way to grow is to focus on delivering top quartile or better performance…I think active managers who operate in alternative strategies like we do, and as well as multi-strategy implementations, and can deliver that performance efficiently can be big winners. –Cohen & Steers’s Joe Harvey

Theme 3: There remains a great deal of uncertainty around the implementation and impact of the new Fiduciary Rule, but many believe larger fee-based advisors are better positioned to adapt to any large scale changes ahead.

  • I don’t think there’s one consistent view. I think you have a trend that was already in place pre-fiduciary rule of going to more of a planning model against the advisor picking individual funds.  That’s going to continue.  I think the fiduciary rule accelerated that.  I think some larger firms favor that rule because it helps them move towards that platform even faster.  And that’s where you get a little bit, I think, some mixed opinions on what to do next. – Franklin Resources’s Ken Lewis
  • Our sense is that in some cases – and it depends on the type of assets you have and the average size of account and what product it is. It’s possible the total cost of revenue sharing could go up a bit, it could go down a bit.  But the trend towards standardization is I think being well embraced throughout the industry. – Cohen & Steers’s Bob Steers
  • We believe that success in the post-DOL world will require a more institutionalized product approach to asset management in sales and marketing. Consistent with this approach, we continue to shake the culture and organization of our firm by enhancing our risk management capabilities, sharpening our investment philosophies and processes, evolving toward more team-managed portfolios, investing in our research capabilities, and emphasizing tighter integration between our investment in sales and marketing personnel. – Waddell & Reed’s Phil Sanders

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