3Q17 Call Reports

Despite gaining 5% last quarter, publicly traded asset managers are still coping with a low fee, passive environment and challenges associated with a ramp up towards full implementation of the DOL fiduciary rule.  The 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 accelerate the shift from commission-based to fee-based accounts.  While net inflows into passive products are a secular trend (particularly on the retail side), the passive inflows seen thus far during 2017 may be unnaturally high due to flows that have been pulled forward from next year by brokers in response to the DOL rule as an effort to avoid litigation.  Still, against this backdrop, many industry participants see opportunity, 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 pacesetters in asset management to gain further insight into the challenges and opportunities developing in the industry.

Theme 1: Pricing pressure and the DOL fiduciary rule have continued to drive flows into low fee passive products, particularly in the US retail channel.

• "Third quarter long-term net inflows of $76 billion, representing 6% annualized organic asset growth, were positive across client type, investment style and region. Global iShares generated quarterly net inflows of $52 billion, representing 14% annualized organic growth with strength across both core and non-core exposures." —Gary Shedlin – CFO, BlackRock
• "Total net flows were positive $0.2 billion in the quarter, an improvement from net outflows of $0.2 billion in the prior quarter, as positive flows in structured products, retail separate accounts and ETF more than offset net outflows in institutional." —George Aylward, CEO, Virtus Investment Partners

Theme 2: Changes in the regulatory environment and client expectations have prompted many traditional asset managers to consider expense caps or variable fees tied to performance.

• "I think that our view [on fees is that] as the industry continues to evolve due to a variety of issues, not the least of which are both regulatory and changing client trends, there are a number of active managers thinking about new ways to evolve fee structure.  So we've seen a bunch of announcements of intentions to introduce a new performance-based model.  I think we saw one change more recently in the United States, including the fulcrum fee, which has actually been in use in the U.S. for some time." —Gary Shedlin
• "With regard to the FlexFee Fund Series … [c]onversations are ongoing with our major distributors; I think they're going well.  We're sort of working up to beginning in earnest at the beginning of the first quarter to begin the process of marketing the [FlexFee Fund Series].  And it will be our focus for the first half of 2018.  We think there's significant potential here to gather additional assets.  We think it realigns client expectation of share of excess returns that managers are taking versus what they, our clients, are keeping.  We think it's a credible alternative to those who are incredibly fee-conscious today." —Seth Bernstein - President, CEO, AllianceBernstein Corporation
• "We have opened to fulcrum fees with many of our clients, specifically in the separate account space, and [they are] open to it." —Eric Colson, CEO, Artisan Partners Asset Management

Theme 3: The trend towards fee-based accounts (as opposed to commission-based) has been accelerated by the DOL rule, and product offerings are under pressure to adapt accordingly.

• "I think what we do know is that as you transition from a brokerage to a fee-based account, it's—you may have 1 out of 3 of your products on that lineup instead of all of them, and that's a general statement.  But one that it makes it difficult to capture the assets that you had.  So anybody with multiple products, with one relationship, is going to be under pressure as those assets transition.  But I do think the pressure of the transition could be alleviated somewhat if we have a standard that allows those 2 to coexist." —Gregory Johnson - CEO, Franklin Resources, Inc.
• "[P]art of it is you have to adjust the product line and make sure that you have mandates and styles and sleeves that are cost-competitive that can fit into solutions.  You have solutions that differentiate, whether it's target date funds or multi-asset funds, that we can build.  And part of that is having now ETFs that we can use in a lower cost way as part of that solution and have open architecture solutions that we've done around the globe with other partners.  Those are the, I think, things that we continue to try to adapt to, but we're certainly not sitting around waiting to get back to the old brokerage model because, I think, at the end of the day, we recognize that the fee-based side is going to continue to be the driver going forward." —Gregory Johnson
• "And as you point out, one of the things we did effectively concurrent with [the launch of the MAP Navigator product] was to add some sub-advised funds that are passive/smart beta-ish. Yes, the uptake of those has been pretty good, I think about $300 million in AUM to-date." —Thomas Butch, CMO, Waddell & Reed Financial
• "In the U.S., there are 2 major shifts converging in wealth management.  First, in one of the largest asset movements, fee-based advisory assets are expected to double by 2020 in the shift from brokerage to fee-based accounts.  The second, digital technologies are disrupting traditional wealth advisory practices, which create competition for client assets and provide leverage for fast-growing advisory practices." —Larry Fink, CEO, BlackRock
• "We spoke earlier in the year about having the strong balance sheet and the financial flexibility, to be patient as we acknowledge what the DOL rules will do for our company, and as we open up gradually, open up the architecture in the broker-dealer, I think we're getting a little better read on kind of where those things are settling out.  Product development is something where it's an ongoing process for us internally." —Philip Sanders, CEO, Waddell & Reed Financial