After a strong start to the year driven by tax reform and global economic growth, markets reversed in February and March and volatility picked up significantly.  While most publicly-traded asset managers posted negative returns for the quarter, the return of market volatility may be an opportunity for certain active managers.  The first quarter also saw notable changes on the regulatory front, with the DOL Rule being struck down and the SEC proposing the new “best interest” standard for brokers.  On the fixed income side, the yield curve continued to flatten during the first quarter, and higher short-term rates may pull cash off of the sideline and into fixed income products.

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: The return of volatility to the markets offers opportunity for active managers.

• [W]hile we have started with the equity markets generally moving upward in January, the trend broke down in February and March as volatility increased as a dispersion across and within those markets.  In this environment, the best active managers were able to outperform, and many of our Affiliates generated meaningful alpha. – Nathaniel Dalton, President & COO, Affiliated Mangers Group, Inc.
• Over the last year or so, we have seen correlations declining, and more recently, we have seen increased volatility and rising interest rates.  We may be returning to a world in which investment returns are not overwhelmed by central bank policy.  We believe that’s an environment in which asset allocators will place greater importance on high value-added investing and an environment in which value-added should be more apparent. – Eric Richard Colson, Chairman, President, & CEO, Artisan Partners Asset Management
• We are optimistic that this higher level of volatility, combined with a gradual trend toward the normalization of monetary policy on the part of global central banks will continue to improve the investment backdrop for active managers. – Philip James Sanders, CEO, Chief Investment Officer & Director, Waddell & Reed

Theme 2: The regulatory environment continues to evolve with the DOL Rule recently being vacated and the SEC’s recent “best interest rule” proposal.

• Obviously, we’re at the very early beginning of [the SEC proposal], which will have a longer road ahead of it before it likely moves forward into any type of finalization of becoming a rule.  But the early indications are based on it being more of a disclosure-based rule.  It does provide for the additional flexibility with regard to the broker/dealer, not causing significant cost increase associated with the broker/dealer and the financial advisers that we support.  So we’re going to continue to monitor that.  I don’t expect at least in the initial stages that to hamper our ability to increase our advisers’ overall annual productivity ranges, but we’re going to continue to monitor what happens in this space with regard to the SEC rule proposal. – Shawn Michael Mihal, President, COO & Director, Waddell & Reed
• With the changes in the DOL rules, a lot of the financial advisers have been using index-like and ETF products to create model portfolios and build those model portfolios with the least expensive products.  But as the cycles start to change, they will start to incorporate more active products in that both active fixed income and active equities. – Robert Steven Kapito, President & Director, Blackrock
• [T]he new … higher standard of conduct or new best interest standard that is under comment period with increasing the suitability requirements and disclosure.  I think what’s important in the proposal is that certainly, brokerage as it exists today, can survive and doesn’t have to be modified to a level where you can’t have differentiated commissions … And so I think it would slow down the acceleration of movement from brokerage to advisory accounts, and the urgency to do that would not be there. – Gregory Eugene Johnson, Chairman & CEO, Franklin Resources

Theme 3: Rising yield curve may pull cash from the sidelines and into fixed income products.

• We see at least three broad opportunities for our fixed income business in a higher rate environment.  First, higher rates are attractive for the retail investor and should increase flows.  Second, higher rates create the need to rebalance into fixed income for many institutional investors.  And third, regardless of the rate environment, the opportunity always exists with strong investment performance to take share. – Joseph A. Sullivan, Chairman, CEO & President, Legg Mason
• [W]e estimate there’s over $50 trillion of cash that’s sitting in bank accounts earning less than 1%, in some places, negative.  So as rates go up, especially in the short end, that is going to attract a lot of this cash into the fixed income markets, of which we can manage that money rather directly into the normal fixed income products or into ETF fixed income products, which seem to be getting a lot of the new flows from rises in rates. – Robert Steven Kapito, President & Director, Blackrock
• While the prospects of rising rates tends to push investors away from long-dated fixed income, the flat curve is creating strong relative risk-return opportunities in short duration funds and cash management strategies, which we saw clients take advantage of in the first quarter. – Laurence Douglas Fink, Chairman & CEO, Blackrock