Management calls are usually, for the most part, fairly mundane. It’s usually not a good sign for a call to be “interesting”, and this quarter we picked up on several “interesting” themes.
In some regards, the second quarter of 2016 seems to be much of a continuation of the first for the asset management space. Most managers are continuing to enjoy handsome margins, but growth appears to be virtually nonexistent and stresses seem to be increasing, generally, across the industry. Although commodity prices have picked up some since the beginning of the year, equities have continued to struggle, favoring ETFs and a flight to other passive instruments, while global strategies have suffered from increased volatility in the aftermath of Brexit among other touchpoints of political unrest. Active managers seem to be struggling to distinguish and substantiate their offerings to retain clients after a period of extended relative underperformance. The DOL’s Fiduciary Rule adds a twist to all of this. Although the ruling was intended to primarily impact financial advisors, the ruling expanded regulatory authority over financial advice for IRA holders and the “appropriateness” of fees. Otherwise known as the “Conflict of Interest” rule, the Fiduciary Rule prohibits compensation models that conflict with the client’s best interest, and further scrutinizes the risk appropriateness of certain product offerings.
As we did last quarter, we take a look at some of the pacemakers in the traditional asset management industry and how they have dealt with the myriad of challenges in the first half of the year.
Theme 1: Although uncertainty remains about the timing and impact of the DOL’s Fiduciary Rule, managers across the board are focused on the challenges and opportunities implicit in the ruling.
- “As I have discussed in past calls, broadening access to NextShares to include major fund distributors is critical to near term commercial success. Significant progress continues toward that goal. Since the publication in March of the final Department of Labor rule adopting a fiduciary standard for advice to covered retirement accounts, our conversations with broker-dealers are increasingly highlighting the potential role of NextShares in helping advisors address their heightened responsibilities as fiduciaries under the DOL rule.” – Eaton Vance’s Tom Faust
- “The Department of Labor’s recent fiduciary standard rule has elevated the scrutiny over the appropriateness of fees and product choices. Advisors are demanding solutions for their clients and better technology to support their practice. […] Our investment in Project E (a series of tech, product and brand initiatives) will bring new options to our clients in a more robust technology platform for the financial advisors associated with our broker-dealer, ultimately strengthening the competitiveness of this channel. We believe we will be able to fully address the DOL requirements while preserving our ability to grow advisor productivity and sales with the ongoing inclusion of our products.” – Waddell & Reed’s Philip James Sanders
- “We’re hearing conversations about all kinds of things, relative to DOL. A couple of things that I think are relevant are – pricing was already decelerating. […] The other piece of DOL I think is that distributors will look intently at their investment offerings and the breadth of them. And in addition to pricing, I think risk, however defined, will be front and center in those discussions. And you’ve read publicly that one large broker dealer has announced a plan to dramatically prune its product offerings. Whether others follow suit remains less clear. But I think this amalgam of risk and expense will be very much a part of the DOL discussion.” – Waddell & Reed’s Thomas W. Butch
- “We’re waiting for some more work done on the client side, frankly, to interpret what those new DOL rules will mean for their businesses. And then we’ll follow along. We have, obviously, some concerns. We also see opportunities for us in the changing landscape. But it’s really too early to have conviction.” – Janus’s Richard Weil
- “I think if the large firms move towards more SMA type accounts, we feel pretty well-positioned for that. As you know, in the tax-aware muni space, that’s a huge incentive or a huge opportunity for us and has been growing persistently for almost 18 months. So that’s an example of us being able to both pivot and take advantage of [the DOL ruling].” – AllianceBerstein’s Peter Kraus
Theme 2: The volatility experienced in the aftermath of Brexit was immediate and acute, but not life-threatening. Many managers believe the impact will be short-term, and have continued to grow their international investments in both Europe and Asia.
- “The Brexit vote in June was yet another episode of volatility and uncertainty. […] The absolute returns of our non-US and global strategies have been impacted in recent periods by poor market performance and overseas developed markets, particularly in Europe.” – Artisan Partners’s Eric Colson
- “I think that Brexit over the long-term will be good for the UK. It will result in some short-term pain, probably a brush with recession. But long term, I think it’s good that they can control their own destiny apart from being tied to Europe. And in terms of commercial real estate in the UK, we are expecting prices to decline anywhere from 5% to 15% or 20% depending on the property type and the biggest declines are being expected in the office market. However, we think that for some other property type such as industrial where for example the decline in the pound could be good for trade interest and to the property markets in London.” – Cohen & Steers’s Joe Harvey
- “We are now investigating how best to service our growing Japanese business and may add additional resources to support that effort. And we have a search underway for a new head of non-US distribution. As our investment capabilities grow more global, it seems natural to focus more attention on serving clients in international markets. While it is unlikely that we’ll do something dramatic, the changes afoot in the US market lend greater urgency to our desire to make Eaton Vance a more global company.” – Eaton Vance’s Tom Faust
- “We’ve made significant investments in building our businesses outside the United States. And in that perspective, our non-US businesses have and continued in this past quarter to deliver strong growth.” – Janus’s Richard Weil
- “I think the major effect has been a resurgence of sales in the Asia ex-Japan space. I think that is the major difference. Brexit clearly had a chilling effect on risk-taking in Europe and on trading activity, which was reflected in the Bernstein numbers. I don’t think we’ve seen any material move of flow from Europe to the US” – AllianceBernstein’s Peter Kraus
Theme 3: The persistent flight to passive has exposed a number of winners and losers in the active management space. Managers willing and able to adapt and respond to the changing climate by offering a greater mix of both active and passive funds have generally fared better than those trying to wait out the storm.
- “During the quarter, we saw a slowdown in gross inflows which we believe is attributable to a number of factors including market uncertainty and the demand for high-capacity low fee products. In the short term, this is a difficult environment for high value-added active managers.” – Artisan Partners’s Eric Colson
- “The pace of change in our industry is accelerating with continued outflows from equity, market share gains by ETFs, investors looking for managers to deliver and distributors responding to the DOL fiduciary rule before it is finalized and while it is being challenged in the courts. […] We are focused on being a specialist manager and delivering more for less. We continue across all fronts to enhance our brand and capabilities and real assets.” – Cohen & Steers’s Joe Harvey
- “In this period of disruptive change in our industry, every investment manager is being forced to consider how to respond. […] We are not willing to concede that we can’t grow our traditional active business. […] As we said before, we view traditional active management as now a game of winners and losers with Eaton Vance’s performance and distribution strengths positioning us to be a winner. We continue to devote significant sales and marketing resources to growing our high performance active strategies.” – Eaton Vance’s Tom Faust
- “What we’re doing is essentially competing against index funds and index ETFs where we’re saying to the client or saying to the financial advisor, we can provide index like or benchmark like returns, but with customization to take into account other holdings that the investor might have, social objectives or social screens that the manager wants to impose, and the ability to achieve better tax treatment because in a separate account you can manage taxes down to the individual lot level and you can pass through losses.” – Eaton Vance’s Tom Faust
- “ETFs will absolutely continue to be an important part of the book of business of the financial advisors that we do business with, and looking to see how we can offer either some differentiated actively managed capabilities, either from our current affiliates or through other sub-advisory relationships, as well as are there those smart data types of opportunities, that we also think would be differentiated and work better in ETF than they would work in an open end mutual fund. […] This is an interesting environment for those types of non-correlated, non benchmark type of products because the indices just keep going up and up and up. Our view is that this is a time that people should be investing in those types of strategies, but it’s really not as easy to get people to be compelling to buy those types of strategies where right now the indices seem to be doing well.” – Virtus Investment Partners’s George Aylward
- “This remains a very challenging environment for active managers. The current global macro-economic and geo-political backdrop has resulted in heightened investor demand for stability, safety, and yield, resulting, in our view, in valuation anomalies across various sectors and markets. We continue to believe that these anomalies will normalize over time, providing a much more favorable backdrop for active management. However, it is also clear that we have not been at our best in navigating the current environment and must do a better job as a whole. The recent performance challenges for active managers combined with an increased focus on fees has resulted in growing demand for passive products. We understand that the landscape has changed, but believe that there is a role for both passive and active strategies in client portfolios. […] We recognize that the industry is evolving and that in order to retain our position of excellence, we must remain open-minded to innovation and change.” – Waddell & Reed’s Philip Sanders
- “Given the very challenging global market dynamics and, in particular, how that affected active asset managers, we were particularly pleased to have slightly positive flows for the quarter and very encouraged by the strength of the flows in our U.S. mutual fund business where we gained market share in both fundamental equity and our fixed income business. […] We have a number of strategies which are particularly designed to help clients in period of market stress, in periods of high market volatility. […] Active managers in the first two quarters were experiencing an extremely challenging environment in 2016. Industry outflows for active mutual funds, equity, and fixed income are on pace to post one of the worst years in more than 25 years of history.” – Janus’s Richard Weil
- “We are doing as well as we are in such a volatile market because our value proposition has never been clearer. Not only can clients be confident of Bernstein’s wealth forecasting, asset allocation, and risk management tools. They can now invest in a series of innovative targeted services that allow them to capitalize on specific market opportunities.” – AllianceBernstein’s Peter Kraus