Q4 2018 Call Reports

Volatility Drives Investors to Low-Fee Passive Strategies

Current Events

Reflective of the headwinds that the industry is currently facing, asset managers generally underperformed broad market indices during the fourth quarter of 2018.  As the broader indices stumbled, many RIA stocks plummeted with falling AUM balances and management fees.

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

Theme 1: Q4 volatility drove investor outflows.

  • Volatility was the dominant theme as 2018 came to a close. U.S. equity markets set record highs during the quarter only to see those gains erased by late December. The selloff experienced toward year-end sent the equity markets into correction territory with virtually every asset class ending the year with negative returns. — Philip James Sanders, CEO, CIO, & Director, Waddell & Reed
  • Turning next to flows. There are a couple of high-level themes that shaped our quarter. In general, elevated market volatility in the fourth quarter increased industry-wide client risk aversion, which led to slowing sales activity and delayed funding. In addition, we had elevated levels of retail redemptions in equities and liquid alternatives due to fourth quarter seasonality, which in the case of liquid alternatives was exacerbated by significant outflows from products with challenging recent performance relative to benchmark. — Nathaniel Dalton, President and Chief Executive Officer, Affiliated Managers Group, Inc.
  • Gross flows for the quarter were strong at $4 billion, while net flows were negative $1 billion as many investors retreated from higher-risk asset classes and rotated into cash. — David Craig Brown, CEO & Chairman, Victory Capital Holdings, Inc.
  • At the end of 2018, the market drawdown, volatility, and industry-wide outflows dominated attention. Our AUM declined by more than 17%, and our stock price declined by more than 30%. — Eric Richard Colson, Chairman, President, & CEO, Artisan Partners Asset Management, Inc.

Theme 2: Previously, industry pacemakers suggested that the return of volatility to the markets offered opportunities for active managers.  However, recent volatility has pushed investors to more passive strategies. 

  • While volatility can, at times, provide a favorable backdrop for active managers, and we firmly believe that research and insight can identify differentiated ideas for investors, the flow toward passive strategies remains steady in 2018. — Philip James Sanders, CEO, CIO, & Director, Waddell & Reed Financial, Inc.
  • Our ETF business, VictoryShares, had positive net flows of $121 million in the fourth quarter, bringing full year of 2018 net flows to $1.1 billion. We continue to be pleased with the strong momentum and market share gains we’re seeing in VictoryShares and note that we have experienced positive net flows every quarter since our acquisition of the business in 2015.
    — Terence F. Sullivan, CFO and Head of Strategy, Victory Capital Holdings, Inc.
  • Clients who faced large tax bills while their equity mutual funds delivered negative active returns experienced this firsthand and shifted to ETFs in the fourth quarter.  […]  I truly believe it’s becoming more recognized, the superior nature of the ETF structure versus a mutual fund.  We have heard many instances where many mutual funds who had negative NAV at the end of the year, but they also had capital gains, taxes that they were identifying to their clients.  And the clients, I think, in many cases, just got quite aggravated by paying taxes with the negative NAV.  Obviously, with an ETF, you control your tax basis.  And I think this is becoming a bigger and bigger issue.  Tax navigating for the long term, your tax position, for taxable individuals and institutions, is very important. — Laurence Douglas Fink, Chairman & CEO, BlackRock, Inc.

Theme 3:  Recent fee compression is largely attributable to a shifting asset class mix on lower equity balances and passive inflows.  Much of this attrition is likely to be temporary in nature.

  • I would say that as you think about the fee movement, it is driven by asset mix shift.  That if you think about it, was a bit magnified in the fourth quarter given the volatility.  I think it’s important to focus on mixed shift versus erosion because that is truly what we’re seeing here. It’s about the asset classes that we’re having momentum in.  And I would also say that it is not a permanent movement.  We have asset classes, and therefore fees that range quite broadly as we’ve discussed in the past.  And we have seen and would expect to see momentum in some of those asset classes that higher–have higher fees, and therefore, could move it in the other direction.
    — Terence F. Sullivan, CFO & Head of Strategy, Victory Capital Holdings, Inc.
  • Our effective fee rate, what you see trending down, it’s really—it is a mix shift topic for us. And you would imagine, in risk-off environments, people putting money in money funds, et cetera, that you see that happen. Oppenheimer [Funds] during the period had the exact opposite. There is an aggressive—or I should say aggressive, quite successful in emerging markets and in international equities, and those are higher capabilities. And again, that is sort of the natural flow of things within an organization. So client demand will drive those mix shifts. There’s very little we can do about it. — Martin L. Flanagan, President, CEO, Director, Invesco Ltd.
  • For the fourth quarter, aggregate fees decreased 27% to $1.2 billion from a year ago, and the ratio of aggregate fees to average assets under management declined year-over-year from 82 basis points to 63 basis points, entirely driven by lower performance fees. Notably, the ratio advisory fees to average assets under management remain flat year-over-year. — Jay C. Horgen, CFO & Treasurer, Affiliated Managers Group, Inc.

In summary, we continue to see many of the same trends we have highlighted in previous quarters.

  • The industry is still evolving to increased fee pressure.
  • Scale remains at the forefront of conversation as demonstrated by recent M&A activity.
  • Rising yield curve and equity market volatility continue to pull assets into fixed income products.

Q4 was rough, to say the least, for most asset managers as both AUM and effective fee rates declined.  However, most saw some normalization of flows in January.  We will continue to follow changes in asset mix, which will drive fee rates in 2019.

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