Investment Managers face contracting fund flows, slowing income & profits squeeze

Confidence in the investment management industry contracted in the 3rd quarter, led entirely by the large managers, who saw continually contracting inflows and slowing income growth, the latest Ernst & Young Investment Management index results reveal.

This is the 23rd quarterly survey conducted to measure confidence in the investment management industry, and the research is conducted by the Bureau for Economic Research in Stellenbosch. Investment Management confidence fell during the quarter, to 67 index points, down from 81 in the 2nd quarter.

Chris Sickle, Investment Management Director at Ernst & Young comments, ‘The fall in confidence is not surprising given the volatility in equity markets, and much lower commodity prices, which has led the JSE ALSI to fall quite sharply, and for investor sentiment to deteriorate, across both retail and institutional markets.’

Comments Sickle, ‘Since the beginning of 2008, investment managers have faced a net outflow of funds, both small and large managers alike. Whilst the small managers reported increased confidence in the current quarter, their basic business fundamentals, as measured by inflows, profits and expenses continues to show a definite declining trend. However, small managers saw some relief in income growth during the quarter, whilst large managers saw contractions in a number of their key measures.’

Large investment managers reported a knock in confidence levels from 84 index points in the 2nd quarter, to 63 points currently. Small managers, on the other hand, reported a marginal rise in confidence, from 74 to 76 index points. Says Chris Sickle, ‘It is surprising that the small managers should currently have a more optimistic outlook, given that the large managers have greater resources to tap into, in such tough times, when absolute investment performance is on the decline, and the net flow of funds has turned negative as a result.

Continues Sickle, ‘For the third consecutive quarter, investment managers have reported contracting fund flows. However, the large fund managers are still attracting net funds overall, albeit marginally positive, and solely due to the institutional segment, where the fund flows tend to be much larger than they are in the retail market. Small managers, by contrast, reported a contraction across all three categories of funds, in line with the previous quarter. This perhaps indicates that investors are moving their investment mandates away from specialist boutiques and channelling funds towards larger generalist managers in these uncertain equity markets.’

The retail segment of the market is also withdrawing funds, with a number of factors likely to be driving behaviour. Lower investment returns may be pushing investors to withdraw collective investments, while the general indebtedness of households may also be a factor that is leading investors to cash out. This can be seen in the net unit trust flows, excluding money market funds, which turned sharply negative in the third quarter. This indicates that many investors who remain invested in unit trusts are shifting their portfolios in favour of fixed-interest securities, and away from the more volatile equity market.’

The survey also found that expenses growth remains high. Comments Sickle, ‘This is not unlike the other segments of financial services. The banks and life insurers are also struggling to reduce the rate at which costs are climbing, despite facing significantly weaker revenue streams. Increased regulatory compliance and systems enhancements are necessary expenses which the industry often has to incur to drive growth. It is however, going to be more difficult to meet these greater expenses in the current environment where the net flow of funds, and income levels are contracting.‘

In line with 2nd quarter findings, operating margins remain under pressure, in turn impacting net profits growth. For three consecutive quarters, income growth has declined sharply, driven by lower base management fees and contracting performance fees. Says Sickle again, ‘ In an environment where absolute returns are significantly lower than they have been in the last few years, coupled with minimum base requirements before performance fees kick in, it is difficult for performance fees to generate the level of income they provided to the industry in recent times.’

Concludes Sickle, ‘ Times remain tough for the investment management market. Even so, nearly seven out of ten managers regard the current business environment as satisfactory. This could be due to their expectations that in the 4th quarter of 2008, market conditions will improve, and income levels will rise in tandem, whilst expenses growth will at the very least remain contained at current levels. However, given the recent instability caused by corporate failures in the financial services markets in the USA, these expectations may prove to be overly optimistic.
Locally, economic conditions are unlikely to improve in the personal sector before the latter half of 2009, and unless corporate growth proves to be a major driver for investment managers, they may well be in for tougher times than expected.’