Investment Managers face declining institutional flows, but confidence remains high.
The latest quarterly Investment Management index, released by Ernst & Young this morning, indicates that rising equity markets continue to support strong confidence in the investment management market. The JSE ALSI index rose 8% during the 2nd quarter of 2007, following a strong 11% rise in the first quarter. This continued growth in the stock markets resulted in rising income for investment managers. However, it appears that growth in income and profits may be slowing.
Other findings include the fact that investment managers face slowing institutional flows, the largest portion of their business. Large investment managers suffered institutional fund outflows. In the case of small managers, they continued to grow institutional inflows, but at lower levels.
Says Lesley Harvey, spokesperson for the Ernst & Young Investment Management Group: "We believe that, to some extent, institutional moneys, certainly in the form of long term insurance products and possibly also in the form of retirement funds, are being channeled into unit trust funds. The survey data supports this. However, it appears that not all institutional moneys being lost by the large investment managers are finding their way into unit trust funds."
Continues Harvey: "Large managers have struggled more than their smaller rivals, to attract institutional funds. South Africa is very much following a global trend where boutique managers, typically smaller, niche organisations, attract funds to be managed according to a very specific mandate or process. Institutions often move their funds to benefit from a boutique's skills sets and investment style. In addition, retirement funds are attracted to the fee structures offered by boutique managers, which are usually performance-based rather than a flat rate that is applied to the funds under management. That largely explains why smaller managers have been more successful than their larger peers at attracting retirement funds."
Large managers are, however, heeding their customers interest in the boutiques' differentiating factors. There has clearly been a shift from flat investment management fees to performance fees and some large managers have restructured their businesses into smaller specialist units. The dependence that boutique managers have on few individuals is not an issue for large managers.
The 2nd quarter findings indicate that despite small managers fund inflows rising overall, they were less confident than they were in the previous quarter. Business confidence for the small investment managers fell from 100 index points to 92 points. Harvey explains: "The downturn can be explained with reference to the quarter under review combined with the expectations of the small managers for the next quarter. Although new business continued to flow into small managers, the pace at which it expanded in the last quarter slowed in all areas other than private clients. This slowing of new business is expected to continue into the next quarter. Costs continued to increase in the quarter, resulting in slowing growth in net profits. For the quarter ahead, small managers anticipate sharply slowing growth in income levels, which we interpret as expected slowing of the rampant markets we have seen over the last two years. Whilst the drop in confidence is not a significant fall, it could be the beginning of a downturn in the investment management market."
Large investment managers saw continued strong confidence, with a reading of 100 index points, the maximum level. This is the eleventh consecutive quarter that confidence levels have remained at the maximum. Says Harvey: "Net profits remain robust, supported by rising markets and strong unit trust inflows, across both the retail and institutional markets, resulting in increased assets under management. She continues: Furthermore, large managers experienced a very welcome rise in average management fees, supported by strongly rising performance fees."
One aspect which must be of concern to large investment managers is their rising costs. Similar to the banking industry, investment managers have incurred significant expenses beefing up capacity, and whilst rising income levels support rising costs, a downturn in inflows growth could lead to a situation where profits growth comes under pressure, particularly if this is coupled with a downturn in markets.
Concludes Harvey: "The industry expects that institutional fund flows will continue to fall. Large managers are suffering institutional fund outflows, as they compete with boutique managers and alternative asset classes.. The retail market is also likely to be squeezed in the months ahead, with higher interest rates and rising inflation leaving smaller funds available for investment purposes. The expectation is thus that inflows are likely to slow, and coupled with less bullish equity markets, income levels are likely to taper off. This is no different to the banking index, where slower income and high and sustained cost growth is starting to squeeze profits."
