Investment Managers face net outflows of funds

Confidence in the investment management industry rose in the 2nd quarter, despite contracting inflows and slowing income growth, the latest Ernst & Young Investment Management index results reveal.

This is the 22nd 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 rose moderately during the quarter, reaching 81 index points, up from 77 in the first quarter. Chris Sickle, Investment Management director at Ernst & Young comments, ‘We suspect that the stronger confidence in the sector is as a result of stronger equity markets. The JSE reached fresh all-time highs during May, despite a lot of uncertainty in the market about overall economic conditions.’

He continues, ‘Whilst there is uncertainty about global economic prospects, and indeed about our own local economic fundamentals, our stock market has benefitted from strong and rising commodity prices. This has led the resources sector to reach new highs during the quarter under review, with platinum and other resource companies’ share prices going from strength to strength.’

Whilst large investment managers reported stable confidence levels, small managers saw a turnaround, from 61 to 74 index points. Says Chris Sickle, ‘The basic fundamentals have not changed since the first quarter. Indeed, margins remain under pressure, there is a net outflow of funds managed by the small and large investment managers alike, and as a result, profits growth is contracting. In fact, the pressure on small investment managers is greater than that faced by the large managers, so one would almost have expected that if anything, confidence for the small managers would have declined further in the 2nd quarter.’

Continues Sickle, ‘For the second consecutive quarter, investment managers have reported contracting fund flows. The contraction took place in the small manager sector of the market. Large managers saw flat levels of funds under management, with institutional business offsetting substantially lower unit trust and private client flows. Small managers, by contrast, reported a contraction across all three categories of funds, in stark contrast to the last few years, when small managers were successfully taking a much larger portion of institutional fund mandates.’



This is the first time since the survey’s inception 5 ½ years ago that there has been a net outflow of funds for two consecutive quarters. Comments Sickle again, ‘Institutional fund flows have been flat, whilst the retail segments (private clients and unit trusts) both responded to the volatility in the stock market via a net contraction in fund flows. Although the JSE did hit new all-time highs during May, the volatility has been much more pronounced recently. Actually, the strong bourse is led almost solely by the resources sector. Other sectors are, for the most part, responding to local economic drivers, and as a result, their direction tends to be downwards.’

Sickle continues, ‘Typically, institutional flows tend to be more erratic than other categories, and are not as directly correlated to stock market movements as what the other (retail) segments are. Typically institutional inflows are more inclined to respond to growing employment prospects and corporate growth prospects. Whilst some industries (such as resources) are performing strongly, many other sectors are struggling, thereby impeding the overall growth in institutional flows.’

The 2nd quarter Investment Management index findings also reveal that operating margins are under pressure, in turn impacting net profits growth. For two consecutive quarters, income growth has fallen sharply, whilst cost growth remains at considerably higher levels. That is to say, cost growth has not moderated in line with slowing revenues. Comments Sickle, ‘Often, expenditure is long-term in nature, and cannot simply be eliminated or slowed in a single quarter. But we expect that over time, expenditure will slow in line with revenue growth. The investment managers are already slowing down their pace of employee hiring, and marketing and distribution cost growth is at lower levels than what we have historically seen.

Concludes Sickle, ‘Over time, operating margins are likely to expand, as investment managers adjust their spending levels in a slower inflow and revenue growth environment. But at the moment, small investment managers are feeling the pinch of slowing market conditions more than their large counterparts. Small managers thus have a need to curtail expenses more urgently than their large rivals. But this may hurt their competitive positioning if marketing costs are curtailed, unless they have a particular niche that is not easily replicated by a larger operation. Both large and small managers are of the opinion that the 2nd quarter drop in net inflows will turn out to be a temporary phenomenon and that total inflows will bounce back in the 3rd quarter.’