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Unbundling costs to weigh on fund group's profits

Unbundling costs to weigh on fund group's profits

Investors were given one of the first real-world previews of how fee unbundling could affect listed fund managers last week, when Bank of America Merrill Lynch (BoAML) slashed its Schroder price target by 14%.

BoAML cut its guidance from buy to underperform and reduced its target from £28 to £24 (currently trading at £22.13). It said while the eventual impact of the proposed changes to EU regulations remained ‘uncallable’, it is applying a 10% discount to fair price for all asset managers affected by the EU rules.

‘We still think it is a quality business with a strong product range,’ said BoAML analyst Philip Middleton. ‘[But] we think it is likely to generate lacklustre returns at least until the regulatory landscape clears.’

Schroder fell more than 3% on the day following the research and is down almost 10% over the previous month versus a FTSE 350 loss of 6.45%.

While proposed European Securities and Market Authority (Esma) changes to rules on fees and payments cover a range of issues, they will primarily affect fund houses in how they pay for research.

Esma last year proposed resolving concerns about potential conflicts of interest by making fund houses pay explicitly for sell-side research, rather than implicitly via placed business.

‘Should the European Commission decide to unbundle commissions, we see more downside to [Schroders], though should the reverse occur, there would be upside,’ added Middleton. ‘Absent unbundling, the stock would be reasonably good value at current levels. However, we think this is likely to remain a drag on performance until the situation is resolved for better or worse, hence
our underperform.’

Research issued by Frost Consulting at the time estimated asset management could face a £3.08 billion hit on the rules, or more than half their active equity profit margins.

‘If the proposed legislation went ahead there would be a widespread impact on profit margins, as asset management firms would be required to pay for research out of their own accounts,’ said Kames UK equity analyst Alice Cooper. 

While agreeing it remained ‘unclear’ what effect the proposals might have or if they would ever reach the rule books, she added the changes were of a piece with the wider trend of regulation. 

‘[It] would only increase the polarisation between the winners and the losers in the industry. [Companies] need to show they can innovate, be nimble, and produce what the customer wants.’

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