It is well known dirty secret that the UK fund industry has been one of the most lucrative fund markets for more than 20 years. It has enjoyed the best of both worlds: the open competition of the US, allied to the higher fees of Europe.
A star manager culture has helped support higher charges and advisers bought in hook, line and sinker. Why else do you think so many large US fund managers came to the UK?
Many confuse funds under management (FUM) with profit or shareholder assets; the reality is that FUM is an input cost for asset houses. An asset business can run multibillion portfolios and still make a loss if its operating margin is wrong.
There is a term used in the fund industry but rarely openly discussed, it’s how much a fund manager can ‘sweat’ their assets (basically how much they can charge).
The implications of compressing fees are that large houses will be less able to sweat assets in future as margins fall. What are the signs – are the revenues of the larger houses going up or down?
Schroders reported £315 million in net revenue in Q3 2013, up from £246 million in Q3 2012. Excluding the addition of acquired Cazenove assets of £27.2 billion, Schroders’ assets over the same period went from £212 billion to £229.5 billion (£12 billion in investment returns and £5.5 billion in inflows).
That works out as £728 revenue for every £1 million assets in Q3 2013, compared to £846 revenue for every £1 million assets in Q3 2012.
Admittedly some of the earnings from the asset growth will have yet to be realised at the reporting date, but generally speaking earnings appear to be going up but at a slower rate than FUM. Looking at the earnings results of a few of the other IMA premiership revealed similar stories.
Now the UK market is going through the biggest reform since polarisation with the retail distribution review (RDR) and rising scrutiny over fund fees.
I suspect if the government weren’t looking into such a long-term savings abyss then it would be quite happy to keep the status quo and keep the taxes coming through the square mile.
It is early days but the biggest presumption made about RDR is that it will force fund managers to become price takers as customers become price makers.
RDR was designed primarily to target adviser standards in the industry and the coincident platform thematic review to unbundle fees. Fee unbundling should give customers more transparency but not necessarily more choice since that also relies on competition and a healthy fund market with many providers.
Large fund houses are responding by increasing their asset bases in order to lower operating break-even points and improve their economies of scale to offer lower charges.
As advisers and platforms find it increasingly difficult to insource the investment component then fund houses effectively become price makers. Smaller fund houses have far less leverage with distributors and therefore become the new price takers.
As the distribution landscape changes then so will the stratagem of fund houses. Some fund houses will target online, direct to consumers; others upstream high net worth and family offices. I used to be in cross-border fund strategy and appreciate just how tactical fund houses can be in order to win.
As fund selectors we have increasingly moved assets from the many fund managers to the few, creating burgeoning superfunds.
Be in no doubt that what we do is Darwinist, deliberate and divisive to the long-term competition of the fund market and long-term returns of our investors. Free competition, not regulation, is the best friend of the investor.
Jon ‘JB’ Beckett, chartered MCSI, was writing as author for the Chartered Institute for Securities & Investments. He is also a gatekeeper for a well-known UK bank and one of the UK’s largest pension unit-linked fund ranges