The easy gains of the long-gone bull market encouraged profligacy at many asset managers. Now spiraling costs threaten to eat away at already thinning profit margins.
By Andrew Capon
November 2001
Institutional Investor Magazine
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Lulled into a state of complacency by the nonstop gains of the late 1990s, money managers found themselves unprepared for last year's nasty lurch. Returns fell, asset growth slowed, and suddenly, investment management didn't seem like such a sweet business after all.
The good times, it turns out, masked an underlying weakness of many firms: spiraling costs, especially in back office, administration and information technology, that now threaten to further erode profit margins already weakened by the bear market. According to a recent PricewaterhouseCoopers survey, unit costs (stripping out the effects of market gains or losses) for 2000 ended up 10 percent over 1999 and more than 20 percent above the 1998 level.
As a result, operating margins for European money managers fell from 29.2 percent in 1999 to 28.1 percent in 2000. PWC reckons that if the markets remain in the doldrums, margins could fall as low as 15 percent this year. But in light of the even grimmer economic outlook that's emerged after the recent terrorist attacks in New York and Washington, the lower margins may arrive still sooner.
To bolster margins, or at least stave off further declines, money managers are working both sides of the new euro coin, trying to simultaneously reduce costs and boost revenues by attracting net new inflows. Says Heinz Haemmerli, global head of investment funds at UBS Asset Management, "The downturn in markets creates enormous pressure to generate new business."
Overall, the Euro 100 firms saw their total assets under management rise from E12.9 trillion to E15.7 trillion between 1999 and 2000. Every one of the top ten firms saw its totals jump. In many cases, though, the gains came from acquisitions, not organic growth, which is one reason 2001 will almost certainly show significant declines.
Indeed, last year saw a spate of landmark M&A deals as European financial services firms rushed to create global platforms. In May UniCredito Italiano paid $1.2 billion for Boston-based Pioneer Group, which had $22.3 billion under management at the end of 2000. In June South African insurer Old Mutual bought United Asset Management Corp.'s motley mix of U.S. investment managers, which claimed $203 billion in assets. And in October Allianz Group bolstered its presence in U.S. asset management by buying Nicholas-Applegate Capital Management, which had $45 billion in assets. That followed the firm's 1999 purchase of $250 billion-in-assets bond powerhouse Pimco Advisors.
ABN Amro's 1995 purchase of Chicago Corp., a midmarket investment bank and asset manager, is widely regarded as a textbook case of everything that can go wrong with an acquisition. (Almost 40 percent of the 1,000 staffers left, along with most of the firm's $3 billion in assets under management.) That didn't stop ABN Amro from paying $825 million for Alleghany Asset Management last year.
Credit Suisse Group, which moves up from No. 4 to No. 2 in the ranking, has gained assets from Donaldson, Lufkin & Jenrette, which it bought in August 2000 for $8 billion. Its asset total jumped from E735 billion in 1999 to E932 billion last year. At the same time, its pretax margin declined from 22.5 percent to 21.9 percent.
UBS, the No. 1 firm in both 1999 and 2000, is now bolstered by the private client and mutual fund business of PaineWebber, which it acquired last November. It ended 2000 with E1.6 trillion, up from E1.09 trillion. However, the performance of UBS Asset Management slipped as assets fell 13 percent and pretax profits declined 26 percent. Rebounding investment performance in 2001 has seen these outflows reverse, as profits gained 9.6 percent in the second quarter.
Axa Group, the third-ranked firm, managed to buck the crowd in reporting organic asset growth. The firm's total increased from E781 billion to E893 billion. Gross revenues from asset management across Axa Group increased 21.3 percent in 2000 over 1999.
But industrywide, margins are coming under renewed pressure as investors grow more risk-averse. UBS's Haemmerli reports a meaningful "shift in asset allocation away from aggressive equity funds and into defensive fixed-income and money markets products." Through July equity funds pulled in $19.1 billion, versus $126.6 billion for the same period in 2000. Since a money manager will charge a typical active international equity account between 30 and 75 basis points for institutional customers, versus 10 to 35 basis points for fixed-income accounts, the change drops straight to the bottom line. This shift to bonds may well accelerate as investors seek a safe harbor amid increasingly volatile political conditions around the world.
As markets slide and margins fall, managers are paying especially close attention to back-office expenses, which galloped along with the bull market and grew faster than either payroll expenses or IT costs. "Administration and custody may be dull, but they are important," says Donald Brydon, chairman and CEO of Axa Investment Managers. "People used to say about this business that you don't get to be great by controlling costs. My belief is those who can both grow and control costs will reap the benefits."
Adds Mark Austin, head of strategy at J.P. Morgan Investor Services in London: "In current markets as front-office fees decline, back-office costs remain. It can't take long for this mismatch to feed through to significant pressure to reduce administration and back-office costs."
At UBS, says Haemmerli, the firm has scaled back the number of new product launches. It has also given marketing and advertising budgets a stringent "sanity check," he adds.
In this stark new environment, many European managers are deciding that they, like their U.S. counterparts, must choose between manufacturing and distributing investment products. Only a very few firms can succeed at both. In this respect, the sale of $38 billion U.K. money manager Foreign & Colonial Management by Germany's Bayerische Hypo- und Vereinsbank last December may prove to be a watershed transaction. Hypo decided that its strength lies in distributing other firms' funds, rather than in having its own manufacturing franchise.
"I think more banks will give up on asset management because it is a complex high-compensation craft with little predictability," says Richard Morris Jr., London-based president of investment bank Putnam Lovell Securities.
Deutsche Bank's $2.5 billion acquisition of ailing Zurich Scudder Investments is a transaction of a different sort, says Chas Burkhart, founder of Rosemont Investment Partners, a private equity fund that invests in asset managers. "There will always be the occasional desperate seller, but that's not a trend," he says.
An ongoing trend toward consolidation continues apace. In 2000 the top ten firms in the Euro 100 accounted for 48 percent of total assets, up from 45 percent in 1999 and 44 percent in 1998. Says Clive Bouch, partner and head of the U.K. fund management practice at Andersen: "Those who have a competitive edge already may find it sharpened further."
At the same time, the top 30 European money managers include only three independent firms (Invesco, Schroder Investment Management and ABP Investments), down from six in 1995. In contrast, the top 30 U.S. firms number seven independents (Fidelity Investments, Capital Group Cos., Vanguard Group, Amvescap, TIAA-CREF, Wellington Management Co. and Franklin Templeton Investments).
Although midsize players will be increasingly squeezed, the market leaders are relatively sanguine about their long-term prospects. Says UBS's Haemmerli, "In the long term this remains a fundamentally attractive, high-growth business." Of course, it never hurts to be No. 1.
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