The three-year bear market in stocks may be gone, but it’s not forgotten. Reduced revenues, tighter profit margins and more-intense competition for less-lucrative mandates have left Europe’s asset managers with little choice but to chop expenses ruthlessly.
“We all got lazy in this business and started to think our costs were fixed. If you change that mind-set and treat all costs as variable, it can give a major boost to the bottom line,” says Barclays Global Investors vice chairman Lindsay Tomlinson. Hurt in part by a decline in its European business, BGI’s global assets, as measured in euros, dropped 17.6 percent last year. But the firm kept such a tight lid on costs that it managed a remarkable 41 percent jump in profits.
Tomlinson and BGI’s major rivals have placed every expenditure under the microscope. A recent survey of European money managers by London-based consulting firms Create Research and KPMG International found that 60 percent of respondents have cut their costs by up to 20 percent since 2000 -- the remaining 40 percent have sliced even further. Amvescap has cut 800 jobs globally since the third quarter of 2002; Schroder Investment Management cut 490 jobs last year.
Among other things, BGI closed nine European exchange-traded funds. The reason was simple, says Tomlinson: “If it is not profitable, it is not business we are prepared to do.”
With the Standard & Poor’s 500 index up 18 percent and the MSCI Europe, Australasia and Far East index up 23 percent on a dollar basis this year through early October, money managers have seen a welcome boost in their assets and revenues since they closed their books for 2002. If they keep costs under control -- and money management CEOs vow to be vigilant on this front -- the industry’s profit outlook should improve significantly.
Says Amin Rajan, the founder and CEO of Create, “Money managers won’t unlearn the lessons of the bear market and allow their costs to bloat uncontrollably again.”
In good markets and bad, it always helps to be selling what institutional investors are buying. Last year some of the firms rising fastest in the 2003 Euro 100, Institutional Investor’s ranking of the region’s biggest money managers, exploited growing demand for specialist asset management. Last year assets at London-based Capital International, a unit of the U.S. Capital Group Cos., declined a modest 4 percent in euros (and were up 13.5 percent in dollar terms). Capital, which has an excellent reputation for specialist equity and bond management in the U.S., benefited greatly as U.K. institutions abandoned balanced (multiasset) managers in favor of firms with expertise in particular types of assets. Goldman Sachs Asset Management International, a unit of the New York-based investment bank, also benefited from the trend.
According to consulting firm Greenwich Associates, 56 percent of U.K. pension plans used specialist management in 2000. By the end of last year, that figure had risen to 89 percent. The move from balanced to specialist money management helped Capital more than double its U.K. institutional market share between 1999 and 2002, from 2 to 5 percent. Another beneficiary: Deutsche Asset Management, which grew its U.K. market share by 2 percentage points, to 9.2 percent, between 1999 and 2002.
Conversely, balanced experts like Merrill Lynch Investment Managers and Schroder have been hurt. In the mid-1990s MLIM’s predecessor money management group, Mercury Asset Management, and Schroder were the biggest of the Big Four that dominated U.K. pension fund management. Last year Schroder’s assets declined 25.1 percent in euros, and MLIM’s dropped 36 percent. (In dollar terms, MLIM assets were down 24.2 percent; in pounds sterling, Schroder’s assets lost 19.9 percent.) Between 1999 and 2002, MLIM lost 6 percentage points from its U.K. institutional market share, falling to 9.1 percent, and Schroder fell 4.5 percentage points, to 9 percent.
Throughout the industry, outsourcing of noncore functions has become a favorite cost-cutting strategy. London’s F&C Management, with E92.5 billion ($97 billion) in assets, is turning over its 95-person administrative group to Mellon Global Securities Services to run; Edinburgh-based Standard Life Investments has given Citigroup the go-ahead to run its back office globally; and DeAM has outsourced the back-office administration of more than half of its assets worldwide to State Street Corp. in a ten-year contract. As DeAM global CEO Thomas Hughes explains: “We are a fund manager, and our focus is on investment performance. Where there is an opportunity to outsource areas not focused on investment performance, we would obviously capitalize on those opportunities.”
European fund managers’ zeal for cost containment is the result of sharp pressure on the revenue side of their ledgers. Despite the impressive rally in shares that started last spring, the MSCI Europe index is still down about 40 percent from its March 2000 high. The direct impact on assets is apparent in the Euro 100. Europe’s leading firms have suffered a 9.5 percent decline in total assets since 2000, from E15.7 trillion to E14.2 trillion. Only one of the top ten managers, DeAM, recorded a gain -- thanks to its May 2002 purchase of U.S.-based Zurich Scudder Investments. All told, 84 of the top 100 companies managed fewer assets at the end of 2002 than they did at the start. Only 13 had more. (One firm had the same assets, and two did not provide comparable year-earlier figures.)
The asset declines reflect not only investment losses but a decrease in the flow of new money. London-based data gatherer Feri Fund Market Information reports that net sales of mutual funds in Europe saw a year-on-year decline of 52 percent, to E98.3 billion, in 2002. That was 80 percent below the 2000 sales peak, says the firm, a subsidiary of German independent financial adviser Feri Trust. “I still believe that there is a trend toward financial asset accumulation in the retail sector,” says Martin Porter, chief investment officer of J.P. Morgan Fleming Asset Management, “but that still doesn’t add up to the double-digit growth that fund managers have enjoyed in the past.”
The bulk of new retail money has been flowing toward lower-risk bonds and cash, where management fees are half those for stocks, and, on the opposite end of the risk spectrum, to hedge funds.
With fund managers eager to boost margins, the lure of alternative assets is strong. Last year saw a rash of acquisitions in the sector. Man Group reinforced its position as the world’s largest purveyor of hedge funds with its $913 million purchase of Swiss-based fund-of-hedge-funds manager RMF. In May, UniCredito Italiano acquired London-based Momentum Group for $110 million. The spending spree may be timely. According to a recent survey of European pension funds by J.P. Morgan Fleming, 37 percent of respondents were considering investing in hedge funds, and 60 percent of those potential investors were considering tapping the asset class via funds of funds.
The revenue picture on the institutional side of the market is not pretty. Overseeing a shrinking pool of assets and, in many cases, funding shortfalls, pension funds are pressuring money managers to rein in fees and thus boost their plans’ total returns. Watson Wyatt Worldwide, a London-based consulting firm that advises institutional investors, advocates that the industry’s standard payment system -- ad valorem fees based on a percentage of assets under management -- be altered. “We would like to see a fee structure with a fixed component and a variable piece based on performance rather than funds under management,” says Roger Urwin, Watson Wyatt’s global head of investment consulting. Under such a system a small group of top performers would generate more revenue, but the majority would see their takes cut further.
Even stringent cost-cutting hasn’t offset the revenue problems at most firms. Publicly held Amvescap, a London-based firm that finished ninth this year with E311 billion in assets, down 31 percent from E449 billion in 2001, has seen its operating margins fall by 5 percent a year for the past three years, to 26 percent, according to a Morgan Stanley research estimate. Profits fell to £8.1 million ($13.4 million) in the first half of 2003, down from £21.9 million during the comparable period last year. The margin pressure is occurring despite Amvescap’s aggressive cost-cutting: The firm reduced expenditures by 12 percent year-on-year through the first half of 2003.
Yet Amvescap is faring better than some. Boston Consulting Group’s London unit calculates that 20 percent of asset managers are losing money and an additional 20 percent are only marginally profitable, despite the sharp rally in equity prices. And BCG grimly predicts that global asset managers will grow revenues at an average annual rate of between 0.7 percent and 6 percent through 2006. In the heady years of the bull market, between 1995 and 2000, revenues grew on average 14 percent a year.
“When you reduce the run rate of a business from double-digit compound growth to half that, it has a dramatic effect,” says David Sachon, head of distribution at $75 billion-in-assets Threadneedle Investments, which was recently sold to American Express Co. for $570 million. “The way you run your business has to change fundamentally.”
One area where change is needed: personnel, which accounts for some 60 percent of total outlays at most money managers. In Create’s survey four out of five asset managers cut payroll in 2002. More than half said cash compensation would fall by more than 10 percent this year. In addition, 40 percent of the firms surveyed have implemented a performance-based payment system, more than double the number last year. Most of the job eliminations have come at the staff level: Even in a bear market, top investment professionals can still command salaries of £600,000 or more, according to City-based headhunter Sheffield Haworth.
Another fundamental and costly part of the business -- retail distribution -- has proved more difficult to rein in. Banks control 70 percent of mutual fund distribution in Europe (more than three times their share in markets such as the U.S.), and they charge asset managers a pretty penny for shelf space. According to BCG, European distributors keep 57 percent of gross revenues from each new account, compared with 41 percent in the U.S.
Fund supermarkets such as Cofunds in the U.K. and E-Cortal in France have arrived in the past few years, but they haven’t loosened the grip of traditional distributors. “The power,” says Threadneedle’s Sachon, “is still in the hands of a few banks and insurers.”
When share prices and asset levels were rising several years ago, most money managers could afford to ignore these facts of life. “Once upon a time -- during the late bull market -- a rising tide lifted all boats. Now that tide has ebbed, and it has left many players exposed,” says J.P. Morgan Fleming’s Porter. Some of those exposed players may sell out or merge with stronger firms; the industry is likely to consolidate in the coming years.
With the exception of hedge funds, promising growth opportunities are hard to find. As a result, competition to win a shrinking number of mandates is fiercer than ever. “When we win, we are ensuring that another firm loses,” says Nigel Wightman, head of State Street Global Advisors in the U.K. “The competition is tooth-and-claw, and this is an environment we’re not used to.”
Top-notch investment performance is the only guarantee of survival in this bruising environment. In Germany, for example, mutual funds that can boast returns in the top third of their particular niches attract 60 percent of all flows, according to Morgan Stanley. In the U.K., funds in the top third get 71 percent of the new money, estimates BCG.
Says DeAM’s Hughes, “To succeed in the retail marketplace, you need four- or five-star funds” from S&P or some comparable validation of long-term performance and high-quality service. On the institutional side, he says: “You need top-quartile performance. That’s the bottom line.”
Even if the recent rally is sustained, money management experts believe that double-digit growth is over for the foreseeable future. “The bear market had been very painful for the industry,” says Create’s Rajan. Only the most irresponsible executives will allow expenses to rise sharply over the next few years.
GSAM pleased to see Europeans adopt American ways
U.S. firms have been the biggest beneficiaries of the shift in the U.K. marketplace from balanced accounts encompassing bonds and stocks to narrower, specialist mandates focusing on individual asset classes. That’s not surprising, since they’ve been competing for tightly defined assignments at home for many years. One firm that’s winning mandates: Goldman Sachs Asset Management International, which last year gained a half percentage point in market share, to nearly 6 percent, reaping gains in specialist assignments. GSAM maintained its No. 51 ranking in Institutional Investor’s Euro 100.
“We didn’t get there overnight,” says Suzanne Donohoe, a Georgetown University and Wharton School of the University of Pennsylvania graduate, who co-heads GSAM’s European business. “It took a lot of work with clients. Frankly, if market practices had not changed and funds been forced to rethink how their assets were managed, it might have happened more slowly.”
As pension funds search for alpha -- the ability to outperform the market -- they are increasingly drawn to managers with a range of specific investment expertise, Donohoe believes. “Some of our bestselling products have been overlays for currency, GTAA [global tactical asset allocation] and funds of hedge funds. But we have also been selling bonds and equity. Investors are looking for alpha wherever they can find it.”
In 2002, Skandia Liv in Sweden and ABB Investment Foundation in Switzerland signed on for GSAM hedge funds of funds; Dutch metalworkers fund Pensioenfond Metalektro allocated money to the firm’s GTAA accounts. But GSAM has also won bread-and-butter international equities accounts from AP-Fonden in Sweden and GE Life in the U.K.
At the start of 1996, GSAM reported just $45 billion in global assets under management, even then a paltry sum. In Europe a staff of 20 managed a handful of global products, mostly for U.S. clients. At the end of September 2003, GSAM boasted worldwide assets of $415 billion, including $82 billion from European clients; its European payroll now totals 400.
In 1996, Goldman, Sachs & Co. bought for a reported $60 million the exclusive right to manage $22 billion in assets of the Coal Board Pension Scheme in the U.K. for seven years. Later that year it paid $60 million for $4.5 billion-in-assets U.S. growth equities house Liberty International Holdings. In May 1997 it completed its acquisition spree, buying $1.8 billion-in-assets Princeton-based hedge fund specialist Commodities Corp.
Since then GSAM has been content to rely on organic growth. “One of our business principles states that we’d rather be the best than the biggest,” says Donohoe. “In fact, we realize that size can sometimes be a challenge in the fund management business.” Until that happens she is happy to pile on new assets. -- A.C.
Off balance
The shift from balanced to specialist money management has hurt many firms on the Euro 100, but none more than Merrill Lynch Investment Managers, which has seen its European assets fall from $150 billion at the end of 2001 to $114 billion a year later, a 24 percent decline. In Institutional Investor’s Euro 100, it fell from No. 23 to No. 33.
In the U.K. today less than 15 percent of domestic mandates are balanced, down two thirds in five years. That’s one reason why MLIM, which specializes in a balanced (multiasset) approach, lost 6 percentage points of its U.K. market share between 1999 and year-end 2002, falling to 9.1 percent. During the same period, Schroder Investment Management, another balanced money manager, lost 4.5 percentage points in market share, declining 9 percent, according to a recent Morgan Stanley research report.
Merrill Lynch & Co. has struggled in the U.K. and Europe since 1997, when it paid a hefty $5.33 billion to acquire Mercury Asset Management, a big U.K. fund management company, and merged its business into a new global platform, MLIM. Mediocre portfolio performance and the larger shift away from balanced management have hit MLIM hard, leading to client losses and staff defections.
Nor has MLIM completely shaken off the damage to its reputation that followed a 1999 lawsuit by client Unilever. The pension plan of the Dutch consumer-products company sued MLIM for £130 million ($190 million), claiming negligent asset management. The case was settled in 2001 for an undisclosed amount widely reported to be £75 million. Last year MLIM also made an out-of-court settlement with J Sainsbury, a supermarket chain, over similar issues for an undisclosed amount.
“Merrill hasn’t gotten completely past these charges,” says one investment consultant. “It’s hard to overcome such a legacy.”
A rash of MLIM executives departed in 2001, including co-heads Carol Galley and Stephen Zimmerman and global head of marketing Colin Clark. Last year the firm saw more investment professionals leave, including Anne Richards, head of the Alpha team. This year the talent drain has continued, with the departure of specialist equities team members Richard Milliken, Steve Thompson and Mark Wharrier. Says Ian Peart, head of manager research at London-based consulting firm Hewitt Bacon & Woodrow, “It’s like they’ve had their heart ripped out.”
MLIM spokesman Nigel Webb points out that the number of voluntary departures from the firm was below the industry average for the past 12 months. MLIM has also picked up some 40 new pension accounts, including £410 million in a range of strategies from U.K. engineering group IMI. Asserts spokesman Webb, “Business is good.” -- Priya Malhotra
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