Low-cost index funds, which continue to squeeze traditional active asset managers, work best in markets that are transparent and efficient. That’s why managers that have moved into the kinds of complex alternative investments and private markets that have so far been resistant to passive strategies have weathered fee pressures better than most.
But that strategy comes with an increase in operational risks and a potential hit to an asset manager’s reputation if things go wrong, according to a Fitch report on the industry, released Thursday.
There’s a reason asset managers can charge more to oversee less-liquid strategies. Alternatives are often complex and require specialized expertise.
Regulators and others are focusing on the risks that may arise when traditional firms expand into alternatives to increase assets and fees, according to Fitch’s report.
Fitch is concerned about the potential for problems when it comes to liquidity, a problem that has engulfed some high-profile funds in the U.K. and Europe this year. Woodford Funds, for example, prevented investors from accessing their money after the manager had trouble selling some illiquid securities.
“In particular, the recent gating of the LF Woodford Equity Income Fund in the UK has highlighted the need for fund structures to be aligned to the underlying investments held in order to limit liquidity risks,” according to the Fitch report. “This could be a particular concern for traditional IMs [investment managers] investing in less liquid assets but adopting an open-ended fund structure which can leave these funds prone to ‘runs’ when risk aversion sets in.”
But Evgeny Konovalov, director in non-bank financial institutions at Fitch, said in an interview that he’s less concerned about the issue when it comes to the large asset managers that Fitch rates in the U.S.
“From the U.S, standpoint, we have traditional big guys investing into alternative funds like Invesco. But Invesco has been in those strategies for years,” said Konovalov. “They have quite a bit of experience.”
Smaller managers moving into new areas such as emerging markets and alternatives may face more constraints than their larger peers, he explained. “These [assets] require unique expertise that they may not have,” he said.
Azadeh Sharif, also a director in non-bank financial institutions at Fitch, added in the interview that liquidity is not a risk to managers’ solvency or to the markets in the U.S. right now.
“It’s more an operational risk,” she said. “If they have to gate certain funds, it would impact their reputation. And that would impact asset flows, and their fees.”
According to the ratings agency, asset managers have been looking for ways to handle redemption risks by increasing their liquidity with credit lines and other measures and by targeting institutional clients.
“However, the larger institutional mandates do come with their own risks. They are typically more fee-sensitive and, if switched to other managers or internalized, can cause significant AUM effects as was seen at several IMs in 2018,” the report stated. Amundi and Schroder had significant institutional outflows in 2018, according to Fitch.
Asset managers rated by Fitch had mixed performance results last year. For the most part, “Net inflows were below recent historical levels as investors appeared wary of committing new capital,” according to the report.
Between the sell off in the fourth quarter of last year, and now trade wars and Brexit, “everything is very volatile,” said Sharif, adding that investors remain skittish on allocating more to asset managers.