The commentary from Morningstar analysts has looked at the effects of the COVID-19 crisis for the asset management industry, noting the disruptions have shaken up a wide range of investment management companies, from mutual fund managers to hedge funds to specialist alternative asset firms.
For most investment managers, the drop in markets and increased volatility have resulted in a direct negative impact on revenue generation and cash flow, because of declining assets under management (AUM) as investors pull out alongside declining market values for managed funds, resulting in lower fee income.
For the period ahead, Morningstar has cautioned the investment mangers most at risk are the ones with high fixed expenses with limited ability to reduce costs – weakened AUM and revenue could constrain a company’s ability to renew its credit line, roll its debt and meet its obligations. Investments on their balance sheets may also suffer losses.
While the report has concluded larger investment managers with extensive distribution capabilities have maintained their AUM base and profitability, smaller companies stand to lose – a result that may see “further amalgamation in an already-consolidating industry”.
If the current volatility stretches to a prolonged recession, unemployment is likely to rise, leading retail investors to liquidate funds to pay necessary expenses – ultimately leading to further falls in AUM, reduced fee income and earnings for investment managers.
Hence, investment managers with a higher proportion of business in the retail segment will be more challenged than those whose client base primarily comprises institutional investors.
Morningstar added retail funds generally do not have lock-up periods or disincentives to withdraw funds, factors that can slow the outflows. Here, closed-end funds are also better positioned to withstand market meltdowns over open-end funds, as a seller must find a buyer to redeem their holdings.
Morningstar estimated actively managed US equity funds saw net outflows of around US$200 billion in 2019.
Another risk, the analysis noted, arises with the liquidity of assets – for funds that are invested in illiquid assets, the combination of high withdrawals and volatile markets can cause liquidity problems, as fund managers struggle to liquidate assets at acceptable prices.
But the analysis has remained somewhat optimistic – saying if the return in normalcy is in a short timeframe, it will mitigate any negative long-lasting impact on an investment manager.
“A downturn has the potential to give active managers an opportunity to demonstrate their value proposition and beat the indices – something that has been difficult for most to achieve over the past few years,” the report said.
Product diversity, strong relationships remain key
Many asset managers, Morningstar reported, were already facing a number of headwinds, including pressure on management fees, increased regulatory scrutiny and a sustained trend of outflows out of actively managed funds into lower cost passive funds.
But those who offer complementary services may be able to withstand the storm, as investors will likely have a deeper relationship and ties with it, Morningstar said.
Another advantage may lie in offering a diversity of funds and products, as some strategies will perform better than others, such as low-volatility funds. Investment managers that offer bond and money market funds along with equity funds may be able to capture the transfer of assets from one fund to another, rather than lose the customer altogether.
Further, investors that place money into balanced funds or longer term target date funds will be less likely to redeem their investments, as those funds encourage a longer term approach to investment.
But funds that offer a narrow set of niche strategies may be more susceptible, if they focus in on certain sectors such as retail, consumer goods and tourism or if they’re honed in on regions or countries that are more affected.
