Money managers see local clients in emerging markets as key to growth

Emerging markets have been a cyclical investment story, but the growing importance of having local clients from those markets should be a secular one for global money managers flexible enough to exploit the opportunities.

In Asia, Latin America and, eventually, Africa, growing economic muscle and wealth will power that trend.

PricewaterhouseCoopers, in a January report on the global money management industry, projected assets under management for those continents will grow an annualized 10% or more between 2012 and 2020, compared with the roughly 5% rate it predicts for Europe and North America.

And New York-based Oliver Wyman Group, the global management consulting firm, sees emerging market clients accounting for 17% of $106 trillion in global managed assets by 2020, or $18 trillion, up from 12%, or $9 trillion, of $75 trillion globally at the end of 2013, said Toby Pittaway, a Singapore-based partner with the firm.

“Fifteen or 20 years ago, for a firm like ours ... defined benefit plans in the U.S. and Europe” would have been the client base, but the trend now is away from active management, effectively “taking risk off the table in a big way,” said Jim McCaughan, New York-based CEO of Principal Global Investors.

Instead, “it's the growing pools around the world” that are more the source of growth now, said Mr. McCaughan. Emerging markets clients account for roughly a third of the $550 billion in assets under management for PGI and parent company Principal Financial Group's other money management affiliates, up from almost nothing 20 years ago, he noted.

For money managers, “it's a tale of two worlds ... the world of the present,” where North American and European clients account for 80% to 85% of firms' AUM, and a future that is being shaped by relatively strong growth in emerging markets client assets, said Kai Sotorp, president and CEO of Toronto-based Manulife Asset Management.

While all corners of the emerging markets universe are poised to see their managed assets grow at a faster pace than developed markets, the current scale of Asia's wealth makes that region the focus of most managers' forays into emerging markets.

PwC predicts Asia's managed assets will surge to $16.2 trillion by 2020, or 66% of an emerging markets total of $24.4 trillion, up from $7.7 trillion, or 70%, of $11 trillion at the end of 2012.

For Manulife, with its “Asia-biased footprint,” growing demand from sovereign wealth funds, local pension funds and high-net-worth individuals has left emerging markets clients accounting for well over 10% of its $312 billion in AUM as of June 30, up from 5% to 6% five years ago, said Mr. Sotorp. Mass-affluent investors, meanwhile, should become a bigger part of the story in the future, he said.

Other managers report similar trends. Emerging markets “are a growing source of clients and flows” for Greenwich, Conn.-based AQR Capital Management LLC, with Asia and the Middle East growing to almost 10% of $136 billion today from a negligible portion of the firm's $23 billion in assets under management five years ago, said Gregor M. Andrade, a principal overseeing AQR's international client relationships.

Some firms are just putting a foundation in place now. Data provider eVestment pegged emerging markets clients at less than 1% of Austin, Texas-based Dimensional Fund Advisors LP's $406 billion in AUM as of June 30, but the firm is committing considerable resources now to pursue opportunities down the road, said Peng Chen, CEO of Dimensional Asia (ex-Japan) and global chairman of the firm's retirement practice. Mr. Chen opened a Singapore office for the firm at the end of 2012.

Analysts expect a growing list of U.S. and European-based money managers to follow suit.

Increasingly, “fund managers in the developed world will need an emerging markets strategy that's comprehensive — not just investing, but investing on behalf of emerging markets investors,” said Daniel Celeghin, a Hong Kong-based partner and head of Asia-Pacific with Casey Quirk & Associates LLC, a consultant to the money management industry.

The level of inquiries from global managers looking for expansion opportunities — as their home markets become saturated — is picking up, said Graeme McKenzie, a Sydney-based partner and Asia-Pacific wealth and asset management leader with Ernst & Young.

Still, it's easy to be so dazzled by the numbers — whether it's the demographic data on China, India and Indonesia, or the expected growth in wealth — that the significant time and effort needed to build emerging markets client businesses can be underappreciated, Mr. McKenzie said.

A broad footprint in emerging markets and brand-name cachet have helped the BlackRocks, Wellingtons, Invescos, Franklin Templetons and Goldman Sachses of the world raise the lion's share of money from emerging markets clients; it's a lot tougher for boutique shops to get noticed, said Jeffery Schutes, senior partner, investment business leader, growth markets with Mercer LLC in Atlanta. Those global managers all have “great upside in emerging markets,” Mr. Schutes said.

For now, the first stops for most global managers in emerging markets are the two or three top pools of institutional capital in each country, which typically include the central bank, a sovereign wealth fund and a national pension plan or provident fund.

J.P. Morgan Asset Management's business serving that “tripod” of asset owners in emerging markets has grown “significantly over the last 10 years” to more than $90 billion, said Michael O'Brien, London-based managing director and CEO for Europe, the Middle East and Africa in JPMAM's global investment management business, as well as co-head of the firm's global investment management solutions.

All managers are “very focused” on those large, important clients, agreed Mark Talbot, Hong Kong-based managing director, Asia Pacific ex-Japan, with Fidelity Worldwide Investment.

And those bulge-bracket investors should remain at the center of managers' radar screens, even if the economic turmoil of the past year clouds their outlook for now.

Sovereign wealth funds have offered big opportunities for managers in the past five years, but the falloff in oil prices and pinched government finances this year might slow their asset growth for the time being, said Paul Price, London-based managing director and global head of distribution for Morgan Stanley Investment Management.

Central banks, however, should continue to offer opportunities, amid a “sea change” in recent years in their willingness to pursue illiquidity premiums to enhance yield, Mr. Price said.

Still, money management executives said other client segments — including high-net-worth investors and family offices, as well as private pension funds and retirement savings vehicles — could ultimately become equally or more important.

With competition for those sovereign capital pools so fierce, and the fee pressures so great, it's tough for firms to make that segment “the be-all-and-end-all” of their emerging markets businesses, PGI's Mr. McCaughan said.

“One of the areas we're thinking will be important to us going forward is Asian private wealth,” as money transitions from the “original entrepreneurial generation” to a next generation more inclined to think about diversification and global investing, Mr. McCaughan said.

Fidelity's Mr. Talbot said private pension and retirement savings — an underdeveloped part of Asia's financial landscape — will inevitably blossom. “In some shape or form, it kind of has to,” he said.

And it could happen relatively quickly, some predict. Within 10 to 15 years, the size of Asia's mass-affluent middle class could be eight times that of North America's, with twice as much wealth and 400 million to 500 million people heading to retirement, said Manulife's Mr. Sotorp. In terms of demand for more sophisticated investment strategies, combining insurance, retirement and death benefits, that market will be “coming up the demand curve very rapidly,” he said.

If the big sovereign wealth funds are the obvious “low-hanging fruit” in emerging markets, then the not-yet-ripe, private retirement fruit at the top of the tree could be the tastiest but require a lot of creativity and flexibility to pursue, Casey Quirk's Mr. Celeghin said.

If a manager needs clients in emerging markets to invest in the manager's commingled funds or through a separate account mandate, and the manager can't deviate from that model, the longer-term, “high-octane” opportunities might prove elusive, he said.

Mr. Celeghin pointed to Sydney-based AMP Capital's recent acquisition of a 20% stake in China Life Pension Co. Ltd., the largest manager of China's small but fast-growing corporate “enterprise annuities” retirement plans, and Principal Financial Group's tie-up of more than 15 years with Brazil's largest bank, Banco do Brasil, as examples of the type of flexible thinking required of managers to take advantage of the inevitable growth of private savings in emerging markets.

Mr. McCaughan said his firm's joint venture with Banco do Brasil, which the two sides extended in 2010 for another two decades, manages more than $40 billion in pension assets, while more recent acquisitions of pension management firms in Chile and Mexico have increased parent Principal Financial's assets sourced from Latin American clients to more than $100 billion.

Meanwhile, both Fidelity's Mr. Talbot and Mr. McCaughan said their firms believe China's enterprise annuities market offers interesting long-term possibilities.

Mr. Talbot, however, said his firm isn't looking to do a joint venture.

Mr. McCaughan, noting that there's “a special art in managing a joint venture partnership successfully,” said Principal is working with potential partners there but would be aiming for a much larger stake in any venture to ensure Principal has sufficient “management influence” to add value to the business.