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  2. MONEY MANAGEMENT
November 14, 2016 12:00 AM

Assets rise, but revenue not so much

Passive juggernaut continues to threaten prospects for profits

James Comtois
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    Chris Goodney/Bloomberg
    Laurence D. Fink believes continued global uncertainties are contributing to investor caution.

    With the market up and volatility down in the third quarter, a number of public money managers saw their assets under management grow. But because of asset owners shifting assets to passive — and therefore, less expensive — strategies, many managers struggled with revenue growth.

    Of the 25 public investment firms (which include private equity managers) that disclosed their third-quarter earnings as of Nov. 3, 17 saw an increase in AUM in the quarter while only four — Legg Mason Inc., Och-Ziff Capital Management Group LLC, Carlyle Group LP and Federated Investors Inc. — reported a decline.

    Four firms — KKR & Co. LP, Franklin Resources Inc., AllianceBernstein LP and Fortress Investment Group LLC — experienced no change in AUM.

    Robert Lee, an analyst and managing director with Keefe Bruyette & Woods Inc. in New York, said that because the market was up in 2016's third quarter, positive returns helped raise AUM.

    Still, many money managers — including Northern Trust Corp., Apollo Global Management LLC and Affiliated Managers Group Inc. — struggled with generating organic revenue growth in the third quarter. Nine firms of that group of 25 reported flat or pullback in revenue on a quarterly basis.

    “Firms with fixed-income or ETF businesses, and in some cases alternatives and global equities tended to do better,” said Mr. Lee. “But domestic equities dragged things down.”

    The KBW analyst said the continued movement from active management means that even though AUM might be growing, revenue is being pinched.

    “Even though they may have grown their assets under management they may not necessarily have grown revenues as much because their mix of assets has been toward things that may have lower fee structures,” Mr. Lee said. He added the lower fees are something that is worrying those who invest in money management firms.

    Facing pressure

    Aiden J. Redmond, managing director and head of North American institutional distribution at Morgan Stanley Investment Management Inc., agreed the industry is facing pressure from low-cost beta exposure and fee compression.

    Despite that pressure, Mr. Redmond said he was “very optimistic about the asset management industry because there is still considerable interest in high active share, concentrated portfolios that are based on thematic investment trends.”

    MSIM reported $417 billion in assets under management as of Sept. 30, up 3% from both June 30 and also from a year earlier. Despite net inflows of $3.9 billion for the quarter ended Sept. 30, net revenue totaled $552 million in the third quarter, down 5% from the previous quarter. By asset class, net inflows of $5.4 billion went into liquidity strategies, while fixed income experienced net inflows of $950 million. Equities saw net outflows of $1.9 billion, while alternatives saw net outflows of $500 million.

    M&A consolidation was another reason some managers experienced AUM growth in the third quarter. During the quarter, OM Asset Management reported a 7% increase in AUM due in part to the addition of $8.8 billion from the 60% stake it took in Landmark Partners LLC, a private equity and real estate secondary market manager.

    State Street Global Advisors reported $2.446 trillion in AUM as of Sept. 30, up 6.3% from three months prior, due in part to its acquisition of GE Asset Management closing in the third quarter.

    And although AllianceBernstein's AUM of $490.2 billion was flat for the three-month period due in part to its quarterly outflow of $15.3 billion, that was partially offset by the New York-based manager buying Ramius Alternative Solutions LLC, a $3 billion money manager.

    Less market volatility even seemed to quell investor uncertainty during times of massive geopolitical uncertainty.

    Laurence D. Fink, chairman and CEO of BlackRock Inc., said in the New York-based firm's quarterly earnings call on Oct. 18 that the market environment in the third quarter was characterized by macroeconomic and political uncertainties, slow global growth and persistent low rates.

    He added, “the lack of clarity around the outcomes of several upcoming political events, including the path forward on Brexit, elections in the U.S., and the constitutional referendum in Italy, is contributing to growing tail risk and investor caution.”

    Despite that underlying uncertainty, however, Mr. Fink noted market volatility reached lows in the third quarter not seen since 1995. “Institutional investors are slowly regaining confidence, and the third quarter was characterized by consistent, diverse client flows rather than any one concentrated activity,” he said.

    BlackRock announced in its earnings release that it managed $5.12 trillion in assets as of Sept. 30, up 5% from three months earlier and up 14% from a year earlier.

    Net inflows to BlackRock's long-term strategies in the third quarter were $55.2 billion. Its institutional business experienced long-term net inflows of $6.2 billion for the quarter.

    Looking forward, change — and apparently big change — is coming to the industry. A new report from McKinsey & Co. said the change to the competitive dynamics of the asset management industry will be seen soon due to a number of converging trends. These include the end of exceptional returns, more assets flowing into alternatives and increased regulation.

    Structural shifts

    Ju-Hon Kwek, partner at McKinsey & Co. and co-author of the report, “Thriving in the New Abnormal — North American Asset Management,” said he's seeing several structural shifts in the market that will affect money managers in significant ways.

    “Market appreciation is going to play a smaller role. That's going to hit the industry pretty hard going forward,” Mr. Kwek said.

    Mr. Kwek added the silver lining in all of this is that now more than ever, asset owners are turning to money managers for more help with constructing their investment portfolios. “There's never been a period in the last 10 years where clients are looking to asset managers for help,” he said. “Clients need help rethinking their entire approach to portfolio construction and to managing liabilities.”

    Gavin O'Connor, chief operating officer at Goldman Sachs Asset Management in New York, agrees that asset owners are looking more to their money managers for help in building their investment portfolios.

    “Our clients are looking for a broad and holistic relationship with us where we can give them advice on asset allocation and risk management, complete portfolio implementation, as well as comprehensive service and reporting,” said Mr. O'Connor.

    New York-based Goldman Sachs reported $1.347 trillion in assets under supervision for its Goldman Sachs Asset Management and wealth management businesses as of Sept. 30, up 3% from three months earlier and up 13% from the same time a year prior.

    GSAM experienced net inflows of $16 billion in the third quarter — $11 billion in fixed income, $2 billion in equities and $1 billion in alternatives. Liquidity strategies recorded net inflows of $2 billion.

    “The inflows we've been seeing over past several years have been very diverse across asset classes, investment strategies and client channels,” said Brian Margulies, chief financial officer of GSAM.

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