Managers optimistic despite pessimism cast by virus

Managers operating in Europe expect to gather assets flowing into environmental, social and governance as well as illiquid and dividend strategies in 2021, but sources expect margins are going to remain under pressure.

Despite the emergence of a new strain of the coronavirus, which could delay the return of pre-COVID-19 economic conditions, sources still expect the deployment of vaccines could bring relief as early as the second half of the year. And when the majority of the high-risk population is vaccinated, allowing cities to open up further, managers are confident that a restarted economy will increase the pace of their AUM growth.

The vaccine announcements are "probably the game changer that markets have been waiting for," said Sonja Laud, CIO of Legal and General Investment Management Ltd. in London. While distributing the vaccine could be challenging, delivering it to the high-risk population by the end of the second quarter is achievable, she said.

On this anticipation, money managers in Europe are developing strategies that can help investors thrive in the early phase of the recovery, while at the same time help them navigate the effects of the pandemic.

For example, they are preparing new dividend and credit strategies that have been unaffected by the asset purchase programs of central banks.

But managers said they also expect European investors' focus will largely be on buying strategies compliant with parts of the Sustainable Finance Disclosure Regulation that becomes effective in March.

"We are hearing very loudly from asset owners that a significant proportion of assets next year will be deployed to Article 8 and Article 9 (of SFDR rules) funds, in other words those that promote environmental and social factors and those that are seeking sustainability impact," said Mike Zelouf, managing director Europe, Middle East and Africa at Western Asset Management Co. Ltd. in London. "We are weighing up launching a new sustainable global corporate fund, although we are aware that many investors prefer to invest in funds with a track record," he said, adding that investors want existing funds to meet disclosure criteria on environmental and social factors embedded in Article 8.

Western Asset had $479.8 billion in assets under management as of Sept. 30.

Deirdre Flood, head of distribution at Wells Fargo Asset Management Ltd. in London, said the firm will continue to focus on building sustainable portfolios for investors in 2021. "We are leveraging data from all of the third-party vendors into a combined quantitative ESG score and layering on top of that a qualitative assessment, which together are the foundation of our proprietary ESG IQ database," she said, as the firms' client needs in the ESG data space are expanding. Ms. Flood said, by way of example, that investors are looking for managers to build portfolios that will have a lower carbon footprint than their benchmark or that align with specific carbon reduction targets set for 2030 or 2050. Wells Fargo Asset Management has $578 billion in assets.

Also, in 2021 investors will need tools to help them manage inflation risk, which can be addressed with alternatives strategies, sources said. Sorca Kelly-Scholte, EMEA head of pension solutions and advisory at J.P. Morgan Asset Management in London, said that pension funds will be thinking about how to get back to their long-term goals as funding plans have been quite substantially damaged during the pandemic, with plans losing as much as 10 percentage points from their funded status. The firm's GDP and inflation outlooks are similar to going into last year but "the difference is that we see more risk to the upside and to the downside," she said.

"Pension funds will need to build a high inflation scenario into portfolio planning," she said. Increasing real yield, which is associated by the firm with high inflation, would mean falling bond prices and hence bonds won't give investors much protection, she said. JPMAM had $2.3 trillion in assets as of Sept. 30.

The source of inflation protection should be core real assets such as real estate and infrastructure rather than inflation-linked bonds, she said, due to better price stability.

Unsurprisingly, money managers running public markets strategies are looking to buy or develop private market strategies. Western Asset's Mr. Zelouf said he is looking to expand the firm's private debt capabilities in Europe, potentially through an acquisition. "We want to increase our footprint in … direct lending and alternative credit and distressed debt. We could be interested in looking at private boutiques specializing in these areas, especially if they have done a second or third round of fundraising," he said.

Managers with existing private markets expertise will be venturing into business with new types of investors in 2021. For example, Natixis Investment Managers U.K. Ltd. is launching a new private credit strategy for a U.K. multiemployer defined contribution plan in January that will be incorporated into the plan's default fund, said Oliver Bilal, head of international sales and marketing based in London. He declined to name the plan. Natixis had $1.1 trillion in assets under management as of Sept. 30.

Managers also said they are seeing opportunities to grow their businesses in 2021 by launching emerging markets and securitized credit strategies.

Mr. Zelouf said that if the vaccine delivery is successful, "it is a good environment for some of the sectors that have lagged, such as securitized credit and emerging markets, that would benefit from a broader-based recovery in the U.S. economy and stabilization in the U.S. dollar."

For example, investors from Europe are looking at local currency Asia debt funds as a diversification to hard currency emerging markets debt exposures. "At least 50% of the search activity we are seeing in Europe is emerging market debt," he said.

Mr. Zelouf is also positive on non-residential mortgage-backed securities and selected asset-backed security strategies. "They don't qualify for the Federal Reserve intervention. As a result, the recovery has not been as strong as in investment grade credit. It's one of the few areas where returns are still negative year-to-date and we think the scope for recovery could work quite well," he said. Western Asset is also building a track record in European bank loans.

Still, some European managers are bullish on equity strategies. LGIM's Ms. Laud thinks that an early cycle recovery will be supportive of risk assets. "We are positive on risk assets and we are aware of the sentiment and how positive it is," she said, adding that equities in relative terms still seem attractive. "Normalization is the most beneficial to those sectors that have suffered the most throughout the pandemic," she said, naming retail and hospitality among these sectors. LGIM has £1.2 trillion ($1.63 trillion) in assets.

For Wells Fargo's Ms. Flood, the focus is on launching dividend strategies as many corporations have halted paying dividends throughout the pandemic. "We have designed an equity strategy that typically delivers a yield in excess of 6%, which combines dividends with the premium from selling options. It's been exceptionally well-received by our clients with income needs," she said. "We are generating income from an option overlay to diversify the source income and help provide more dependable income," she added.

Still, despite optimism over the continued economic recovery in 2021, managers are aware profit margins will be under pressure.

Financial services consulting firm Zeb showed that in a quick recovery scenario, profit margins of European managers will dip 30% from pre-pandemic levels with an average overall AUM growth at 5.1% per year over the next five years. A slower recovery means that European firms' AUM will grow at 1.3% per year over the next five years, while their profit margin will slide 60%, the consultant estimated.

Even with the vaccines ready, the outlook for the money management sector remains negative.

"We expect an uneven economic recovery that will be dependent on pandemic management, vaccine distribution and government policies," said Marina Cremonese, vice president-senior analyst at Moody's Investors Service Ltd. in London.

"The way the vaccine will be distributed might translate to different outcomes for different countries. This uncertainty will likely drive higher asset price volatility and will add to an already challenging environment," she said.

Ms. Cremonese said that the uncertainty affects the risk appetites of investors, which may choose to continue to stay focused on more conservative strategies rather than moving into alternatives. "All of that will result in lower revenues for managers," she said, because assets have mostly been flowing into money market and fixed-income strategies in the recent months.

Managers should also be prepared for some of the profits to be eaten away by new costs associated with the coronavirus.

"We are spending more money or making the office COVID secure. We are in the process of moving premises. We have about 65 staff in the London office and it was designed for that headcount. We now have to completely change that for social distancing," Mr. Zelouf said, adding that the firm will need 120 workspaces to account for social distancing.