Madame Tussauds will later this month reopen its Chamber of Horrors. It should include charts of asset management company shares alongside Jack the Ripper’s wax statue and Dr Crippen’s spectacles. For while this has been a horrific year for most investors, it has been even worse for most investment managers themselves.
Just gawp at the share price performance of listed asset managers — from Schroders and Abrdn in the UK, Amundi and DWS in Europe and even US giants such as BlackRock and Franklin Templeton. In constant currency terms every single one has markedly underperformed the broader stock market in 2022.
The dollar-denominated declines range from 34 per cent to an astonishing 72 per cent for the UK’s Jupiter. And this is no irrational market tantrum. Talk to industry executives and it becomes clear that many insiders are strikingly morose about their own business.
Nonetheless, asset management remains an industry with enviable profit margins. And some corners still enjoy powerful tailwinds that the current financial turmoil will only interrupt, rather than reverse. For investors with the stomach for volatility, some opportunities are now starting to emerge.
The reason for the woeful performance in 2022 is obvious. The post-financial crisis bull market obscured a severe deterioration of the asset management industry’s fundamentals, which is now laid bare as central banks ratchet interest rates higher and higher.
The twin bond and stock market rallies since 2009 ballooned the industry’s assets under management and the revenues derived from them. This counteracted ferocious underlying pricing pressures, rising costs and in many cases even outflows, as investors shifted towards cheaper passive funds.
BCG, the consultancy, has estimated that rising equity markets alone accounted for 90 per cent of all industry’s revenue growth between 2005 and 2021. In other words, without the bull run, asset managers would have pretty much been treading water for a decade and a half.
Now that the financial tide is receding, it is revealing a multitude of bad swimmers. The UK money management industry looks particularly troubled, as even domestic giants such as Schroders struggle to keep pace in asset growth with its biggest US and European rivals. Smaller ones will probably emerge as prey for stronger rivals, or simply become zombie-like institutions that are too profitable to die but too lifeless to thrive.
The overall picture is grim. Morgan Stanley estimates that after a compound annual growth rate of 11 per cent over 2019-21, the traditional asset management industry will see revenues shrink by 8 per cent, and operating margins will fall by an average of 4 percentage points. “We see a less certain growth outlook amid sticky inflation, rising interest rates, growing recession risk and elevated geopolitical risk,” Morgan Stanley analyst Michael Cyprys wrote in a recent report. Indeed.
However, like a person with their head in the freezer and their feet in the oven, the average can hide a more nuanced picture.
Some investment managers do look like they are in terminal decline, but many will be fine. Morgan Stanley reckons that average operating margins will remain healthy at 38 per cent in 2023, barely down on 2022’s 39 per cent. These are often companies that might not have great growth prospects but still churn out cash.
Even poor investment results can be fine, given the regrettable stickiness of investor money. Given their inherent gearing towards the fate of financial markets, the stock price recoveries are likely to be powerful once central banks feel on top of the inflationary spiral, pause their rate hikes and markets bottom out.
And a handful will emerge from the detritus strengthened. Most obviously, sprawling financial supermarkets like BlackRock that can offer any investor — from ordinary savers to sovereign wealth funds — a panoply of options, and firms that specialise in hotter, higher-fee areas like “private capital”.
The data provider Preqin recently released its twice yearly report on the private capital industry — which invests in non-traded assets such as venture capital, real estate, private equity, direct lending and infrastructure — and estimated that it will almost double in size to more than $18tn by the end of 2027. Of course, Preqin has a natural tendency to look at its own world with rose-tinted glasses. But its aggressive forecasts actually seem reasonable to me.
Yes, the next year or two are going to be characterised by a wave of embarrassing markdowns on acquisitions and investments made during headier times, which is going to turn many buyout, venture capital and property funds into duds.
This is one of the reasons why the shares of industry giants like Blackstone, Apollo, Partners Group, Carlyle, Eurazeo, 3i, and Brookfield have also performed poorly in 2022. In fact, most have underperformed the wider stock market, and EQT, Intermediate Capital Group and Carlyle’s stocks have lost more than half of their value this year.
I have also long worried that the boom had gone a bit mad in recent years. That has led to risks being hidden in the more opaque private markets — such as rising corporate leverage and an incestuous investor ecosystem where firms invest and lend into each other’s deals. And with so much capital sloshing around the space, returns are inevitably going to disappoint a lot of investors.
Nonetheless, the combination of the lack of volatility (private assets that don’t trade on exchanges) and the desperation of many sovereign wealth funds, endowments, pension plans and private banks for at least a semi-plausible promise of above-market returns means that the wind will remain at the private capital industry’s back.
A word of warning, however, around mergers and acquisitions in the investment industry itself, and the lofty promises of synergies and growth that often accompanies them.
For now, the asset management industry is battening down hatches. But once the market storm abates there will be a renewed spate of consolidation between money managers, as the stronger companies stalk the weak, and the weak seek solace and hope in each other’s arms.
Yet investors should be wary of these consolidation plays. Scale will undoubtedly be a huge advantage in the coming era, perhaps even essential. But the history of asset management M&A is grim. There is only one clear undisputed success story — BlackRock swooping for Barclays Global Investors in 2009 — and a litany of career-ending, wealth-destroying failures.
UK investors need look no further than Abrdn and Janus Henderson for potent examples. Investors should therefore be wary of thinking that tying two drunks together will make them walk any straighter.
Instead, anyone who fancies a punt on something racier than a cheap index fund could look at the beaten-up shares of the last investment cycle’s winners, like Blackstone and BlackRock. Perhaps they might falter in the coming higher-interest rate era, but at the moment they look the best of a muddled bunch.
Robin Wigglesworth is FT Alphaville editor