Given that trillions of dollars worldwide have been written off from company balance sheets, pension funds and investment portfolios, it is little wonder that asset managers are looking for good news. Many argue that it could be a long time coming if reports from certain quarters are to be believed.
According to a study released by researcher Cerulli Associates of Boston, it mat take at least five years for the global asset management industry to recoup the $10 trillion that disappeared in the last six months of 2008. The firm found that worldwide, the investor assets managed by the industry had shrunk to $43 trillion as of December 31, 2008, representing a loss of $10 trillion, most of which occurred in that year’s fourth quarter.
Every asset class, except for money market funds, was hit by the downturn. Assets held in money market funds posted a 1.7 percent increase, while equity funds were the hardest hit, posting a decline of 39.6 percent, the report found. Revenue for asset management firms also suffered. With the decline in asset values and relocation of assets away from higher-yielding equities to lower-yielding fixed-income and money market funds, net revenue declined, Cerulli reported.
While annual revenue peaked in 2007 with $167 billion. That total dropped to $156 billion in 2008, Cerulli found. And asset management revenue may decline further, to an estimated $133 billion in 2009.
Other consultants have suggested that the industry needs to shake up its practices. Money managers must offer new portfolios and keep cutting costs to survive in an era where frightened investors prefer safer fixed-income funds to stock and hedge funds, says a recent report by business consultants The Boston Consulting Group (BCG). Badly bruised by last year’s financial crisis when tumbling markets and investor redemptions shrank global assets 18 percent to $48.6 trillion, the consultancy – writing in its seventh annual asset management industry survey – says that asset managers face more tough times in 2009 and the years ahead.
BCG forecasts that profits will shrivel again, likely falling to 30 percent or less this year from 34 percent at the end of 2008. Even though the Dow Jones industrial average just finished its best quarter since the fourth quarter of 2003, BCG warns firms against becoming too confident or thinking the worst is over.
In what the consultants called an “Armageddon scenario” where the recession deepens and asset prices drop even more, industry assets could decline between 30 percent and 35 percent by 2012. In a “recovery scenario” where the economy recovers gradually, assets could still drop between five percent and 10 percent by 2012. And in a “Happier Day scenario,” where the economy rebounds next year, the industry could pull in between 10 percent and 20 percent in new assets, the report said.
The survey found that investors who lost billions in retirement savings last year and will soon need to retire on their smaller nest eggs will want safer and cheaper investment options. Even company and state pension funds will be affected by the shift in the tastes of retirees, the consultants said, forecasting that institutional investors will cut stock allocations to somewhere between 35 percent and 45 percent by 2015 from roughly 55 percent in 2007.
The end is nigh
Funds that deliver returns by altering asset allocation instead of trying to pick the best stocks will prosper, while exchange-traded funds and portfolios that follow indexes will be very popular, the survey found.
Similarly, the appetite for hedge funds has declined after many of these loosely regulated portfolios failed to return money to investors in a timely way last year. The survey found that hedge fund assets, after shrinking to $1.4 trillion from $1.9 trillion last year, will not top that peak by 2012.
In any case, says BCG, fund firms should specialise in certain areas, review how they pay their managers and possibly consider merging with others to gain market share. The industry is already seeing mergers such as the sale of BGI to BlackRock by Barclays and the proposed divestiture of Columbia Asset Management by Bank of America. In July, Societe Generale and Credit Agricole signed a final agreement to merge their asset management arms and create a top 10 global player with €591 billion of assets under management. The new company will be 75 percent owned by Credit Agricole and 25 percent owned by SocGen.
Credit Agricole and SocGen say their combined asset management company would be the fourth-biggest in Europe in terms of assets under management and the eighth-biggest in the world. The transaction remains subject to approval from regulatory authorities and is expected to close during the fourth quarter of this year. “The next few months will be used to define the organisation of the new entity to enable it to be fully operational for the 2010 fiscal year,” the banks said. The SocGen/Credit Agricole deal is part of wider consolidation in the asset management industry as fund managers face a withdrawal of clients’ money and write-downs caused by the global financial crisis.
Industry observers expect similar announcements to take place throughout the rest of the year. Investment bank Jefferies Putnam Lovell has said that there will likely be a steady flow of asset management mergers and acquisition activity in the second half of 2009 and that divestitures by companies needing to shore up cash – like the blockbuster deal by Barclays to sell its asset management business to BlackRock – will be the strongest driver of activity.
Continual trend
Divestitures accounted for 47 percent of the deals announced in the first half of 2009 compared to 26 percent of the deals announced in the first half of 2008. Asset managers looking to add scale and private equity firms looking for inroads into the growing asset management market will also play a role. There were 72 announced transactions in the first half of the year, down from 109 in the same period last year. “We expect divestitures to remain the driving force in M&A activity through the second half of the year as the asset management industry faces its most radical reshaping on record,” said Jefferies Putnam Lovell’s managing director Aaron Dorr.
While convergence in the market may end up bringing some welcome results, the news that Europe wants to impose greater regulatory oversight on the hedge fund industry has been met with utter dismay in its principal market – the UK. London is the current home of 80 percent of Europe’s hedge funds, but they could be tempted to move to Switzerland and the US, say experts, if the EU proposals are enforced.
The UK government has already slammed the proposals. Financial Services Secretary Lord Myners has said that the draft European Union law that would subject hedge funds to new regulatory controls would need “major surgery” before the UK can support it. The minister has also hit out at European countries seeking to “make political capital” from advocating a clampdown on the hedge fund industry, calling their actions “woefully short-sighted” and “bordering on a weak form of protectionism”. “It is perhaps easy for other European countries to make political capital out of demanding intrusive regulation of an industry of which they have little or no direct experience,” Lord Myners said.
The EU directive, a response to public anger at the excessive risk-taking that led to the credit crisis, would require many hedge funds and private equity firms to register with regulators and disclose more about themselves and their investments. They would also have to meet increased minimum capital requirements and limits on borrowing, which have triggered threats from some big UK hedge funds to move overseas unless the plan is rewritten.
Most hedge funds with more than €100 million in assets, buyout firms managing more than €500 million and companies more than 30 percent-owned by a private equity firm would be regulated under the EU plans. The rules would limit the amount of leverage, or borrowing, funds can use and require the use of European-domiciled banks.
Hedge funds use complex investing strategies to make returns, even when markets are falling, and they have been blamed – the industry says unfairly – for threatening future financial stability. Under the EU plans, hedge funds would be required to be more open, and their ability to borrow would be limited. Investment associations are concerned that if these rules are adopted, hedge funds will be driven out of the EU.
Yet some of the criticism surrounding the industry are being reviewed. The UK Financial Services Authority (FSA), the City watchdog, is conducting a survey of hedge fund borrowing. “This will allow the FSA to identify the warnings signs of excessive leverage and we will ensure it has the powers to intervene directly with managers to prevent the build-up of excessive leverage wherever this is justified,” said Myners.
Myners has said that Britain will seek “significant changes” to the EU proposals, with officials lobbying in “a dozen key capitals” over the summer. Speaking to the Alternative Investment Management Association in July, Lord Myners said: “Our aim is a framework which allows efficient, well run and well regulated fund managers to compete for business without restriction across the EU and to make the EU a base from which to compete in global markets. The draft directive needs major surgery before this can be delivered.”
“The UK is reaching out bilaterally to leverage natural alliances and win over others. Officials will lobby in more than a dozen key capitals over the summer. I myself will be engaging directly with my opposite numbers in key member states.” The minister added that there was now widespread acceptance among leading European regulators, including Jacques de Larosière, chairman of the strategic committee of the French treasury, and Charlie McCreevy, EU internal markets commissioner, that hedge funds and private equity funds had not been central to the financial crisis.
Over three-quarters of Europe’s hedge fund-managed assets, worth about $300bn, are managed out of London. The City is hoping to win support from the US administration to head off the new regulations from Brussels, which have been roundly condemned by just about everyone associated with the industry – particularly since London has so much to lose from any regulatory interference.
Robert Jenkins, chairman of the UK’s Investment Management Association, has said that the EU’s approach to alternative investment legislation was “curious”. “When the banks ran out of liquidity, our customers for whom we act as agents, helped supply it,” he said. “When the banks ran out of capital, the funds we manage contributed to the take up of new debt and equity issues. And when one day, governments divest their shares in the walking wounded of the banking world, to whom do you suppose they will sell? In short, the investment management industry is not part of the problem but we are part of the solution,” he added.
Mayor of London Boris Johnson, has warned that the Commission’s plans to regulate hedge funds could “strangle” the City as a financial centre. “It is a weird thing that under the fog and confusion of war, the Commission seems to be proceeding to attack something in which London simply excels and was not responsible for the recent catastrophes. I think it is very, very dangerous to the City. It is very important that we defend an industry that generates huge sums of tax for this country.”
However, the European Commission says its proposals are necessary “to overcome gaps and inconsistencies in existing regulatory frameworks at national level” and that they will “improve the macro-prudential oversight of the sector and [allow governments] to take coordinated action as necessary to ensure the proper functioning of financial markets.”
Hedge funds have used their most prominent annual gathering – the GAIM conference in Monaco in June – to speak out against the “disastrous” new regulatory proposals, especially after a number of hedge fund managers feel that they may have been complacent about how quickly the momentum for the industry’s reform would gather pace. As one fund manager said: “We’ve assumed that the political will will follow the economic will. Historically that’s wrong. And now lots of us are beginning to think that maybe we’ve been a bit complacent.”
As well as speaking out against the EU, attendees at GAIM have also criticised an apparent lack of action from the UK government on the issue. Several fund managers have said they had previously had confidence in the UK’s ability to resist punitive regulation from Brussels, but were now fearful that the Brown government was too politically distracted to act decisively.
”The FSA’s hedge fund regulation has actually always been very good, and the UK has the infrastructure, the capital markets and the prime brokerages that make it ideal for hedge funds. But now we risk driving them out,” said Simon Luhr, the managing partner of London-based SW1 Capital. ”The prime minister can’t stand up for himself right now… I think it’s going to be a disaster.”
Other managers, though, have been much more sanguine. Lobbying efforts have intensified in recent months and a considerable amount of behind-the-scenes work was going on said one major London-based fund partner. ”I think people just need to be a bit patient. It’s only the first draft of the new rules,” he said. Hedge fund managers will be hoping that the process goes no further.
