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Asset managers are being pushed to increase their share of industry revenue to steady the top line. Profitability for most established managers will become equally—if not more—a story of efficiency.

The Fund Manager’s Dilemma: Sales and revenue growth becoming disconnected as competition for MPS mandates puts pricing front and center  

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The third quarter saw over £57.3 million in 12-month forward-looking revenue1 won by underlying fund managers within the UK’s platform model portfolio (MPS) business. Close to £57.5 million, however, was lost via gross redemptions of investment funds.  

MPS net flows therefore contributed to an approximate £200k loss in annual projected revenues for fund managers. Even though MPS net sales were positive to the tune of more than £3.1 billion in the quarter. 

So, how could £3.1 billion in net flows generate a negative revenue impact? Front and center to this story was the equity asset class. While equity net sales accounted for nearly £2.5 billion of the £3.1 billion total, these net sales only generated an additional £1 million in projected annual revenue.  

A growing passive tide slows investment fund revenue growth 

Two factors were at play in explaining how such sales led to so little additional revenue. First and foremost was the impact of the ongoing adoption of passive equity funds by model providers, as portfolio cost control remains high on advisers’ radars. As shown in Figure 1, while passive equity funds accounted for 46% of gross sales, they accounted for a mere 32% of redemptions.  

Figure 1 

Q3 gross sales and redemptions of underlying equity funds by active and passive management

In millions 

 

Source: ISS MI 

This led to passive equity funds bringing in £2.0 billion to just £450 million for actively managed funds. As passive money flowed to equity funds with a sales-weighted ongoing charge figure (OCF) of 10 bps, compared to 69 bps for active money, it followed that overall revenue growth was severely constricted. The observed active versus passive management transition alone, however, does not explain why £2.5 billion in equity flows resulted in such a small revenue boost. 

Figure 2 

Q3 sales-weighted ongoing charge figure of equity funds by active and passive management 

Source: ISS MI 

With great sales, comes great pricing power 

The second factor at play is that money flowing into equity funds is trending toward lower-cost options within both active and passive fund groupings, as highlighted by Figure 2. Were it not for this second factor, Q3’s equity net flows would have generated £5.9 million in projected annual revenue. Money leaving active funds, however, left at a sales-weighted OCF of 77 bps—eight bps higher than it came in at. Passive money, meanwhile, left at an OCF of 12 bps versus 10 bps for incoming funds, which, while not a large absolute difference, represents a relatively steep drop.  

This observation reveals two trends: A substitution of funds in favour of lower-cost funds and the movement to lower-cost share classes—the latter being directly tied to the size of the UK’s MPS business. As MPS providers grow in size, so, too, has their pricing power. With the largest MPS providers being able to table mandates in the £10s if not £100s of millions, fund managers have become much more willing to compete on price, which can include allowing MPS programs access to institutional share classes. The share class movement effect is even more magnified if one considers that much of the MPS money flowing in, is coming out of portfolios previously managed by advisers themselves, which were more likely to only have retail only share classes available to them. 

Figure 3 

Estimated annual revenue impact from Q3 sales of underlying active and passive equity funds 

In millions 

Flow Type Active Passive 
Gross Sales  £                    33.15   £             4.26  
Redemptions -£                    33.56  -£             2.49  
Total -£                      0.40   £             1.77  
Source: ISS MI 

With an eight-basis point (bps) differential in OCFs between inflows and outflows, active managers collectively took a revenue hit from Q3’s equity net sales even amid positive net sales. Passive managers meanwhile, continued to add to their revenue base through flow activity. Passive managers, nonetheless, faced the fact that money is flowing in at a lower price than it is leaving, which means that standing still requires achieving ever better sales results.  

Looking at the big picture, equity money exited MPS programs at an underlying fund OCF of 56 bps and entered at 42 bps, which means that equity managers as a whole struggled to generate new revenues by net sales alone.  

Opportunity beckons, but at what cost will tomorrow’s fund sales be won? 

Opportunity for individual managers, however, was there for the taking. After all, Q3 saw £57.3 million in projected annual revenue won across all asset classes. Two managers, both active, saw MPS net flows add over £1 million to their projected annual revenue line. 88% of the £57.3 million in fact went to active managers, highlighting that there are still millions of reasons for active managers to compete. The dilemma, however, is in what price to compete at. Knowing that each price concession made, likely portends another, as competition for scarce investment flows in the UK remains high.  

What is happening in the UK MPS market is symptomatic of a bigger challenge facing today’s asset managers. Revenue is simply not growing at the rate of asset accumulation. Rather, asset managers are being pushed to increase their share of industry revenue in order to steady the top line. As a consequence, profitability for most established managers will become equally—if not more—a story of efficiency.  

A story that is by no means unique to UK fund managers. ISS MI’s “Growing Revenues, Not Assets, New Name of the Game” whitepaper highlighted how this challenge is also playing out in the United States.  

No pain, no gain 

Expect the decade ahead to be about managing this transition, as until current assets align with today’s value—and ultimately pricing—demands, a revenue squeeze will be felt. Pain management, not change management, is what advisers and investors appear to have ordered for the fund management business. With the pain, however, will come the opportunity for gain, as conversations on pricing and value are putting mandates in motion. 


By: Benjamin Reed-Hurwitz, EMEA Research Lead, ISS Market Intelligence

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