Summary:
Join Christopher Davis, Head of U.S. Fund Research, and Benjamin Reed-Hurwitz, Head of EMEA Research at ISS MI, as they unpack the findings of the Global Whitepaper: Growing Revenues, Not Assets, New Name of the Game. Uncover why seeking growth at the right price is essential, how active managers are adapting, and what the future holds for index funds and ETFs in the U.S. and U.K.
The full report is available now in the newly launched MarketSage research platform, a key addition to ISS MI’s suite of solutions designed to provide unparalleled access to surveys, insights, and unbiased research that empowers financial services professionals to make informed decisions and stay ahead of market trends.
Transcript:
Goshka: Welcome to MI Talk, the podcast series brought to you by RSS Market Intelligence. Thank you so much for tuning in. The focus of our discussions and MI talk is the global retail financial services business, and its many subsectors asset management, wealth management, life insurance, banking, fintech and in the coming episodes we will be showcasing some of that, vast array of research pieces that we, deliver covering all these various sectors of the financial services business for more than three decades. ISS Market Intelligence team has been a passionate student of this business. And our specialty here on this podcast is to explore what I would call the second day story, so not just the headlines, the industry headlines, but really try to dig in deep and try to understand what’s going on with the help of industry experts. we create new, episodes monthly so please do subscribe, to our podcast on the platform, of your choice. My name is Goshka Folda, I am your host and global head of research at ISS Market Intelligence. Can you believe that we are almost nearing the half year mark of 2024, and it has been on this end that ISS Market Intelligence an incredibly busy, five months and, couple of days. We have been working on a lot of different research stories around the globe but this is exactly how we love it so don’t feel badly for us. Actually, this is the best time, when we get to think about the business and discuss it and mobilize our vast data banks around the world to tell stories, about what’s not only happening now, but what’s coming tomorrow and one such research project that has been, in particular, I think, is something that I have been, incredibly supportive of. And, and, and, excited about, is a Global Whitepaper on asset management revenue picture. This has been long in the making and those of you who know me know how, passionately I feel about understanding the profitability drivers of the asset management business, wealth management business, really all businesses that we cover. But those two, probably most importantly, so it is with great pleasure that, I, will discuss, this global white paper, which is, which has just been released. And invite you to listen to my conversation with the two researchers on the ISS Market Intelligence team who led the creation of this interesting report. Joining me today are both repeat guests, Christopher Davis, who heads our US, investment funds research and Ben Reed-Hurwitz, who heads our EMEA research says both have been here before. I will ask you to check their bios, on their LinkedIn pages. But let me offer a couple of fun facts, and I hope I did not tell my guests that I was going to do it. So I do hope this is okay. Otherwise, our editor will have to do some quick snips here. Number one, Christopher has a delightful dog, whose name is Oliver and whenever Christopher is working from home, and we’re on a team’s call, I insist that Oliver make an appearance. Because he is my favorite. Ben and I, meanwhile, go some ways back, and we have many interests that we share, traveling, Europe in general. He’s now located, of course, in our London office but I think one of the things that we, we really love, there are actually two things, we both love, opera and, also mysteries. Arthur Conan Doyle and his supporters, Sherlock Holmes, are among our favorite writers here on combos. Welcome to you both.
Christopher: Thank you, thank you. Oliver is sitting at my feet right now.
Goshka: Wonderful. Thank you guys. Thank you Christopher. So let’s start, let’s dig right in because, this is a really, interesting report. Lots of, data mobilization, some of our newest data sets, including our fees and expenses, data sets and some fund global that have just arrived in the last, little while and I’m glad that we are able to immediately mined them for insights. But let’s start, with kind of the benchmark for success in the asset management business. Traditionally managers, of course, have focused on asset growth but in the paper, you’re arguing that perhaps asset growth isn’t the be all and end all of this business anymore. What do you think should managers be looking at in addition to the traditional, assets under management, benchmarks? Ben?
Ben: I think the next place to look is really going to be fund revenue. And the reason for this is, as you said, AUM was the traditional measure. And it was sort of assumed that as AUM grew, revenue would really grow in lockstep. But increasingly, this no longer appears to be the case and that’s really the big finding coming out of this report. When Christopher and I looked at the 2023 data, we saw that in the US, UK and the European cross-border markets that it was no longer the case that sort of AUM in revenue track together and in fact, when it came to growth rates, there’s actually a difference over 5% in the UK. And it’s really one factor sort of stands above the rest in driving this divergence. And it’s something talked about a lot. But again, often we’re talking about sort of how much AUM and what the flows are here but it’s the adoption of sort of low cost indexing solutions by investors across the wealth spectrum in Europe, and the US. And this adoption in the markets is also sort of picked up steam because it seems as these as these solutions have increasingly been adopted, a positive feedback loop forms where essentially, you know, whether pushed by regulators or not, the more we see these solutions, the more they’re talked about, the higher essentially cost of investing becomes on the agendas of advisors and investors. And really coming into focus and you know it very well Goshka, you’ve seen it multiple markets with regulators. The idea of total cost to consumer both on the product side and on the advice side. And we have seen both, but it’s really been product costs have sort of faced the brunt of the scrutiny, particularly in those markets where we’ve seen product costs and advice costs separated. And with this, we’ve seen a groundswell of low cost indexing solutions and now the money coming into the business or the money sort of replacing and sort of substituting for current money, again, has this much lower cost and therefore revenues moving in a much different way. All that being said, another interesting finding those and that in all three markets we looked at, even though index is share of AUM has increased sort of 15% or more in those markets over the past decade. Active funds, active management is still about 90% of the revenue. So again, just watching where the money goes isn’t going to sort of tell you where the revenues going to go in may not sort of relate to your profitability in the end. So this paper is really a story of that, with the US obviously being the prime focus given how far along they are on index adoption.
Goshka: Yeah, that’s, that’s a fantastic opening, Ben. And you talked, you touched on so many important points, but then that metric that you delivered, that 90% of the revenue being tied to act as, I think is a really stunning, stunning result. But you mentioned the US, so let’s pivot to Christopher and his thoughts about the US market. Clearly. If anything, the US marketplace, as my great friend, I mean, not many used to say the world’s largest laboratory of asset management and wealth management ideas, without any doubt. You know, is, in many ways foretells developments in other markets. We’ve recently seen the index, fund or index ETF assets surpass the 50% mark in terms of the overall asset pool, in, in funds in the US, what do you think that has meant for the in terms of experience, with growth and revenues for the US managers?
Christopher: Well, Goshka, that was pretty catastrophic, at first blush. You know, keep in mind that a decade ago, active funds were still more than 70% of the assets. Imagine, for example, if you were a car manufacturer and, just a vehicles and a share of what would be a loss went from 25% to 50% in a decade. You’d say the internal combustion engine is toast but if you look at the financial, active management really isn’t toast. You know, even with less than 50% market share, active funds in the US still generate more than 85%. The revenues, not as successful, are not as big of a share as, active managers globally. Valid reference 90% earlier, but so 85% with less than 50% market share. Pretty impressive at first blush. Now, of course, a big reason, is that investors have flocked to low cost index funds, meaning an ever larger slice of the assets is invested in funds that generate relatively little revenue. And we’ve also seen a proliferation of new kinds of index funds, thanks, to the ETF, which has brought new kinds of buyers into the index fund fold. But if you look at standard measures of profitability, active managers have coped pretty well, with this whole state of affairs, operating margin sunk in the mid twenty tens. But by 2021, they reached heights last seen in the 1990s. And, I don’t know, an asset manager that isn’t a little nostalgic for those days. And, you know, managed to get there with a little bit of luck. Markets were mostly up over the past decade, with some short, little downturns along the way. But managers also consolidated, they cut costs, they removed deadweight, from their product shelves. And that and those two, factors restore profitability, to the, glory days of the business. Unfortunately, in 2022, we saw some of this luck run out, there were major declines across asset classes and when markets rebounded last year, profitability did not. We just published our annual survey, public asset manager profitability and found that for the median manager, operating margins went from something like 33% to 25%, in just a year’s time. And the main reason for that is active managers are suffering from a sales drought, just a handful of active funds are attracting flows. So while we see a vast pool of active assets still generating almost all of the revenues, this pool is shrinking at an accelerating rate. So active managers are going to need to have to, but they’re going to need to find new sources of organic growth. And we’re going to see a continuation of the consolidation story, that we saw in the 2010s.
Goshka: Yeah. Christopher so well said. And I think, you kind of, mentioned the idea that there has been, I would say a cleansing of the product shelves and, you know, a rationalization would be a much nicer word, clearly. And also there have been some new ideas and I think you mentioned, ETFs being one of the instruments, able to pursue, have a vast array of, of indexing strategies, including some even now, you know, the rage of the day in the US, of course, are active ETFs and we are just doing some great work on really trying to measure that activation quotient because not all active and not all passive are made in the same, format, but kind of talking, you know, thinking through that product shelf, it has not been just, all the story of product development and re-organization has it? Christopher, you mentioned something about the fundamental changes, the distribution side on the wealth management side.
Christopher: Right I mean, as you know, any growth story in business as product distribution, we like to focus on products because it’s more glamorous. It’s easy to see the financial press. There’s way more time talking about all of the new products that are coming to market. But underneath the surface, have been some massive changes in how funds are distributed and, especially over the past decade, maybe past 15 years, in the US, if you go back 10 or 15 years ago, most advisors had business models that were based on selling products with transaction based fees. The investor would pay, a sales load or they would pay an ongoing, trailer, fee. In the US, there typically those will be one phase. And now we see most of the sales based on AUM based fees. So now advisors on average are, earning about 1% of their clients assets under management every year. And that’s really changed the, way that assets are managed in the US. Now, you might have noticed that while asset managers have been pulling their fees, advisors really haven’t. The 1% I just cited was what we would have said 10 years ago, 15 years ago, what fee base advisors, charge. But so, you know, so what advisors have been doing is they’ve been controlling cost of the end client by choosing lower cost investments. And, you know, when you add some of the regulatory forces which have made the advisor client relationship more fiduciary, like, you have a recipe for an intense focus on costs. And, you know, we’ve seen that in the US and we increasingly see that, across the Atlantic and we’re not arguing, in the paper that active managers do not have any opportunities. You mentioned that that active ETFs. I think that shows that active management can be an attractive proposition when it’s priced correctly. And we’ve also seen how managers can develop new product niches, that create new kinds of demand for active management in the US. For example, defined out, for funds that are colloquially referred to, they didn’t exist. I think even as, maybe five years ago, they were barely a speck, in the market and today we see them, you know, growing quite rapidly. And so when active managers can bring effective solutions at the right price, you know, advisors have proven receptive.
Goshka: Definitely. I think, Christopher, that’s, you know, such, such a great and balanced point of view and you underscore that, that kind of the unbundling process of the advice fees, away from the kind of product fee, I mean, the point, the point is also well-taken that that has not. And I think, Ben, you mentioned that as well. There’s no specific evidence that the total cost to customer ultimately has decreased meaningfully. That’s something that we haven’t we did this research several years ago. We might, well, repeated this year or next year because it’s clearly a fascinating topic. But now let’s Ben, let’s pivot to the UK. Clearly there has been also an app upheaval and advisor practices. Perhaps you can give us a little bit of background, for how that has come about, because I think the impetus, was similar to the US, but maybe came from different drivers.
Ben: Yeah, you’re right, it was it was certainly a different driver. The big driver has really been regulatory in the UK, and the actions of the FCA and that story really picks up on what we’re talking about, sort of back in 2012 with the retail distribution review. And of course, the UK was one of the few markets to actually fully ban embedded commission that obviously supercharged this movement to sort of fee based practices. The thing it’s important though for people to understand when, when sort of thinking about Europe in relation to what you heard from Christopher is, is Europe in some ways is maybe about ten years back as and if you look at the statistic in terms of the adoption of index, it sits about a decade ago. And it’s really a question now about how how quickly Europe catches up, including the UK and what their options are for adapting. But kind of keeping with the UK story RDR and then there’s sort of been future pieces of regulation that were to follow, we have the assessment of value which which puts the cost of funds right front and center, requires one sort of justify them. And then most recently we have consumer duty as well, which, which in a very simplified manner is basically a cost benefit analysis of almost everything you do for the client. And doesn’t sort of progress them further on their goals. So, so all this is say cost custody laser focused in the UK. So one obviously this is created that separation of product and fees. So what we’ve seen again is, is increasing attention on the product costs. And probably only, only now is maybe there a little more attention on advice fees. We’ve had that increasing element of product costs. But the other part is actually led to a lot more outsourcing of investment solutions as well by advisors. As, as it’s really that, again, that separation allowed more room for others to sort of handle the investment side and to sort of drive costs and performance there. And I bring that up because the UK, likely more than, than sort of other markets, really is seeing a dual pressure on pricing. One is this index adoption, which we’ve already talked about quite a bit, but the second is they’re more and more consolidated sort of fund buyers, drivers of flows. And they’re increasingly demanding, lower price share classes. So, so even where there is active business, it’s likely to come in at a lower cost than before. So it’s going to take even more scrutiny from managers to understand where the sort of profitable segments are.
Goshka: Yeah, that is fascinating, Ben, that that second driver, which is that that emerging power, if you will, of the gatekeepers and very broadly understood as gatekeepers or the fund selectors is something, something that’s that’s really very evident and I know that actually you prove, that with the research that you and Marc Hamper do and the, NPS report, that I know is the second issue will be, will be in the fall, I believe. So we’ll see more of that. But I think that, also, it would be interesting to hear your reflection of, of how these things are developing in the continental Europe. So outside of the UK and in Europe, because clearly, most jurisdictions there, you could make a case of method in some cases did something and certainly Netherlands have gone, and that kind of a commission van, way similar to, to other markets like, you know, the UK and Australia, but by and large, continental Europe did not see the type of, of of massive regulatory initiatives like, the aforementioned, retail distribution reform or RDR in the UK. So can you tell us a little bit what’s going on in Europe?
Ben: Sure. And I think that’s a great point. Gosh. MiFID two did not in the end go all the way toward sort of embedding banning embedded commission so you do have a different regulatory environment. And then it is worth noting you have very different distribution environments in many of the EU markets. Many of them do sort of lack this sort of independent financial advisor channel as we sort of define this IFA’s in the UK. So that is an important distinction, as in many bank distribution. For example, dominates and obviously you coming from Canada, you know how that that sort of can change the economics of retail distribution. So it’s important listeners understand that to begin with. And I think it is why part of the reason may be in Europe, it’s been a bit more of a product story and maybe a bit channel specific. The story of index adoption, because it still has occurred, on mass certainly if you kind of look at AUM levels, it’s not really all that far off what we’ve seen in the UK, even if there’s different drivers. One of those drivers though, that that sort of been, counteracting force, is in fact sustainable investing. So it might interest people to know that if you were to look at article six funds so for those not familiar with the European landscape, these are sort of the non sustainable funds. If you want to sort of use it as a late SFT as a labeling machine but these funds index accounts for over 40% of the AUM. So if we aren’t talking sustainable funds index is actually increasingly becoming half the market,it’s very easy to see it reaching that. But if we turn to sustainable funds, in which case I’m talking article eight, an article nine funds index is less than 20% of this AUM. So, so sustainable funds in the aftermath of the SFDR are was very much an active story and gave active managers an edge and they drove very large flows in 2020 and 2021 off these sort of active ESG strategies. Now that turned in 2022 and 2023, we’re ESG sort of fell out of favor in all this active money. Almost an equal amount flowed out leaving sort of a net zero. But again, it showed the power and the connection between active and sustainability messaging. So the future of sort of sustainable investing is growth will play a key part in determining a large portion, I think, of Europe, and where we sort of see the money goes. Now, second to that, there has been a clear ETF story in Europe. Year in and year out, ETFs are generating positive flows basically through the good times and the bad. And in ETFs are now over 1.5 trillion. And this is part of a new asset story but also a product substitution story. And the remarkable thing though is a lot of this has occurred with ETFs really only in sort of being fully accessible and used in more of institutional and high net worth channels, as many sort of retail wealth management platforms where they exist in Europe and in fact, including the UK, don’t really integrate ETFs that well. So there’s potentially still a large retail consumer base that could provide a groundswell of new assets. So Europe is definitely different and there definitely seems currently to be competing narratives around sustainability and the role of active and cost. I really think we have to watch to see if these two trends kind of intersect more in which way investors go. Is it about having that low cost core or again, is it maybe a bit more aligning your investments to your values in needing a more active manager to do that? So that’s really where we stand currently in Europe.
Goshka: And I think it’s a fascinating discussion on the on the issue of fees and controlling the cost of the portfolio and how, you know to your point, Ben, if there are still active pockets and I think, Christopher, you mentioned the same thing. You know, how does an asset manager recognize that the pricing still has to be right? And I think that’s where the active ETFs are really coming into focus on delivering that story. That interest is huge and active. If it’s priced right and packaged right to fit in to all sorts of fee based and discretionary portfolios. So I think that’s a really, really great perspective on both the Americas and on Europe. So now we spent a fair amount of time focused on the active side and but what has been, kind of the other side of the coin. So the growth of index, funds in, in their various structures, what that has meant to managers that, who that do have that type of capability? Christopher, let’s start with you.
Christopher: Well, you know, man doesn’t live by bread alone, and, passive managers don’t live on index funds. Oh, go to either. You know, even the biggest index fund providers out there are surprisingly reliant on, active management. Think of Blackrock, its roots are actually as an active manager. And it still is, depending on how you look at it, profoundly driven by active management, even though its US assets are, you know, 90% passive, still 40% of its revenues come from active loans. The story is also similar for Vanguard. You know, which its roots are as a, index manager, but it has quite a notable, active business, it’s funny to think about the fact that index managers are giving up on the active management. And so, you know, maybe active managers shouldn’t give up on active management either.
Goshka: Yeah, that’s a great point. Then maybe, Christopher, to the point that that philosophical divide is not really I think so, powerful. Maybe it’s vocal is vocalized, but in reality, even asset managers, you know, that happen to be specialists on either side of the or either end of the active versus passive spectrum. Still recognize that there are use cases for investors and for advisors on both sides of that, divide. Ben, what do you think how the kind of the, the capability of index fund provision, has worked, what it has done for asset managers in Europe?
Ben: Yeah. I think the only thing I would add to Christopher’s comment is, is it kind of goes along with his comment as an index capabilities have often been used to support additional business lines, and they should always be seen. Any asset managers capability should be seen in the broader organization. And to me, index is very much been used this way by a number of managers. Just to give an example is many managers for example, are using their their index prowess to support their multi-asset solutions. So obviously this could be traditional Unity’s multi-asset funds, which most markets have seen sort of the passive providers be in the space or increasingly in model portfolios and supporting one’s own model portfolio range, because now it’s giving you access to sort of that asset allocator fee. So through index you’re getting access to another revenue stream. And again, without going into too much detail, you can see something similar in the retirement business. As in in many markets, whether it’s index or not, asset management capabilities have been used to sort of bolster a retirement business, whether sort of a DB or DC solution in this can also be quite popular because, again, index can help you control some of your costs within your pension funds, and this ultimately may allow you to win certain business.
So I think the question for all managers out there when thinking about index capabilities is it’s really a holistic question, and it really is how does this help the rest of my business? You know, how does this help me grow? My bottom line and index does not necessarily have to do that directly. And I think more than a few, managers out there are using it in a bit more of an indirect fashion.
Goshka: Yeah, that’s also an absolutely great point. And I think Christopher’s examples of both Vanguard and BlackRock are also supportive of that, that clearly both firms, you know, with particularly BlackRock not really having come from passive, but have really risen to prominence on the strength of their passive offering and therefore the active can trail behind. So that’s a great point. So let’s wrap up with Christopher. Christopher, you and I have spoken about this, this a lot. And of course, I am, a well known, well, to those of you who know me, a gloomy, may say. And. No, not at all. I do think there is, there is, there are plenty of opportunities in the asset management business, but this is a challenging picture. What do you think asset managers should be thinking about? And, you know, how can they, think about growth and and managing that revenue picture and how do they have to change the narrative of growth as they move forward?
Christopher: Well, you know, an obvious takeaway from our work is that, you know, managers need to be more selective in where they pursue opportunities. The old game of maximizing asset growth alone, I think, is dead. I, I think, you know, seeking growth at the right prices is rising in importance. And, and sizing target markets. You know, that’s one of the big reasons why, you know, traditional asset managers are so keen on alternatives. Alternatives are probably going to remain a relatively small part of the typical retail investors portfolio. But if you go to see price tags associated with these strategies or fees associated with these strategies, there are many multiples, of the kinds of, funds we were we’ve been talking about today. So that’s an example of, you know, maximizing not necessarily asset growth, but, you know, thinking about it more holistically in terms of revenues. Now there’s no one right way to do this, I think it will depend on the strength of, you know, the underlying organization if you don’t have any alternatives, capabilities, no heritage in this area, I wouldn’t suggest going out and becoming an alternative manager, because that’s where the revenue growth is. You know, for some managers, they will find, revenue generators that are kind of beyond the traditional, mutual fund structure. We talked about active ETFs as one example, of that. You know, of course, we know that, investors, are keen on finding different kinds of product wrappers, you know, depending on the strategy. So we’ve seen SMA assets rise a lot recently. We’ve seen some of the several liquid product structures also attractive in some instances. And, you know, in a world where, getting advisors attention and showing value to advisors is increasingly important, it means that asset managers, you know, need to become advisors, partners, and that’s, you know, supporting their businesses in numerous ways. You know, very resource, rich organizations like BlackRock do so by providing technological tools to asset managers. You know, but we’ve seen, you know, smaller, smaller scale boutique managers do the same kind of thing by supporting advisors. It builds loyalty, it builds and that loyalty, translates, into eventual revenue growth.
Goshka: Thank you, Christopher and I think that if I were to paraphrase for the largest, managers, it’s, about, I guess, sticking to the mantra that you’ve delivered to investors, which is diversification, not putting your all your eggs in one basket and really try to diversify your sources of revenues as much as possible. And you, you raised the example of, of BlackRock and, clearly others and for the more niche players, you know, stick to your knitting and be focused and, and, deliver on that. And the rest should sort itself out. Guys, this was, fantastic. Thank you very, very much. It’s a longer episode, but I just felt there were so many important topics, that, that, interest me as we continue to look at, our various, research pieces from around the world. And we now will have also will be incorporating, more work from Australia, and also from Canada. And I think that as we look at various jurisdictions, of course, the devil is in the local details. And Ben, for example, mentioned the different pace in Europe versus, the U.S and where we are in the market, place in terms of the penetration by ETFs and index funds. But the reality is that I am seeing slowly a convergence of various, trends in the asset management business globally. And this is really wherever we look, this is really happening, even though we recognize that that it’s all about the local detail and color and the regulation and the structure of the market and the structure of the distribution. So this is all very, very important and we will continue to monitor those trends. You know, I think that the second takeaway for me is that asset management remains a highly profitable business. Christopher to your will read with interest the newest, piece on, profitability, of, public managers in the US but the vice is squeezing. I thought it was a quite, a rapid, fall from that, above 30%, operating margin, that line the to 25. You know, I think that that what this suggests is that in an environment where growth in terms of markets and flows is plentiful, I think you can always make up that shortfall in the actual margin by growing the revenue base, because the asset book is growing. But right now, asset managers have to, course correct or to solve for households generally not having enough financial means to, to kind of accelerate and intensified their saving activity or investing activity. We are going through what I call the demographic debt, which is when many baby boomer households that has powered this business, over the past 30 years are moving into retirement zone and of course, stopping to contribute rapidly into their investment portfolios. So it’s lots of and you mentioned both of you mentioned the unbundling of the asset management value chain. The takeaway game, as we like to say here, that ISS Market Intelligence or that competitive, that intense competition for asset dollars. And for investors and advisors, Hearts and minds is on. And, I know that, like in every competitive game there will be when there is and those will likely share the traits of strategic foresight, data driven, decision making, investment management excellence and agility. And we’re here to help out, those of you who are interested in reflecting further on the, this content. This is a wrap for today. Thank you for sticking with us, for a longer episode. I hope you found that discussion as interesting as, as I have found it. We have, a number of exciting episodes, and we’re going to be, in accelerating our releases again in the summer has been a very, very busy spring for us, but we’re going to catch up throughout the summer. As always, I encourage you to ping us, with ideas about specific topics or industry guests you would like, for us to feature. Thank you and on behalf of Market Intelligence, I wish you a wonderful second half of 2024.
About the series:
MI Talk, a podcast series brought to you by ISS Market Intelligence (MI), delivers global coverage of developments in the asset management, wealth management, insurance, and distribution industries. Each episode features ISS MI’s experts in conversation about topical issues, trends, and developments that are shaping the market intelligence landscape, specifically, and global financial services industry more broadly. Financial services professionals focused on funds, annuities, insurance, mortgages, and related areas will find MI Talk particularly helpful in staying abreast of what’s of import across the industry.