SUM OF ALL TOTALS - JSE MAGAZINE

SUM OF ALL TOTALS

Despite economic challenges, the fund management industry remains agile, with large independent asset managers emerging in the last decade

SUM OF ALL TOTALS

For asset managers, 2012 and 2013 were good years. During this period, a combination of signing new clients and rising markets boosted basic annual fees, and saw them earning performance commissions for beating targets. So, while the SA economy faltered, confidence among asset managers and their clients remained high.

‘The last decade has seen the emergence of large independent asset managers. As of June 2015, the three largest independents collectively held a market share of 29%, compared to 12% in 2005,’ says Matthew Pouncett, analyst at Laurium Capital.

‘These gains have been at the expense of large life assurance companies whose combined market shares decreased by 30% over this period,’ he says.

The precise relationship between stock markets and economic growth is much debated and the two can deviate for relatively long periods. However, few disagree that poor economic growth will eventually halt years of stock market expansion, as has eventually come home to roost in China.

Data suggests that SA asset managers, along with their emerging market peers, may have reached that watershed moment too. This dilemma is faced by firms listed on the JSE asset managers board, most of whom derive core earnings from running investments, as well as the fund management units of the bigger financial services groups such as Old Mutual and Sanlam.

The fund disclaimer ‘past performance is not necessarily an indicator of future performance’, is not only apt for buyers of investment products but also for those who buy shares directly from the listed asset managers.

Despite economic challenges, the fund management industry is one of the nimblest. This is because the only significant capital they have is intellectual capital and this can quickly adapt to changing market conditions, making it relatively affordable to diversify geographically and open modest offices outside SA. However, building meaningful offshore operations is a greater challenge.

This dynamism is characterised by the mobility of skilled staff with start-ups not only common but there are also positive examples of start-ups converting into industry leaders. In SA, one of the best examples is Coronation Fund Managers, a mid cap listed on the JSE.

The company, founded by 18 staff in 1993, is a ‘pure’ asset manager, giving it the most direct benefit to the upside of successful investment allocation. This also makes it vulnerable to inferior fund performance. ‘The earnings stream of a fund manager is cyclical and volatile,’ says Coronation.

By way of contrast, Alexander Forbes – which relisted on the JSE in 2014 and is the second-largest firm in their asset managers sector – is more weighted towards the steadier income earned from administering retirement funds and more skewed towards momentum in the real economy. Consequently, it is less tied to the performance of the funds clients are invested in.

Coronation, like most of the newer wave of asset managers, is owner-managed, with staff holding a stake of 24%. The rationale for this is to align staff interests with those of the clients. In Coronation’s second year of operation, it already had R3 billion in assets under management. This growth continued at a rapid pace, reaching a total of R558 billion in assets under management by 2014. In addition to earning fees for growing the funds under management, Coronation also acquired performance fees from clients for beating benchmarks.

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The precise relationship between stock markets and economic growth is much debated and the two can deviate for relatively long periods

Coronation and JSE-listed peers Peregrine Holdings, Prescient and Efficient Group were all helped by rising markets. The FTSE/JSE All Share Index experienced an eightfold increase from the end of 1996 to the end of 2014. In the six months leading to March 2015, Coronation continued to gain new business, with assets under management rising by 8% to R636 billion. However, its biggest institutional business was flat and there was an outflow in SA, partly on account of the maturity of the industry in the country. This was offset by gaining new investments from retail investors and offshore funds. Coronation’s international institutional offering attracted net inflows of R10.28 billion, largely into the emerging market product. 

Steve Meintjes, head of research at Imara SP Reid, notes that international assets made up more than one-fifth of assets under management and nearly one-third of profits. ‘Time will tell whether international profits growth will be enough to drive overall earnings growth on top of the mature local base,’ he says.

Industry-wide, asset managers struggled to win new business for most of 2014, consultancy EY said in a survey published earlier this year. However, Coronation and most of the firms listed in the asset managers sector increased funds under management, suggesting that they may have held up better than the wider asset management industry.

EY asset management lead director Chris Sickle says the survey results showed a drop in asset manager confidence in the fourth quarter of 2014 due to strong net outflows of institutional funds for the third consecutive quarter.

‘The sustained loss of funds undoubtedly pressures earnings. While profits continued growing in the fourth quarter, the pace at which profits are growing has slowed considerably,’ he says, going on to caution that ‘asset managers are no doubt concerned that should funds under management continue shrinking, they will most likely face a profit squeeze very soon thereafter’.

For Coronation, of greater short-term importance to profitability was the halt in the extraordinary performance fees earned in the same period as compared to the previous one. This was as growth in the FTSE/JSE All Share Index slowed to 7.3% in the six months leading to March 2015 after two buoyant years, resulting in profit attributable to equity holders falling 11% to R863 million.

Coronation grew concerned that the risks of investing in rising markets, without a strong economic underpin, were too great and on a relative basis pulled back investments in some of the most popular and expensive stocks to increase exposure to the beaten-down mining sector. This approach to seeking value may well turn out to benefit the firm in the longer run as, globally, investors are becoming jittery – and at times downright panicked.

Peregrine Capital, SA’s best-known hedge fund manager, uses this alternative investment strategy to achieve positive fund returns in all market conditions, including falling markets.

Historically, hedge funds started betting against stocks and bonds when analysis showed they were overvalued and due for a correction, in order to reduce risk to capital. However, today the alternative approach includes taking on debt and increasing risk.

The Peregrine Capital division offers three funds with varying risk profiles, from its Pure Hedge Strategy Composite to its High Growth Strategy Composite.

In the year leading to March 2015, Peregrine Capital helped boost group profits attributable to shareholders by 59% to R677 million – this after profits at the Peregrine Capital unit more than doubled. However, profit generation at wealth manager Citadel was more muted after perform-ance fees were not repeated.

In 2014, Peregrine Holdings executed a small strategic shift in acquiring a 50% stake in corporate advisor Java Capital. This sees Peregrine Holdings now providing advisory services to listed companies in areas such as mergers and acquisitions. Java has successfully competed against the investment banks and it’s a business less tied to the dynamics of financial markets.

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‘Survey results showed a drop in asset manager confidence in the fourth quarter of 2014’

CHRIS SICKLE, ASSET MANAGEMENT LEAD DIRECTOR, EY

Meanwhile, Alexander Forbes has a bigger market capitalisation than Peregrine Holdings, but it has a very different business model. Like the JSE-listed asset managers, Alexander Forbes offers fund management through its investment solutions unit but that is where the similarity ends. This is because it earns almost a quarter of its profits from the steadier pension fund administration business, which includes everything from running the day-to-day operations of a pension fund such as collection and payout systems, to the expert services that ensure funds will be able to meet future financial commitments. Importantly, it also includes analysing the fund performance of the third-party assets managers.

Before Alexander Forbes was fully relisted in 2014, and under the heavy debt burden of its private equity model, the group shed underperforming businesses, including those in Europe. This saw the firm return to a profit of R505 million (on a continuing operations basis) in the year leading to March 2015.

Like Old Mutual, Alexander Forbes argues that the business now has more of a competitive edge in the rest of Africa and is focusing on expanding beyond its Southern African base. The combination of strong economic growth in Africa, albeit muted by the commodity price plunge and a still small pension industry, is tempting to many financial services players.

Alexander Forbes’ performance in its home market is more constrained by the economy. While the pension administration business is more stable than a stock market fund enterprise, it is also more dependent on strong economic growth to expand the employment pie.

According to the group: ‘The number of active member records administered within the institutional businesses exceeded 1 million as at 31 March 2015, a 2% growth on the comparable number as at 31 March 2014 in an environment of little or no employment creation.’

Their success in attracting government pension business has also been noteworthy. However, as a market leader, it will need an economy able to create more private-sector jobs to ensure the sustainable growth of this division.

Prescient Limited, which includes an IT business, also bucked the industry-wide trend in its asset management unit to increase both funds under management and fund performance fees in the year leading to March 2015.

‘The increase in total income was driven largely by the improved performance on mandates that generate performance fees and, in addition, there was also the strong contribution from the China Balanced Fund in the latter half of the financial year,’ says Prescient. ‘The China Balanced Fund significantly outperformed its benchmark and generated a robust performance fee flow as a result.’ Prescient will have its work cut out in continuing a strong performance in China after their main stock market plummeted this year.

Among the small players, Efficient Group continues to perform better and is in the middle of a turnaround. To achieve this, Efficient has sought to reduce its reliance on volatile performance fees by expanding businesses that can earn steadier annual fees. The group also made a significant acquisition, buying 71% of peer ARX Investment Partners for R123 million, the final amount depending on the performance of ARX.

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Investment holding firm London Finance & Investment Group (Lonfin), is listed on both the London Stock Exchange and the JSE – a character-istic usually associated with highly traded companies with substantial market caps of more than R200 million. Despite this curious state of affairs, the Lonfin general portfolio of European blue-chip shares managed to outperform both the FTSE 100 and the FTSEurofirst 300 indexes from 30 June 2014 to 31 December 2014.

While other asset managers won’t feel threatened by Lonfin, the firm’s London listing will not go entirely unnoticed. This is because a geographic diversity of clients is the best way to reduce the rising political and economic risks of SA.

For industry players, not much capital is needed to establish these businesses but they will nevertheless be tested. One way to do this is to sell themselves as emerging market specialists to European and North American investors. The more recent decline in appetite for developing country assets due to the emerging markets crisis will, however, make this difficult right now. A relatively quick recovery in commodities will help create the right conditions for this to resume.

An expansion into developed markets with European and US domiciled investment products will be a bigger challenge. Reputation in SA does not necessarily translate to reputation on a London high street beyond the expat market.

Marketing costs will be significant – witness Investec’s sponsorship of English Test match cricket in order to gain acceptance as ‘part of the establishment’. The brands of SA asset managers likely carry more weight in the rest of Africa, even if the client base on the continent is still relatively small, the stock markets small and shares less tradeable than those at home.

By Tom Robbins
Image: Fredrik Broden/ReneeRhyner.com