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The writer is an FT contributing editor
Britain is second only to the US as a centre for asset management. The business is fabulously profitable and employs tens of thousands in highly paid jobs. But the mood among traditional asset management executives has hardly been celebratory of late given the gale of headwinds they face.
Private pension funds constitute half of the UK institutional market and the rise in bond yields since the pandemic is now delivering a double whammy to managers’ revenues. First, fees have collapsed in line with the financial value of their largely bond portfolios. Second, the rise has thrown defined benefit pension schemes from chronic deficit to massive surplus.
This negates the need for pension sponsors to make deficit reduction contributions, which have averaged £15bn a year. It also allows an increasing chunk of sponsors to exit the business altogether, transferring assets to bulk annuity insurers in “buyout” deals.
LCP, an investment consultant, forecasts up to £590bn of such buyouts over the next decade. Furthermore, the Department for Work and Pensions will extend the Pension Protection Fund’s mandate to become a public sector consolidator of schemes that are too small for cost-efficient buyouts. This could lead to an additional £80bn of outflows. Collectively, these flows would see the institutional UK market shrink by a sixth by 2034.
It is true that actively managed institutional portfolios have, as a whole, outperformed for clients. Despite this, passive investment has flourished. Boston Consulting Group estimates that 90 per cent of net flows into the industry since 2010 globally have been into passive, and active strategies have recently moved into outright net outflow.
Across the retail market, low-fee passive investing has expanded more rapidly. This comes partly from the woeful long-term performance of active retail funds and partly from regulatory change. Of the 1,462 active Global Equity funds managed out of Europe, only 18 per cent beat their low-cost passively managed counterparts over three years after fees. This proportion falls to 6 per cent over 10 years.
Twenty years ago Huw van Steenis forecast that investors would gravitate towards passive funds for cheap benchmark performance, and to specialist managers capable of delivering outsized returns. His widely cited “barbell thesis” left no room for traditional active managers. It has proved prescient.
Since then a series of mergers and acquisitions have resulted in many firms huddling together for warmth, seeking some combination of better economies of scale or expertise to navigate the new environment. But as Mark Burgess, an independent non-executive director at Aviva Investors, put it to me, this has seen “big, and indeed small, firms merge to mediocrity”, morphing into “meaningless blobs”.
It’s easy to be downbeat, and perhaps right to be so, about the fortunes of individual firms or markets. But there are also reasons to be optimistic.
First, several traditional UK firms like Schroders and LGIM have made intelligent acquisitions or invested to expand their alternative capabilities — the higher fee end of that barbell. While it seems unreasonable to expect client allocations to private markets will grow as rapidly as they have over the past 10 years, UK firms are increasingly able to provide a compelling offering.
Second, buyouts represent a transfer in the supervision of assets, rather than the removal of them from the UK financial ecosphere entirely. This may destroy some individual firms, but it needn’t leave the industry smaller any time soon.
Third, the Brexit drag is starting to fade. The vote to leave the EU put at risk the ability to delegate asset management across borders, endangering almost three-fifths of the overseas client book. But that risk now seems to have passed, restoring vital capacity for organisational change and business development.
Finally, there are still significant tailwinds to factor in. Life expectancy in high-income countries is expected to continue to rise, and their populations to become ever richer. As an international asset management centre, UK asset managers should be able to capture this growth.
Many an active manager has pondered whether passive investing may be for them what digital photography was to Kodak. When it comes to retail funds, they may have a point. But retail is only part of the landscape. Active managers that adapt to the new institutional market can still flourish.