Rethinking active equities businesses

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These are tough days for active equities funds managers.

The announcement last week of another closure of a fundamental equities business was the latest in an extended period of retrenchment in active Australian equities. This is not just an Australian phenomenon – you can see it happening in domestic equities in other major asset management markets in the UK and elsewhere.

There are still active equities businesses doing well, and there is the odd start-up and expansion. But it’s fair to say that success has become much harder and elusive.

There is no simple answer, either. Sorry. As we will see, great performance is not enough on its own. New product is (in most cases) not enough. Marketing initiatives are not enough either.

They are all part of the puzzle though – a way forward which requires a sophisticated approach which integrates investment, product, and marketing competencies more effectively than has been achieved historically.

Today we’ll look at the problem, and what the product response can achieve. Next week we’ll look at the marketing response, and how to tie it all together.

An integrated approach would be bread and butter for an FMCG firm. But for asset managers who have become intermediated over the past 20 years, it means re-building or acquiring lost skills, and working out how to combine them coherently. Let’s be honest – in many asset management firms, the level of investment in marketing (which is much more than sales and advertising) would be seen as a joke by a major FMCG firm. We are seeing the consequences of that lack of investment.

The symptom, as today’s chart demonstrates, is sustained net outflows. And this is not just a cyclical issue. Historically there has been a strong correlation between index performance and net inflows. But since 2009, this has broken down. Flows are not responding to a market which seems to have at least found a floor.

As noted, excellent performance has not insulated managers either. Perpetual, for example, has had exceptional investment performance for the past 3 years and yet is suffering deep outflows.

Although an end to the bear market in equities would obviously help, the real concern is that the structural challenges will outweigh the cyclical recovery, when it comes. These include:

In retail, the disintermediation of core equity funds by direct equity portfolios (generally not sourced from equity managers), enabled by improving wealth management technology and new dealer group equity offerings.

In institutional, the scale effect which works to cap the amounts that large super funds can allocate in active mandates to domestic markets like Australian equities. A $100 bn fund might not be able to allocate any more than a $30 bn fund.

In all segments, the threat of rotation from active to passive. Sometimes this is the flipside of the above issues. But the pressure to cut portfolio investment costs is as an important driver for the financial planner as it is for institutions.

So what’s the way out of this conundrum?

In terms of the product response, some products are inherently better positioned:

Well differentiated product with a hard-to-replicate process. The halcyon days of the middle-of-the road active large-cap fund may be over, but it will be a long time before something like the Zurich Equity Income Fund (managed by Denning Pryce) can be replicated.

Niche products where active management often has a better story, and fees can be higher.

Products which serve new needs and applications, such as pension portfolios, where there will be substantial expansion even though the shape is not yet clear.

Offshore and global products, where the opportunity set is much wider and active management should have more to offer.

So far, however, new product successes have not been enough to plug the outflows. Active Australian equities have been the industry’s cash cow. You need a lot of new sales to fill the hole in that dyke when it starts leaking.

Continuous efforts in product development are still needed, and will be part of any solution. But the solution needs to be as much about marketing as much as it is about product.

The revival of marketing will be next week’s topic. Stay tuned!

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