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Blue Chip Journal, Issue 77

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  • Advisor
  • Management
  • Equity
  • Finance
  • Planning
  • Advisors
  • Financial
  • Planners
  • Investments
  • Offshore
  • Wealth
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Blue Chip is a quarterly journal for the financial planning industry and is the official publication of the Financial Planning Institute of Southern Africa NPC (FPI), effective from the January 2020 edition. Blue Chip publishes contributions from FPI and other leading industry figures, covering all aspects of the financial planning industry.

ASSET MANAGEMENT Asset

ASSET MANAGEMENT Asset manager headwinds For a well-established industry, there is a surprising amount of ongoing changes taking place behind the scenes We are at an interesting point in the local asset management industry, with several headwinds facing asset managers. Where we have the ambition of looking for high-quality, stable investment propositions, these are generally quite hard to identify, and when we do find them, we have a permanent anxiety around their ability to sustain themselves at this high level. The extent of organisational, process and people changes within an asset management business is higher than you would expect. Being a good fund manager does not easily translate into being a good business leader. Human capital businesses, by their nature, have relatively low barriers to entry and so we find a fragmented industry, dominated by relatively few large players. There are over 80 separate, independent asset managers in South Africa [1] . Profit margins in asset management are attractive which attracts a lot of competition, but is there room for all of them? Below we list a few of the headwinds we are observing across the industry, where we need to objectively evaluate the potential for these issues to impact our outlook for the funds we cover. Headwind #1: Access to asset flows. No Money, No Honey. The ability to build a sizeable client base has proven exceptionally difficult for smaller managers. In part, this is due to how the industry has migrated towards fewer “gatekeepers” – platforms, discretionary fund managers, multi-managers and the like, rather than establishing close relationships with the end investor. However, much of this “underachievement” rests with the managers themselves where the ability to build a good asset management business, in addition to a good investment process, is not something we have seen occur frequently. The resourcing applied to good business management has been far outweighed by the value placed on investment-related intellectual capital. The problem is that in many cases, being a good fund manager does not easily translate into being a good business leader, and so their success in gaining market traction has been underwhelming. A consequence of this is the migration of a number of smaller asset managers (“boutiques” in the colloquial, but essentially small asset managers) towards some form of distribution agreement or partnership whereby a business with a large footprint of fund buyers acting for the client creates a linked deal with individual asset managers looking for assets to manage. We count around 80% of the independent fund managers we cover having a form of “inhouse” distribution to get access to assets to manage. Relying simply on investors to “buy” funds seems to be a thing of the past. By design, managers who need access to this asset pool also have less leverage in a fee negotiation, so they can potentially give up their “crown jewel” mandates at relatively low fees, creating longer-term business longevity questions. Secondly, where smaller managers have partnered with fund distributors, they are often allocated mandates where they are not necessarily ready in terms of their capacity to manage the assets. A balanced fund for example requires the full suite of expertise: local and offshore equity, fixed income and asset allocation, and this requires a substantial investment over a long period of time to establish. Ultimately the asset managers are becoming dependent on fund distributors, and this leads to headwind # 2: fees. 14 www.bluechipdigital.co.za

ASSET MANAGEMENTINVESTMENT Fee pressure creates an additional business model problem, where advisor’s business. The advisor has the ability to consistently and efficiently small managers implement their generally investment advice have a higher hurdle to make ends meet, and large across their managers client base by using typically a range have high legacy cost bases to fund. of portfolios through a Discretionary Category II licence, either that of the DFM, or their own. A fourth benefit of outsourcing to a Headwind #2: Fee DFM pressure. is one of governance The Big Squeeze. and compliance. While assets have The increasingly DFM should moved be able from to large ensure scale, that low-cost institutional pools similar towards clients retail are products, treated we consistently have not seen a commensurate (and reduction therefore in fees reduce to TCF reflect concerns), this. The that average investor is still paying the advisor a premium has a documented for investment investment management fill the demand for offshore assets from investors. In many cases there are high-quality fund managers coming into South Africa, at significantly lower fees. Not only does this lower the fee potential for existing local managers (headwind #2), it also reduces their potential market share (headwind #1). despite the cost process, efficiencies and of running that comprehensive larger unit trust due funds. Why is this so? Common diligence sense is should provided tell on us the that funds many used. competitors should drive down The high RDR investment discussion fees, paper not led preserve to many them. We do see signs of this claims changing: that independent financial advisors • A few of the (IFAs) smaller would fund struggle managers to survive are reducing and thrive costs to try to entice new once clients. RDR is implemented, and that IFAs • “Premium” larger would managers need to who either have sell captured their business the lion’s to share of the market a have corporate had mixed or outsource performance, to a DFM. undermining the Headwind #5: The value cycle. How Low can you Go? Value managers gained prominence in South Africa in the postdot-com era when overpriced new-economy share prices imploded, allowing the old-economy value managers to outperform. Asset flows chased performance and many investment products oriented toward a value style. Post the Global Financial Crisis (GFC) we have seen a difficult environment for value managers, where for the premium fees they We charge. do not agree Investors with are that questioning assertion. We whether long-term most business part, expensive partner to shares an advisory have stayed • Global expensive, and local and portfolio cheap construc this premium believe is worth that paying. the majority of investment IFAs business. value shares have stayed cheap. This long-term capabilities. underperformance • With clients do increasingly not have to organised make material in collective changes in groups, We believe has had that several the two casualties most important where businesses • The skill have and either relevant closed experience of negotiating power their business is starting to to comply shift from with the RDR, fund and manager factors that doors, advisors lost significant need to consider flows or when needed to core change investment their investment team. to the investor. we This do not trend believe is consistent that this should with what be the we see choosing approach a DFM are: to survive. • The DFMs back-office compatibility w the UK market, reason and has for resulted using a in DFM. large-scale It is an fee added reductions • Understand With the this unique value value bias being proposition prevalent in the many advisor’s investment current pro- processes. to investors. benefit but should not be the key driver. of the cesses, DFM structural given how industry different underperformance the • The scale has been of the commonplace, business. DFMs’ and offerings has led investors are, and to question how • their The fee fund structures. managers, and Fee pressure creates In summary, an additional the services business of model a quality problem, various where small managers DFM can generally benefit a have financial a higher advisor hurdle in the to make this value move proposition to alternatives complements including low-cost the passive funds. ends meet (small following assets at ways: lower fees), and large managers typically advice process. have high legacy • cost An bases evidence-based to fund (large assets, investment declining fees). • Make What sure can that we there expect? is a good culture In our opinion, DFMs do have an impor role to play in helping advisors Offshore there has philosophy been a strong and process pattern that of aligns large with managers and philosophy We believe the fit between trends highlighted the advisor above professionalise are relatively entrenched, and grow their busines merging to deal with the the business’s lower fees advice expected framework in future. • A sustainable investment range that is Headwind #3: Emigration able to cater risk. to All different My Bags client are needs Packed. and the bar DFM. headwind #5 where conditions today ensure are very consistent much in investment favour outcom Meeting of these value-based considerations approach. will decrease However, improve the trends communication of increasingly to clients the probability difficult access of “buyer’s to assets, remorse” pressure from on fees, enable new offshore advisors competitors to focus on their core Emigration is nothing • Consistently new, but it comes managed at a time portfolio now when an we advisor and disruption who getting of investment something teams through of giving emigration comprehensive are here financial ad do see vulnerability, solutions especially across in the client larger base managers. Looking different to from stay. what they expected, and to clients. back, today’s established • Access to a winners dedicated made team their of investment gains building ensures that We when expect differences to see consolidation of opinion strong investment specialists propositions in a market where life company emerge, or there attrition is common among ground investment and asset managers • held Consistent the majority and of assets. cost-effective Rolling forward respect to businesses. between the The parties industry to simply allow for has a today, these businesses implementation have reached high across levels different of market share, compromise too many that fund does managers not disadvantage for what managers have benefitted investment as a platforms result, and so they can start to look the client. has been a relatively slow-growing outside of our borders • Constant given compliance the success with they the have various had. South Key factors pool of assets. to investigate Going forward, when carrying we are African-specific risks regulatory also undermine requirements. the long-term stability of out any your keeping due diligence a keen eye on the on DFM these options issues management team. We have seen a few departures already include: and and the potential implications for expect to see more All DFMs soon. are This not does created have the equal potential to hollow • Whether funds the DFM we cover. is independent We hope to see and out investment teams, Advisors which are clearly do not ordinarily spoilt for choice run with given deep levels how the important strong independence businesses emerge is to the so of cover. all the DFMs now operating in South Africa. advisor. that we have the luxury of choice However, because they are still a relatively • The in investment future. philosophy and Headwind #4: Offshore new concept competition. to many advisors, David vs choosing Goliath. a performance history of the DFM. With similar trends DFM offshore can be (fee overwhelming. pressure, distribution The right pressure) DFM • we The depth [1] Source: of the RMI DFM’s Boutique global Asset and local have seen global has managers the potential increasingly to be come a transformative, into South Africa to research Management capabilities. Study, 2016 Ian Jones, CEO, Fundhouse 15 www.bluechipdigital.co.za www.bluechipjournal.co.za 2

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