It has been a Darwinian decade for asset managers with some parts of the industry eating the lunch of others. Companies have forced to become nimble and adapt to the rise of low-cost passive investment.

The ability to design products which track indices at cheap prices has reshaped the way portfolios are designed. The growing recognition that wealth is concentrated in a small number of stocks meant active equity strategies have become unappealing.

Institutional investors now use passive products to allocate to large liquid security markets and preserve active management for less efficient private markets.

The ability of investors to get market exposure for low prices has also made investors less tolerant of underperformance of active strategies with managers under pressure to demonstrate performance over shorter time periods.

And pension schemes becoming less willing to swallow large fees has meant managers had to reduce their operating margins to win market share.

Higher regulatory burdens have also put additional pressure on profits. The popularity of sustainable investment has added both to the complexity and resources needed to run the funds which appeal both to the individual and institutional investors.

Equities driven out of DB

Over the last two decades asset managers have also had to flex to accommodate significant regulatory and macro-economic changes.

They have had to adapt to the more stringent accountancy valuations of pension liabilities which closed private sector defined benefit schemes and moved assets out of equities and into fixed income.

According to a report by the think-tank New Financial allocations UK pension schemes allocations listed equities went to 27% in 2020 from 71% in 2000.

Asset managers overcame these challenges by offering interest-rate hedging as part of liability-driven investment, making money from helping companies control the volatility of legacy schemes on their balance sheet.

But not every asset manager has become a player in this market. Its complexity and scale required to make it profitable has created an oligopoly with three asset managers controlling most of the UK’s pension LDI assets.

Some managers developed the passive equity products that would appeal to open DB and the emergent workplace DC pension schemes and limited their active equity sales to the LGPS and wealth market.

Quantitative easing and ultra-low interest rates created another challenge – fixed income became a zombie asset and while equity markets rose ever higher, yields became lacklustre and remained too risky for DB schemes.

Asset managers took advantage of banks being less willing to lend to companies in the aftermath of the global financial crisis.

They developed alternative assets such as private debt, infrastructure and real estate to compensate for the low yields on listed securities. The lower efficiency of these market enabled managers to charge higher fees.

But that all changed last year when Russia invaded Ukraine in February 2022. The next blog will discuss how these events ushered in once in a generation changes.

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