Analysts at AB Bernstein have written a report highlighting concerns about the tendency of asset management firms to chase assets under management (AUM) at the expense of profits by offering 'slightly-better-than-passive' solutions at lower costs.
In a report seen by Investment Week, the analysts said the "accelerating" rotation from active to passive funds had tempted active managers to offer smart-beta type strategies at a low fee in order to halt the loss of assets under management (AUM).
However, although this use of "slightly-better-than-passive-products" has been driving an increase in AUM, the report said it was destroying profit margins.
Inigo Fraser-Jenkins, head of global quantitative strategy and European equity strategy at Bernstein Research, said: "The margin of the industry is already under pressure from the rotation from active to passive, but in chasing AUM rather than profits the asset managers are likely to accelerate this contraction in the margin through a process of cannibalisation.
"What we are most worried about are cases of active managers launching lower margin product simply with the goal of defending AUM."
Fraser-Jenkins said the reason this asset chasing was that the stock prices of listed asset managers werebeing driven predominantly by AUM, unlike other industries where profitability was the main factor.
He said: "In a world where passive is growing and the active-passive distinction is being blurred by smart-beta products, which themselves are seeing a halving in fees each year, this is a particularly invidious dynamic.
"Where we worry is if the intellectual capital that was previously used as part of a fund selling at, say, 70bps is now repackaged into a product being sold at 20bps or less. That does not seem to be sustainable in the long term."
The report also argued asset managers should not focus on fees alone, but on the quality of the outcome their products were producing.
"The pressure on fees is never going away; indeed, it should intensify in a low return world. But fee level is not an end in its own right. What really matters for the asset owner is the quality of net of fee outcome."
As a solution, Fraser-Jenkins said asset managers could price "beta" at a lower level, while "idiosyncratic" retuns should carry a higher price.
"This is not just about what makes commercial sense for asset managers, it also would be better aligned to an efficient fee allocation on the part of asset owners.
"For the asset managers it would be preferable either to simply lowering fees, or else offering 'smarter smart-beta' which amounts to the same thing."
He has also urged asset managers to focus on multi-asset solutions as an asset class where a passive alternative does not exist, while asset allocation is becoming ever more important to asset owners.
Lastly, the report suggests introducing fees that would encourage loyalty by reducing after a certain number of years.
"[This] would help both asset managers and asset owners by encouraging longer investment periods and thereby reducing the churn cost that asset owners impose on themselves," it said.
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