Global asset managers after the financial crisis

The institutional asset management industry after the financial crisis of 2007-2009 is likely to return to the role of one of the largest and most dynamic parts of the global financial services sector in the years ahead. But what shape it may take is a matter of considerable uncertainty. 

by Professor Ingo Walter, Director of SimCorp StrategyLab

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The estimated extent of the damage from the crisis borne by various financial sectors is shown in Figure 1. Losses outside the banks have affected insurance companies and hedge funds, but indirect losses, as a result of massive price declines in financial and non-financial shares as well as crisis-related bond defaults, have eroded equity and fixed-income values. Compounding investor returns were the indirect effects on yields attributable to a flood of liquidity by central banks trying to contain the crisis. Taken together, this means that asset management clients are far more sensitive to risk and cost than before the crisis, requiring much more focused attention on these two dimensions of asset management. 

	Total reported sub-prime exposure ($ billion)	Reported exposure
US investment banks	75	5%
US commercial banks	250	18%
US GSEs	112	8%
US hedge funds	233	17%
Foreign banks	167	12%
Foreign hedge funds	58	4%
Insurance companies	319	23%
Finance companies	95	7%
Mutual and pension	57	4%
US leveraged sector	671	49%
Other	697	51%
Total	1,368	100%

Figure 1: Distribution of exposure to sub-prime loans, mortgage-backed securities (MBS) and collateralised loan obligations (CLOs) 2008.
Note: The total for US commercial banks includes $95 billion of mortgage exposure by Household Finance, the US subprime subsidiary of HSBC. Moreover, the calculation assumes that US hedge funds account for four-fifths of all hedge fund exposures to sub-prime mortgages.

Nevertheless, savings have to go somewhere, and the asset management industry will, as before, capture its share of these flows. This is based on a number of long-term drivers.

LONG-TERM DRIVERS

On the pension side, long-term drivers include the continued recognition that most government-sponsored pension systems, many of which were created wholly or partially on a pay-as-you-go (PAYG) basis, have become fundamentally untenable under demographic projections that appear virtually certain to materialise. They will need to be progressively replaced by asset pools that will throw off the kinds of returns necessary to meet the needs of growing numbers of longer-living retirees. Further changes have grown out of the partial displacement of traditional public- and private-sector defined benefit programmes. These, backed by assets contributed by employers and working individuals, have come under the pressure of the evolving demographics, rising administrative costs, and shifts in risk allocation by a variety of defined contribution schemes. Despite the impact of the crisis, which has led some to believe that a return to defined benefit programmes will develop, it seems likely that the pre-crisis trends will resume once stability returns to financial markets.

Even with the crisis-related losses in asset values, the substantial increases in individual and institutional wealth in a number of developed countries and a range of developing countries, especially in Asia, will probably resume (see Figure 2). This is likely to run alongside reallocation of portfolios that have, for regulatory, tax or institutional reasons, been overweight domestic financial instruments, notably fixed-income securities. There will possibly be a greater role for equities and non-domestic asset classes, which may again promise higher returns but may also reduce the beneficiaries’ exposure to risk, due to portfolio diversification across both asset classes and economic and financial environments that are less than perfectly correlated in terms of total investment returns.

Rank	Fund type	$ billion	Figures as of
-	Private wealth	$ 37,200	2006
1	Pension funds	$ 28,228	2007
2	Mutual funds	$ 26,200	2007
3	Insurance companies	$ 18,836	2007
4	Real estate	$ 10,000	2006
5	Foreign exchange reserves	$ 7,341	2008, Feb
6	Sovereign wealth funds	$ 3,300	2007
7	Hedge funds	$ 1,535	2006
8	Private equity funds	$ 1,160	2007
9	Real Estate Investment Trusts (REITs)	$ 764	2007

Figure 2: Estimated global asset pools by type and growth. Source: Watson Wyatt.

The growth implied by the first of these factors, combined with the asset-allocation shifts implied by the last, will tend to drive the dynamics and the competitive structure of the global institutional asset management industry in the years ahead.

HIGHLY COMPETITIVE ASSET MANAGEMENT INDUSTRY

Asset management will continue to attract competitors from an extraordinarily broad range of strategic groups. Commercial and universal banks, investment banks, trust companies, insurance companies, private banks, captive and independent pension fund managers, mutual fund companies, financial conglomerates and various types of specialist firms are all active in investment management. This rich array of con-tenders, coming at the market from very different starting points, competitive resources and strategic objectives, is likely to render the market for institutional asset management highly competitive even under conditions of large size and rapid growth. Securities firms, such as broker-dealers, have also penetrated the asset management market, and so have insurance companies reacting to stiffer competition for their traditional annuities business. Commercial banks, watching some of their deposit clients drift off into mutual funds, have responded by launching mutual fund families of their own, or marketing those of other fund managers. Firms in each category have also launched in-house hedge funds or funds of funds. Such cross-penetration among strategic groups of financial intermediaries, each approaching the business from a different direction, makes global asset management markets one of the most competitive in all of finance.

Figure 3: Serious money. Global assets under management, $ trillion. Source: Watson Wyatt.

Nevertheless, this cohort is likely to change after the crisis. Independent broker-dealers have at least temporarily disappeared as the big players either, like Lehman Brothers, failed, were absorbed, such as Merrill Lynch or Bear Stearns, or converted to financial holding companies, in the case of Goldman Sachs and Morgan Stanley. Universal banks in Europe and elsewhere are rethinking their business models based on what has happened. For example, the future role of financial conglomerates active on both the sell-side and the buy-side of the market may well advance, despite the conflicts of interest built into the model. On the other hand, pure buy-side firms such as insurers and independent fund management companies and those affiliated with commercial banks will be handed strong marketing arguments that could bolster their market share. How this pans out will be materially affected by the regulators as they begin to price systemic risk or force the separation of businesses whose cohabitation could impose unacceptable costs on the system.

POST-CRISIS OUTLOOK

So the global asset management industry is destined to live though some interesting times. The basic drivers are intact and will resume much of their pre-crisis course, but the contours of the industry itself and the impact on the various players that comprise it remain highly uncertain.

Ingo Walter, Ph.D., is director of SimCorp StrategyLab and Seymour Milstein Professor of Finance, Corporate Governance and Ethics. He also serves as the Vice Dean of Faculty at the Stern School of Business,New York University.