EY Luxembourg has just released its 2018 edition of Investment Funds in Luxembourg – A technical guide, designed to answer many questions on setting up and operating investment funds in Luxembourg. The 2018 publication has been updated to cover recent legislative and regulatory changes.
One may initially assess last year as having been very good for the industry, assets under management grew on average by 15 %, asset flows grew by 5 %, profits grew by 10% while margins were broadly maintained somewhere close to 37%.
These positive trends were supported by:
- Strong underlying demand for investment products driven by an ageing demographics, the shifting for long term savings to individuals and a growing middle class in emerging markets,
- Rising equity markets across the globe, coupled with a relatively benign interest rate environment. This resulted in very strong asset flows into the passive sector with continued greater focus and flows to alternatives.
Notwithstanding the many positive headlines on passive sector growth, active managers that have been able to demonstrate true alpha credentials have been able, and will continue, to attract assets.
However, the initial positive headlines mask some key fault-lines that the industry is facing and will have to deal with over the coming years. Many of these have been on-going for a number of years, and include:
1. Implementing the ever-evolving regulatory agenda, made more complicated by a series of political uncertainties (including Brexit),
2. An increasing cost base arising from implementing the regulatory agenda along with having to absorb certain costs that were previously charged to the investor,
3. Downward pressures on overall fees – a contagion (or active alignment?) of passive sector pricing along with increased challenge from investors and regulators of the value for money proposition of the active sector,
4. The investment cost of dealing with technology and digital innovation in all parts of the value chain coupled with the related competitive disruption challenges and the increasing investor demands for a digitalized service experience.
Alongside these challenges the phenomena of “winner takes all” is accelerating, with the top 10 global managers attracting over 80% of all flows: “biggest is seen as best” as size drives better operating margins and asset retention. In addition investors, both retail and institutional are increasingly focused on the non-financial returns of their investments with a growing demand for compliant solutions.
The likely outcome of all of this over the coming 3 years will be an assets under management growth rate of around 4 – 5% per annum with revenues remaining broadly flat and the gap between winners and losers getting wider.
So, the one and only remaining key question is: how to remain relevant and continue to grow in these changing times?
A twin track strategy of enhancing distribution and getting bigger is required, in order to make the most of the remaining good times whilst preparing for disruption and leaner times ahead.
Enhancing distribution will involve: gaining a better understanding of the investor through clearly identifying who the target customer is, the use of customer analytics to predict buying needs, and above all, “owning” the customer relationship. In addition, product evolution and agility will be critical, moving away from product to solution, from relative to absolute returns (with pricing alignment) and providing a range of ESG / sustainable investment solutions. All of this will also involve enhancing the investment process through the use of alternative data, analytics and artificial intelligence.
Getting bigger: size does matters as it drives economies of scale, large firms’ costs as a proportion of AUM are half that of smaller firms , outflows for smaller firms are twice the industry average, larger firms have deeper pockets for investment in innovation and there is an increasing trend of institutional asset owners looking for fewer, larger strategic partners.
So, if organic growth is not possible, consideration must be given to acquisitions, to purchase more of the same assets to generate cost synergies, or to acquire new capabilities e.g., quant, expanding distribution or obtain greater geographical reach.