M&G Investments’ annual bond forum in London earlier this year featured an unusual presence on the stage: a large colourful statue of an elephant. Fixed to it was a piece of paper reading “6.2 per cent”.
It was there as the literal “elephant in the room” — a visual representation of the challenge that fund managers now face: to win a place in a portfolio, they have to beat the rate that a client can earn on ultra-safe short term savings accounts.
An aggressive campaign of interest rate hikes by central banks over almost two years has left asset managers locked in a battle for client inflows against cash deposits and low-cost, low-risk money market funds. While the 6.2 per cent account is no longer available, savings rates above 5 per cent in the US and UK still present a major challenge for fund managers.
“We’re in a different environment now and many of the assumptions of the last 15 years are being thrown out,” said Peter Harrison, chief executive of FTSE 100 asset manager Schroders. “Cash and short-term fixed income are more attractive, structured products are coming back, and income products are more valuable.”
The new regime, industry insiders believe, will mean hefty outflows at fund firms unsuited to a world of higher rates, compounding existing challenges such as higher costs and pressure on fees that are sweeping across the industry. Equity fund managers, already squeezed by years of competition from ultra-low-cost index tracker funds, could be among the losers, insiders say. For fixed income managers the picture is less clear — while they face a higher hurdle from cash, the return they can make from bond yields has improved.
“The return of cash is the biggest theme in asset management right now,” said Stephen Cohen, head of Europe, Middle East and Africa for BlackRock.
“It has put cash and money market funds front and centre with many of our clients, and raised the hurdle rates for what risk assets need to deliver. It used to be that there was no alternative [to risky assets] — but now there is.”
A record $5.76tn now sits in US money market funds, which park buyers’ dollars in safe instruments like short-term government debt, according to data from the Investment Company Institute.
That is welcome news for asset managers with large money market businesses, such as Fidelity, Vanguard and JPMorgan. But it puts pressure on firms whose offerings are not in demand in the new regime. Reduced fee income as a result of falling assets under management is putting cost-to-income ratios — a key measure of investment manager profitability — under pressure, especially for less efficient players.
“If you’re in a mono-asset class that is not of interest, you will struggle to get flows. You need diversification of asset class, client and geographical perspective,” said Andrea Rossi, chief executive of FTSE 100 savings and investment group M&G. While mergers between asset managers have often proven unsuccessful, Rossi said they will become more frequent as firms try to cope with pressure on their fees and tap growth areas.
“I think we will certainly see some of the narrowly focused players finding strategic partners,” said David Hunt, chief executive of PGIM.
Among those that have been suffering in the new regime is T Rowe Price, a $690bn active equities manager based in Baltimore, Maryland. It has been struggling with large outflows since 2021 and has tried to cut costs over the past year with two rounds of lay-offs.
Assets run by Baillie Gifford’s Scottish Mortgage Investment Trust, many of whose technology holdings have been hit by rising interest rates, have dropped from about £18bn in June 2021 to £12bn as at October this year. Baillie Gifford as a whole shed more than £100bn in assets in 2022, its most recent figures show.
Bond fund managers have also come under pressure, but see some reasons for optimism. Yields on ultra-safe US government bonds and investment grade corporate debt have surged over the past two years as interest rates have risen.
That has proved painful as the value of the bonds they have held has fallen sharply. But it also means they can now earn more income on bonds they buy, although a fall in yields over the past two months has eroded some of that benefit.
“Fixed income has come back as a really investable asset class — the ability to invest in fixed income and make mid single-digits of yield,” says John Graham, president and chief executive officer of CPP Investments, which invests the assets of the Canada Pension Plan. “That hasn’t been available for a very long time.”
Manny Roman, chief executive of the world’s largest bond-focused manager Pimco, thinks the new environment will favour its business. “Fixed income looks really good because it gives you equity returns for one-third of the risk,” he said.
Many asset managers without a large money market business are nevertheless hoping that central banks will win their battle with inflation without triggering a recession and be able to cut borrowing costs next year, avoiding a so-called “higher for longer” rates environment. That hope has grown in recent weeks after below-forecast inflation readings in the US and eurozone. US headline inflation for November released on Tuesday was in line with forecasts.
Some in the industry believe this scenario could finally drive client flows back into riskier assets.
“To the extent that you get a little bit more clarity on a soft [economic] landing and you get some stability from a geopolitical perspective, there’s a ton of money on the sidelines that will be ready to go risk on,” said Meena Flynn, co-head of private wealth management at Goldman Sachs.