Spotting the winners in great crisis shake-out

At a time of upheaval there are some absolutes that will shape the competitive landscape of the US mutual fund industry for years to come.

That is according to several top leaders in the US fund business who say the credit crisis may have dramatically changed how investors view the markets, but it has not changed investor demographics.

“I think there has continued to be an enormous opportunity in the investment management and mutual fund industry, but it’s hard to see that in the storm,” says Martin Flanagan, president and chief executive of Invesco.

At least one key factor will separate winners from losers as firms struggle through the ongoing recession.

Firms that can offer strong long-term performance across a range of investment management capabilities will succeed, Mr Flanagan says.

“Those firms that have diversified business, whether it’s by asset class, geography, or by channel, will be well situated,” he says.

Mr Flanagan also says he sees opportunity in the global demographic trends as populations age and as corporations shift away from defined benefit to defined contribution plans, placing greater responsibility on the individual to save for retirement.

Under Mr Flanagan’s leadership, Invesco has taken steps to diversify its line of products, buying exchange traded funds provider PowerShares in 2006, and WL Ross, which runs money for institutional investors in the US, Europe and Asia.

As with the majority of fund outfits, last year was a tough one for Invesco. The company’s total assets under management plummeted from $500bn (£344bn, €383bn) in 2007 to $357.2bn at the end of last year, according to Invesco’s annual report. In 2007, roughly half of Invesco’s assets were in equities. At the end of 2008, that percentage had dropped to 36 per cent. The drop in assets hit the firm’s investment management fees hard. Fees totalled $2.6bn, a 15 per cent drop from the previous year.

“What drove that was market depreciation in equity markets as opposed to outflows,” says Mr. Flanagan. Investors who did move their money out of equities and other asset classes parked it in cash as they sought safety on the sidelines, he says. In fact, Invesco’s money market funds grew from approximately $75bn at the end of 2007 to $84bn at the end of 2008 – an 11.7 per cent increase, according to the company.

Across the industry, bond fund managers, money market fund managers and more conservative firms managed to attract net flows. That included bond giant Pimco, which garnered far and away more net new money than any other firm, posting net flows of $23.6bn, according to research and consulting firm, Strategic Insight.

Firms that can offer a strong line-up of bond funds are in a good position, says Russ Kinnel, director of fund research for Morningstar. “I think there is potential that bonds will continue to draw more in than they have for most of the last few decades because you have some high yields out there . . . and at the same time Treasuries aren’t yielding anything.”

Still, it is hard to ignore the fact that the US mutual fund industry shed an estimated $3,000bn in assets last year from depreciation and redemptions.

“Overall the industry is in a tougher way because the asset destruction is off the charts and it’s unlikely the markets are going to recover to the point where the fund industry is back to where it was,” Mr Kinnel says.

He suggests firms with fixed income expertise and those that can offer good absolute return strategies will be able to attract assets in the years to come.

Like Invesco’s Mr Flanagan, Jon Baum, chief executive of Dreyfus, says his firm sees its future success in its ability to leverage a broad range of offerings through the stable of portfolio managers that are part of BNY Mellon Asset Management.

“Our belief is that what will set apart winning managers is a broad standard of offerings,” he says.

Last year, Dreyfus managed to build its assets, thanks in no small part to its line of money market funds. The firm’s assets totalled more than $350bn at the end of last year, up from about $260bn the previous year. All of the growth came from its money market funds, according to the company.

Another key factor that will differentiate winners from losers is firms’ ability to win investors’ confidence, according to Jeff Tjornehoj, senior analyst at Lipper.

“The new dynamic is that people have lost confidence and if it’s not permanent, it’s, at the very least, long term,” he says.

Many investors have been left feeling burned by the inability of fund managers to get out of the market in time to save their retirement funds, he says.

Funds that use quantitative models are likely to be less popular in coming years, he adds. “Quant models are all predicated on history and that history was no indication of the volatility of 2008.”

Many of the widely held assumptions about investing, such as stocks outperforming fixed income over the long-term, have been turned on their ear and investors are frustrated and nervous, according to Matthew Schiffman, head of product and marketing for Legg Mason’s US operations.

Investors are looking for products that are not constrained by any one asset class or geographic region, says Mr Schiffman. To that end, Legg Mason, like Dreyfus and Invesco, is looking to tap its network of affiliates to deliver positive returns.

Legg’s hedge fund unit, Permal Group, is running the Legg Mason Tactical Allocation Fund. The fund of funds will invest across asset classes and countries. And while it will use Legg Mason-affiliate funds, it will also be able to invest in outside funds, he says.

Legg Mason has been hit especially hard by the market downturn. The company reported that its revenue had dropped 39 per cent in its fiscal third quarter from the same period the year before. Meanwhile assets under management were $698.2bn for the fiscal third quarter, down 17 per cent from September 30 2008 and 30 per cent from $998.5bn at the end of 2007.

Still, Mr Schiffman says there is good reason to look on the bright side of things. A whole generation of baby boomers is on the cusp of retirement and they need advice and good counsel.

“I’m not cautiously optimistic. I’m wildly optimistic,” he says. “The demographics have not changed.”

Andrew Greene is managing editor of Ignites.com, a Financial Times publication