Presents in the stocking – for some

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The buy-side of the financial services sector is often seen as the poor relation of the sell-side. People migrate from investment banking to asset management for a quieter life, perhaps, but rarely for a better pay deal.

The tax grab on banking bonuses announced last week by Britain and France may make a move to the buy-side a lot more attractive. Initial uncertainty about whether asset managers owned by UK banks would be caught by the tax was resolved in favour of the managers. The UK chancellor, Alistair Darling, had not intended to penalise simple fund managers it turned out. He was only after the greedy bankers who have benefited from all that taxpayer largesse pumped into the system.

Details are still being finalised, but it appears Mr Darling is playing Santa, not Scrooge, for the buy-side.

The Financial Services Authority also put something in the stocking last week, with the announcement that it would not demand oversight of asset managers’ pay and bonus policies, as it does for the 26 largest banks and brokers. The regulator let managers off more onerous capital requirements too. All in all, the asset management sector can raise a glass to a better year than looked likely in January.

But it is not all good cheer. Russell Reynolds, the recruitment consultant, notes that profitability remains under pressure for most asset managers. Although flows turned positive, the money poured into lower priced money market and corporate bond funds. Morale may have improved but margins have not. “The industry is in for some challenging conversations regarding year-end bonuses,” says Russell Reynolds.

Bonus pools, on the whole, will be 20-35 per cent lower than last year’s, it adds.

This is in sharp contrast to the sell-side, where big banks and securities firms are “enjoying a considerable improvement in earnings”.

No wonder Mr Darling is hitting the banks but sparing the asset managers – they are just not in the same league when it comes to bonuses. Even at hedge funds, 2009 will be a down year for compensation, according to Heidrick & Struggles, another recruitment consultant.

Before we feel too sorry for asset managers, though, consider how much worse 2009 could have turned out. Like the banks, managers have benefited from the market recovery engineered through expanding the money supply by quantitative easing – just not to the same extent. We might have seen a lot more M&A activity without the recovery, as managers watching assets drain away through market losses and redemptions could have decided to call it a day.

As it is, there is much speculation about the wisdom of banks and insurers hanging on to their asset management subsidiaries, especially where they cannot afford to invest to expand the offering or move into new markets.

Looking at the shape of the industry, it is increasingly assuming the barbell look predicted for years by Huw van Steenis, head of banks and financial research at Morgan Stanley. The combination of BlackRock and Barclays Global Investors creates the first supergroup, and puts big active and passive businesses under one roof. Few other managers have a foot in both camps, Vanguard and State Street Global Advisors being the main examples. But the increasing penetration of exchange traded funds may persuade other active managers they need to buy into this business.

Rather than seeking the scale a successful passive business demands, though, they may look in the other direction, at the hedge fund business model. This is gradually moving onshore as hedge fund managers put a Ucits wrapper on their strategies in a bid to widen their investor base without lowering their charges.

Mr van Steenis expects growth in specialist fixed income mandates, concentrated or thematic equity mandates and alternative investments, with groups such as Ashmore, BlueBay, and Man set to benefit. These specialists are at the other end of the barbell.

What hope for traditional asset managers? Is there much point in index-hugging active management now that ETFs offer such a wide range of investment opportunities? It is only the way fund managers’ skills are sold that keeps them in business. Investment consultants advising institutional investors and independent financial advisers selling to retail investors both have to justify their existence by claiming to be able to identify the managers able to outperform. This job becomes increasingly important as funds and fund managers proliferate.

It is in the interests of these advisers that asset managers do not outperform consistently, so they can earn their keep by telling clients when to switch. This is not going to change any time soon, so the traditional managers have some breathing space. But when they hang up their stockings this year, they might want to ask for a Ucits hedge fund or two to boost next year’s bonus prospects – but not enough to attract the attention of the taxman.

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