Vanishing profit margins pressure managers

Profits for money managers are expected to come under increasing pressure as the prospect of a quick recovery in the equity markets continues to fade.

That is one conclusion in a report due out this week from Investment Counseling Inc., the Mill Valley, Calif., consultancy that annually surveys Canadian and U.S. money managers.

Money manager profit margins had begun to slip even before last year’s tech stock meltdown, declining by more than 5 percentage points in 1999 compared with 1998.

“There is still a lot of opportunity,” says Paul Schaeffer, managing partner of Investment Counseling.

“However, the economics of the business are going to have to get reset because the underlying market appreciation isn’t going to be there to bail them out. It’s going to be a much tougher business to manage.”

While the investment management industry saw assets grow an average of 25.4% between 1994 and 1999, the industry’s absolute growth, absent market appreciation,fell steadily – to 3.7% in 1999 from 22.3% in 1994.

Though industry demographics remain favorable – with individuals continuing to invest more, and with the number of rich investors continuing to grow – the downturn in the equity markets means that companies can no longer depend upon market performance to subsidize profits.

To be sure, the money management business still offers some of the most attractive margins in financial services. Investment managers generated an average 28.8% profit margin in 1999, down from 34.3% in 1998 and 29.2% in 1997, the survey says.

Mr. Schaeffer estimates that asset growth from market appreciation bolstered operating margins by 50% through 1999.

If the equity markets remain stagnant and operating expenses continue on their upward path, profit margins will evaporate by 2003, according to Investment Counseling projections.

That’s an unlikely scenario, of course. Companies already are moving to trim expenses by reducing the number of new funds and acting more quickly to shutter funds that fail to attract sufficient assets to be profitable.

Indeed, fund companies launched 950 offerings last year, off 28% from the average of 1,327 funds launched the three previous years, according to Morningstar Inc. in Chicago. Fund mergers and closures rose to 974 last year, up 37% from the average of 609 in the preceding three years.

“The situation could gain a lot of steam if the market doesn’t go up at all from this point,” observes Russel Kinnel, director of fund analysis at Morningstar.

“A lot of the new fund issuance in 1999 and 2000 were growth funds invested in technology and Internet issues. If you have a 30% loss in the first year, it’s very hard to build back a track record and attract new assets.”

In addition, Mr. Schaeffer expects concern over expenses to drive a major wave of product consolidation among companies that made multiple acquisitions in recent years. “In some ways, the consolidation of products may be a bigger wave than the M&A consolidation we’ve seen,” he predicts.

Some of those efforts already are under way. Zurich Financial Group, the Swiss insurer that acquired Kemper Corp. of Chicago in 1996 and Scudder Stevens & Clark Inc. of New York in 1997, is in the midst of a major housecleaning.

By July, Zurich Scudder Investments Inc. – Zurich Financial’s new name for the 80%-owned New York holding company for the two asset managers – expects to have eliminated 30 Kemper and Scudder funds through mergers or liquidations, and re-branded most of the surviving 65 funds under the Scudder name.

no number on savings

A spokeswoman for Zurich Scudder wouldn’t say how much the company expects to save from the overhaul, which is still subject to regulatory and fund shareholder approval.

And while the hot pace of deals on the mergers-and-acquisitions front is expected to continue – fueled by succession planning by aging managers and companies seeking to push into attractive customer segments – price multiples could soften.

“People are going to be much more selective on deals,” predicts Mr. Schaeffer. “Premium properties will continue to command a premium multiple. But you will see a lot more diversity in the multiples.”

So-called wealth managers are expected to remain among the most sought-after targets for acquisitions.

But the migration to serve the rich presents its own problems. “Companies need to build out services to attract the business, but in many cases these services are being given away in order to get the assets,” says Mr. Schaeffer. “Companies are viewing them as a marketing expense, and offering these other services lowers margins.”