Good news never sells for journalists or management consultants so it should come as no surprise that anything written about the wealth management and asset management sectors tends to stress the challenges and potential problems facing the sector and its constituents rather than its virtues.
The threats posed by increased competition, the disruptive influence of new technologies on business models and an ever tighter regulatory regime on margins and profitability always tend to be emphasised in preference to the growth in revenues, profits and margins actually achieved. And this was before the publication of the Financial Conduct Authority’s (FCA) Asset Management Study on 28 June.
For investors, however, asset management companies possess considerable virtues and will continue to do so notwithstanding any new initiatives introduced by the FCA to increase competition and reduce profit margins.
Nick Train, of London-based Lindsell Train, one of the UK’s best-known and most successful equity managers, highlights their attractions in his most recent commentary for the Finsbury Growth & Income Trust plc, a London-listed closed ended investment company he manages.
“We invest in three UK fund management companies - Hargreaves Lansdown, Rathbone and Schroders,” he writes. “In each case it has long been our expectation that their investment management fees will FALL over time. This is a result of the clear competitive and regulatory forces at work.
“However, just because fees will fall it does not follow profit margins or even absolute levels of profitability must fall commensurately.
“This is for three simple, but structural reasons. Equity markets have a tendency to go up. Ad valorem fees give fund managers leverage to this tendency and protect margins when costs are rising. Technology change will lead to significant cost savings for fund management companies...Economies of scale are meaningful.
“Past growth is a poor guide to [the] future, but it must be worth noting that these structural industry characteristics have allowed Schroders to grow its dividend at an annual compound [rate] of 14.5 percent since 1988. Rathbone’s since 1989 is 11.4 percent and Hargreaves since 2008 23 percent.
“Worth noting because these dividend growth rates are way ahead of the market average and have driven superior total returns too. Since 1991 - as far back as Bloomberg will allow us to look - Schroders shares have increased 17-fold, Rathbones 21-fold while the FT All-Share is up 3.5 times. Since its float in May 2007 Hargreaves has sextupled - the All-Share is up 17 percent.
“With historic operating margins of 60 percent for Hargreaves and circa 30 percent for Rathbones and Schroders there is scope for [a] narrowing of margins - if this is indeed to be required of the industry - that would still leave this trio much more profitable than the average quoted company in the FT All Share.
“Provision of investment services is a growth industry and future growth, even on lower margins, is still highly accretive for companies as profitable as these. We think it would take an industry-wide abolition of ad valorem fees to undo our expectation of continued superior economic returns.”
Of course, as Compeer’s most recent UK industry report illustrates not every firm active in the UK wealth management sector is anywhere near as profitable as Hargreaves Lansdown, Rathbones and Schroders. Around 40 percent failed to make any profit at all or cover their cost of capital.
But 60 percent of the Compeer universe did manage to be profitable and generate very healthy margins. And this is something that seems to routinely get overlooked.