Protect your assets

Given that trillions of dollars worldwide have been written off from company balance sheets, pension funds and investment portfolios, it is little wonder that asset managers are looking for good news. Sadly, however, it could be a long time coming if recent reports on the state of the market are to be believed. According to a study released by researcher Cerulli Associates of Boston, it will take at least five years for the global asset-management industry to recoup the $10trn that disappeared in the last six months of 2008. The firm found that worldwide, the investor assets managed by the industry had shrunk to $43trn as of December 31, 2008, representing a loss of $10trn, most of which occurred in that year’s fourth quarter.

Every asset class, except for money market funds, was hit by the downturn. Assets held in money market funds posted a 1.7 percent increase, while equity funds were the hardest hit, posting a decline of 39.6 percent, the report found. Revenue for asset management firms also suffered. With the decline in asset values and relocation of assets away from higher-yielding equities to lower-yielding fixed-income and money market funds, net revenue declined, Cerulli reported. While annual revenue peaked in 2007 with $167bn. That total dropped to $156bn in 2008, Cerulli found. And asset-management revenue may decline further, to an estimated $133bn in 2009.

The end is nigh In what the consultants called an “Armageddon scenario” where the recession deepens and asset prices drop even more, industry assets could decline between 30 percent and 35 percent by 2012. In a “recovery scenario” where the economy recovers gradually, assets could still drop between five percent and 10 percent by 2012. And in a “happier day scenario,” where the economy rebounds next year, the industry could pull in between 10 percent and 20 percent in new assets, the report said.

Specifically, the survey found that investors who lost billions in retirement savings last year and will soon need to retire on their smaller nest eggs will want safer and cheaper investment options. Even company and state pension funds will be affected by the shift in the tastes of retirees, the consultants said, forecasting that institutional investors will cut stock allocations to somewhere between 35 percent and 45 percent by 2015 from roughly 55 percent in 2007.

Continual trend industry observers expect similar announcements to take place throughout the rest of the year. Investment bank Jefferies Putnam Lovell has said that there will likely be a steady flow of asset management mergers and acquisition activity in the second half of 2009 and that divestitures by companies needing to shore up cash – like the blockbuster deal by Barclays to sell its asset management business to BlackRock – will be the strongest driver of activity. Divestitures accounted for 47 percent of the deals announced in the first-half of 2009 compared to 26 percent of the deals announced in the first-half of 2008. Asset managers looking to add scale and private equity firms looking for inroads into the growing asset management market will also play a role. There were 72 announced transactions in the first half of the year, down from 109 in the same period last year. “We expect divestitures to remain the driving force in M&A activity through the second half of the year as the asset management industry faces its most radical reshaping on record,” said Jefferies Putnam Lovell’s managing director Aaron Dorr.

The EU directive, a response to public anger at the excessive risk-taking that led to the credit crisis, would require many hedge funds and private equity firms to register with regulators and disclose more about themselves and their investments. They would also have to meet increased minimum capital requirements and limits on borrowing, which have triggered threats from some big UK hedge funds to move overseas unless the plan is rewritten.

Most hedge funds with more than €100m in assets, buyout firms managing more than €500m and companies more than 30 percent-owned by a private equity firm would be regulated under the EU plans. The rules would limit the amount of leverage, or borrowing funds can use, and require the use of European-domiciled banks.
Hedge funds use sophisticated, complex investing strategies to make returns, even when markets are falling, and they have been blamed – the industry says unfairly – for contributing to the financial crisis and threatening future financial stability. Under the EU plans, hedge funds would be required to be more open, and their ability to borrow would be limited. Investment associations are concerned that if these rules are adopted, hedge funds will be driven to relocate outside the EU.

Yet some of the criticisms surrounding the industry are being reviewed. The UK Financial Services Authority (FSA), the City watchdog, is conducting a survey of hedge fund borrowing. Myners has said that Britain will seek “significant changes” to the EU proposals, with officials lobbying in “a dozen key capitals” over the summer. Speaking to the Alternative Investment Management Association in July, Lord Myners said: “Our aim is a framework which allows efficient, well run and well regulated fund managers to compete for business without restriction across the EU and to make the EU a base from which to compete in global markets. The draft directive needs major surgery before this can be delivered.”

Robert Jenkins, chairman of the UK’s Investment Management Association, has said that the EU’s approach to alternative investment legislation was “curious”. “When the banks ran out of liquidity, our customers for whom we act as agents, helped supply it,” he said. “When the banks ran out of capital, the funds we manage contributed to the take up of new debt and equity issues. And when one day, governments divest their shares in the walking wounded of the banking world, to whom do you suppose they will sell? In short, the investment management industry is not part of the problem but we are part of the solution,” he added.

The Mayor of London, Boris Johnson, has warned that the Commission’s plans to regulate hedge funds could “strangle” the City as an international financial centre. He said: “It is a weird thing that under the fog and confusion of war, the Commission seems to be proceeding to attack something in which London simply excels and was not responsible for the recent catastrophes. I think it is very, very dangerous to the City. It is very important that we defend an industry that generates huge sums of tax for this country.”

As well as speaking out against the EU several fund managers have said they had previously had confidence in the UK’s ability to resist punitive regulation from Brussels, but were now fearful that the Brown government was too politically distracted to act decisively. ”The FSA’s hedge fund regulation has actually always been very good, and the UK has the infrastructure, the capital markets and the prime brokerages that make it ideal for hedge funds. But now we risk driving them out,” said Simon Luhr, the managing partner of London-based SW1 Capital.

“The prime minister can’t stand up for himself right now… I think it’s going to be a disaster.”

Other managers, though, have been much more sanguine. Lobbying efforts have intensified in recent months and a considerable amount of behind-the-scenes work was going on said one major London-based fund partner. ”I think people just need to be a bit patient. It’s only the first draft of the new rules,” he said. Hedge fund managers will be hoping that the process goes no further.