At one time, investment management was considered to be the poor relation in banking and insurance groups, for people who were not bright enough to work in corporate finance or to become actuaries. But over time, asset management businesses have become recognised as important hubs for both profitability and intellectual capital in financial services groups.
In SA an industry that was once dominated by the big insurance companies, Old Mutual, Sanlam and Liberty, has seen the launch of glamorous independent fund managers such as Coronation and the more low-profile Allan Gray which have made their founder shareholders extremely wealthy. Merchant banking groups such as Investec and Rand Merchant Bank have launched highly successful fund management subsidiaries.
Asset management has two main attractions to financial services groups. One is that it needs little capital - other than what it pays to its often self-important staff - so it is not a strain on the balance sheet.
The other attraction is that once a manager achieves a critical mass of assets, fund management is a reliable source of annuity income. It is also a highly scaleable business as R200bn can be run on a similar cost base to R50bn.
The benefit of scale was the main attraction in the biggest merger of the past 12 months, the merger of Liberty Asset Management and SCMB Asset Management into Stanlib.
The combined group will be the fourth-largest asset manager in SA with R132bn under management, and it will run these assets on a lower cost base than the separate parts could.
There is a recognition that the easy profitability of the Eighties and Nineties is over. In recent years, the failures of wannabe Coronations such as Velocity, Gryphon and Prodigy have been more notable than the successes.
Old Mutual Asset Managers (OMAM) MD Tim Cumming says the barriers to entry in the industry may seem low. A dozen or so investment professionals can rent office space and offer their services to the market. But to build up a sustainable business, asset managers need to win the support of the asset consultants. Consultants are unwilling to risk their reputations on a start-up business.
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In a bull market, fund management income, which is invariably linked to the quantum of assets under management, can rise faster than costs. But stagnant markets lead to stagnant margins and bottom lines if asset managers cannot increase their asset base by taking mandates from competitors or cutting their costs.
There are additional pressures to margins in the SA market. One has been the growth of multimanagers such as Investment Solutions, m Cubed and Momentum Advisory Services. They have taken a much higher share of the market than their counterparts in the UK and Europe. In absolute terms, SA is the largest multimanager market after the US and Australia. And because multimanagers bring bulk assets to asset managers they can demand lower fees.
Another pressure has been the disaggregation of manufacturing and distribution. Not all the assets sold by life assurers are managed by the in-house asset manager. Perhaps as a defensive move, the life offices are offering pension funds their own in-house multimanager products such as Sanlam's Matrix, Old Mutual's Symmetry and Liberty's Lodestone.
Thabo Khojane, head of business development at Investec Asset Management, says the days of the bundled product, in which a life office would sell administration, investment and risk in a bundled package, were the Iron Age. In the modern world the winners will be the multimanagers and those single managers who can offer competitive products across the risk spectrum .
Margins are also squeezed by the costs of meeting empowerment obligations. The largest pots of money are held in the large government and parastatal funds. If asset managers have any chance of getting an allocation of this money they will need to show progress on economic empowerment. None of the top 10 asset managers has significant black ownership, nor are their shareholders likely to want to dilute their shareholding. Instead, the main effort has been to improve employment equity.
RMB Asset Management CEO Jan Hugo says the firm has established an Institute of Investment Excellence which takes on 10 trainees every year. RMB hopes to have nurtured 15 or 20 strong career investment professionals within five years.
Another empowerment initiative has been the move to set up a separate asset management business, often with noncompeting products, into which black shareholders can invest. Recently, OMAM took a 20% stake in the new Umbono Fund Managers, which specialises in index products, and Coronation Fund Managers took a 49% stake in Kagiso Asset Management, another new passive management house.
And FirstRand finally found an empowerment partner, Wiphold, to take a 40% stake in Futuregrowth, which also offers passive and quantitative products that do not compete with RMB Asset Management, FirstRand's active fundamental manager.
The downfall of most empowerment managers has been their inability to show consistent investment performance. There are certain exceptions such as Oasis . Black-controlled African Harvest Value has also been a strong performer - though unfortunately with a lily-white investment team. But there is much less risk of underperformance from a passive manager, which is often simply replicating an index or benchmark.
Ultimately, performance will continue to be the main driver of growth. Allan Gray is certainly making an effort to increase employment equity, but that is not the main reason it has grown its asset base from R7bn in 1998 to R36bn today. It has been driven by its huge outperformance of the other large managers since the August 1998 equity market crash (see tables).
Allan Gray's asset base has shrivelled during its periods of underperformance in 1991-1992 and 1997-1998. But chief operating officer Mark Herdman says there is much more awareness of the value in holding assets with Allan Gray for diversification.
There is often little difference between the returns of the other nine managers in the Alexander Forbes Large Manager Watch but a big difference with Allan Gray.
It can stick to its purist investment philosophy because it does not have outside shareholders.
But Investec, for example, has more demanding shareholders as it is part of a large, listed financial services group. Investec Asset Management CEO Hendrik du Toit says there will always be a role for a true specialist, as long as it can tolerate outflows. But Investec has opted for a multispecialist approach to maintain its client base.
Du Toit says it is more credible to offer specialist skills across a range of disciplines than it is simply to offer a balanced product that hugs the index. The traditional balanced business is vulnerable as balanced returns can be offered more efficiently using a low-cost index tracker and a number of satellite portfolios, which take bigger bets against the index.
The performance of the All Share index is becoming irrelevant as there is growing demand for products that promise to deliver a return above inflation, regardless of what the peer group or the market delivers.
Herdman says this is what Allan Gray has offered all along, so he is intrigued to see competitors starting to offer inflation-beating products. And often they are run by ex-Allan Gray employees - such as Piet Viljoen, who runs Investec Inflation Opportunity and Louis Stassen, who runs Coronation Absolute.
Stanlib MD Alan Miller says some quite different products can be sold under the banner of absolute returns. Stanlib offers it in two different formats. In its Absolute Return fund, there is a fixed allocation, with just 20% into SA equity, and big positions in local and international property as well as inflation-linked bonds. This is expected to outperform inflation steadily with low volatility.
Another way to deliver absolute returns, but with more upside potential, is by moving in and out of asset classes as their relative valuations change. This is the approach followed by the Liberty Quants fund and several of the absolute return funds.
But it is often not clear to institutional or retail investors what type of absolute return fund they are buying.
Absolute returns have been the main attraction of the fastest-growing product range in asset management, hedge funds.
Coronation has gone further than its competitors by investing the offshore portion of its pension clients' money into funds of hedge funds.
Coronation Fund Managers MD Thys du Toit says it may be an unconventional approach but there is a more favourable trade-off between risk and return than in conventional long-only funds.
"We would be uncompetitive in a sustained bull market, but when we started the process in 1998 we determined that US equities were already overpriced. And we still think a sustained bull market in the developed economies is highly unlikely."