Fee compression drags on active managers

Active fund managers including Magellan and Platinum are facing continuing challenges around fee compression driven by passive shops and industry superannuation funds which are using scale to lower prices, according to Morningstar.

The research and ratings house has used its latest industry pulse analysis to forecast continuing fee compression for all fund managers, but said this would be most acute for Magellan and Platinum “as they have higher fees than their peers”.

What is more Morningstar’s analysis reinforced that exchange traded funds (ETFs) and superannuation funds are continuing to capture most flows and said this was likely to continue, particularly for traditional asset classes such as equities.

“Industry superannuation or profit-for-member funds will likely grow in scale and challenge traditional active managers,” it said.

“Through default choice and mandatory contributions, industry funds are pressuring fees and can tap into a broad range of investment opportunities, including unlisted options – a byproduct of scale,” Morningstar said.

“We believe traditional active managers’ competitive position is weakening overall. However, they can partially mitigate share losses to ETFs and industry funds by diversifying into more niche or exotic products that are harder to replicate through passive options.”

Mixed in with Morningstar’s negativity around fee compression is its view that investors have become unduly pessimistic about Insignia Financial and Perpetual, allowing themselves to be spooked by negative headlines while neglecting to recognise fundamental improvements.

With respect to Insignia the Morningstar analysis said that it believes the market underestimates Insignia’s ability to stabilise earnings, with cost-outs counterbalancing tepid revenue declines.

With Perpetual, Morningstar said it believed the market is pricing in an excessive deterioration in Perpetual’s future cash flow generation.

It said the proposed acquisition of Perpetual’s wealth management and corporate trust businesses by KKR vindicates Morningstar’s view that their values are not reflected in the current stock price.

“A successful sale of these assets would allow full repayment of Perpetual’s borrowings, leaving the asset management business debt-free,” it said.

“While the asset management business is in net outflow, potentially lower interest rates should help reduce redemptions, which are presently elevated. There is room to centralize operations and remove duplication from the Pendal acquisition, while its balance sheet also holds considerable surplus cash that could be returned to shareholders.