Being a big ’un can bite you
Size does count in the asset management industry — but not always in your favour. Witness the reaction to a trading update from Coronation Fund Managers after it warned of lower profit for its 2015 financial year as the strong performance fees of the prio
MOST fund managers don’t outperform the market. The few that do are rewarded with the performance fees they charge over and above their standard management fees. So, when the market is caught off guard — as it was with last year’s dramatic fall in commodity prices and the accompanying slump in the value of listed resources stocks — those managers not quick enough to get out are unlikely to maintain their market outperformance and performance fees suffer.
That was the case with some of the larger managers that weren’t able to exit positions as quickly as their smaller peers. Coronation is a case in point. It’s not as agile as smaller managers and cannot switch positions as easily or take advantage of opportunities.
It’s all about alpha for active managers and the larger you are, the more difficult it becomes to deliver returns that beat your benchmark as you effectively become the market, says Bjorn Zietsman, an equities analyst at Avior Capital Markets.
“I think it is easier for smaller fund managers to find alpha as they don’t become the market, as Coronation does,” he says. “Coronation has to take a big position to move the needle so it becomes more difficult to generate alpha.”
Based on SA assets, Coronation is the country’s largest fund manager. Though Investec Asset Management beats it with more than R1 trillion in funds under management, these include funds managed under international mandates for offshore clients. As it takes on more assets it’s becoming tougher for Coronation to lead the rankings for equity and balanced-fund performance, as it has done for an extended period.
“Coronation did well for a very long time, but always maintained that investors couldn’t expect these returns into the future,” says Trevino Ramsamy, head of investment surveys at Alexander Forbes.
Performance fees have fallen because of performance, but that’s a factor of the markets, he says.
“In the global balanced funds, it’s still one of the best performers,” he says. “Obviously it has taken some pain in the short term. Investment strategies cannot remain dominant in all market cycles.”
So while Coronation’s strong performance over the past few years has made it the largest manager of SA assets as it attracted new mandates and more customers, it’s also become a victim of its own success and has stopped taking new clients in its SA equity and multi-asset funds. Managing growth by closing off some funds to new institutional investors effectively puts a cap on the amount of funds they manage in any given portfolio. This helps them to better manage their performance, says Zietsman.
“They want to provide the same level of management and integrity to existing clients, but it’s difficult to take on more clients based on the size of their business at the moment,” says Ramsamy. “As a house, it’s also a
It is easier for smaller fund managers to find alpha as they don’t become the market
Ramsamy cautions that past performance is no guarantee of future performance
lot more difficult to take meaningful positions in their portfolios because that may inadvertently trigger an offer to buy out other shareholders if they breach 35% of the total ownership.”
Apart from Coronation’s correlation to market levels, which ultimately affects assets under management, it was already expensive relative to its global peers on a price-earnings relative basis and when comparing price to assets under management, Zietsman says.
“I believe the reason why they were so highly rated could be attributed to their growth potential and ability to attract retail flows,” he says. “Their ability to attract retail flows remains high relative to competitors, but the quantum of flows in the industry has slowed, and I believe that has to do with a more conservative investor mindset as a result of expensive capital markets.”
Zietsman says Coronation’s performance fees aren’t linked to market performance, but to how it outperforms its specific benchmarks.
“In a period when the market is performing well, it has to outperform the market by taking views and being overweight or underweight in specific stocks and sectors,” he says. “Prior to Coronation’s trading statement, I don’t think any of the analysts saw earnings going backwards and I think that surprised the market.”
While outperforming benchmarks in weak market conditions should also boost performance fees, Zietsman says a rising market should benefit them more as this boosts assets under management.
Analysts may have underestimated the contribution of performance fees to Coronation’s revenue, he says.
“We estimate that performance fees made up between 25% and 30% of the revenue in full-year 2014 and that is now between 10% and 13%,” says Zietsman. “Performance fees as a percentage of the revenue mix have come down significantly.”
Coronation was overweight in sectors such as resources, he says. While this remains risky, it could also present an opportunity as they present value at the moment and could boost performance fees if they come off their low base.
Its exposure to African Bank also hurt as it tried to reduce its holdings ahead of the microlender’s collapse last year. Coronation wasn’t alone — Investec Asset Management’s SA business was also exposed in its money market funds. It, too, struggled to maintain its performance in the second half of its 2015 financial year.
“Investec Asset Management has been performing well from a global perspective but the SA business has struggled recently,” says Avior Capital Market’s Harry Botha. “They have seen net outflows due to weak performance, mostly the Value Fund, mandate rotation — institutional clients moving away from balanced mandates which affected the Opportunity Fund — and exposure to Abil in their money market funds.”
Botha says the SA business’s operating profit before minorities was up 20% year on year in rand terms in the six months to September 2014, but up only 7% year on year for the year to March. The UK asset management’s operating profit before minorities was up 13% in the first half and 12% for the full year in sterling.
However, Investec has refocused its SA team and hopes to slowly start improving its performance relative to its benchmarks in order to earn higher performance fees and attract more funds, he says.
While large managers such as Investec and Coronation battle to move the needle, Zietsman says smaller managers such as PSG Konsult can take a relatively large position in an illiquid share to help generate returns above the market.
“PSG Konsult has generated positive one-year, three-year and five-year alpha in its performance-fee earning fund,” he says. “You are seeing smaller managers coming up the ranks.”
Other managers that are starting to gain traction include Visio Capital, Mazi Capital, First Avenue Investment Management and 36One Asset Management.
“These small and upcoming managers no longer sit with the R1bn to R2bn they managed a few years ago,” says Ramsamy. “Now they are managing in excess of R10bn and much more in some cases.”
One manager attracting significant flows is Foord, he says. Though it was smaller, it had significant outperformance, which has allowed it to more than double in size over the past two to three years.
“For a long time, it managed less than R50bn, but as per our 2014 survey it has more than R130bn under management. With better than average performance since this survey, it’s likely that they have grown further. ”
But while some of the smaller managers have fared well, some have lost assets due to management style and poor performance, particularly those with a value bias.
“We don’t think they are bad managers, but they haven’t been rewarded due to their investment style,” Ramsamy says. “Value should be seen as a strategy that develops over mid- to long-term cycles, but some investors aren’t prepared to wait that long and can’t keep on taking the pain.”
Despite some of the smaller managers moving up the ranks, Zietsman doesn’t believe that Coronation is losing business to boutique managers. Flows remain positive and the industry as a whole has been affected by market uncertainty.
“There is a lot of brand value in Coronation, which is helping them to continue to attract retail flows,” he says.
And while managers like Foord rise up the rankings, Ramsamy cautions that past performance is no guarantee of future performance — as has been illustrated by Coronation.
“We don’t judge the quality of an asset manager on its short-term performance; we look at its philosophy, style, process and people,” says Ramsamy. “For a long time Coronation consistently outperformed. It’s one of those managers with a very experienced team.”