FOFA fallout along the value chain

7 March 2013

Jarrod Brown, CEO of Bennelong Funds Management, has experienced life at every stage in the financial services value chain since starting his career in the industry over 20 years ago. Charged these days with running Bennelong's growing funds management business, Jarrod is ideally placed to comment on the challenges and opportunities facing asset managers and the industry as a whole in the year ahead.

It's no surprise that 2012 was a difficult year for many in financial services. Regulatory change in the form of the Future of Financial Advice (FOFA), Stronger Super and MySuper reforms presented challenges for investors, asset managers and indeed the value chain alike, as the industry struggled to come to grips with the potential effects.

Couple this with a challenging investment environment, equity markets in a state of flux, a struggling United States economy, poor data and a leadership change in China, not to mention the ongoing sovereign debt crisis in Europe, and it hasn't been smooth sailing for anyone. Nervous investors have continued to flee the falling or flat returns from perceived risky equities and sprinted into the safe haven of cash and bonds. As a result, most asset managers have endured outflows.

Consolidation and concentration

Against this backdrop of several years of weak investment returns and regulatory change, we've seen a number of structural shifts towards industry consolidation and concentration. It seems likely that as the detail of FOFA and MySuper reveal themselves in their entirety, these consequences will continue despite a warming macro environment.

Nonetheless, it's important to understand it's still early days for the reforms. No one really knows how to assess the end impact of FOFA and its related costs. Even for asset managers like Bennelong, which has good relationships with a number of platform providers, it's telling that we have as yet received no communication from them about FOFA transition arrangements.

The lack of clarity around compliance mechanisms is particularly challenging for smaller managers, who have little option but to play a waiting game until the bigger players reveal their solutions. The clock is ticking.

The big question - what FOFA will ultimately mean for different groups in the value chain - may be unanswerable at this stage, but unfortunately this very uncertainty is creating additional costs. For example, professional indemnity insurance has risen significantly over recent years due to a number of factors, including regulatory change.

And the flow-on effects to dealer groups have been noticeable. Increased costs combined with net outflows have meant closure for some groups that have found their business models untenable.

For those struggling to see the way forward, some dealer groups have been offered prices that represent significant multiples of the value of their businesses, and the temptation to sell up has been impossible to resist.

Others, looking for a way to stay in business but keep control over their offerings, are joining with larger boutique players to form a more competitive group.

For a number of smaller dealer groups, there's a belief that merging with other boutique firms means maintaining independence and culture, and continuing to focus on their core business of providing financial advice.

The flow-on effect has also reached asset managers, with a number of groups being forced to close their doors.

Overseas suitors may come knocking

In the asset management sector, we're starting to hear rumblings on the street about some of the global behemoths turning their eyes to the Australian market. Our superannuation guarantee (SG) equates to a steady flow of funds looking for an investment home.

With the SG set to rise, the flow is only going to get faster and larger. Many of the huge global players would love access to our SG dollars, and absorbing some of the boutique players, or even amalgamating a number of them, is seen as a very real option.

Another blow for smaller asset managers (and even some of the larger ones) has come in the form of industry funds insourcing the asset management capability. At first glance, it would seem that consistent fund inflows would benefit asset managers, and certainly the SG did initially spur strong growth in the asset management industry. However, as their funds under management have grown, some industry funds, including AustralianSuper, have chosen to take their asset management capabilities in-house rather than outsourcing to independent investment managers.

What will 2013 bring?

So what's the net effect of this trend towards concentration and consolidation? Will it continue through 2013 and is it beneficial for investors?

Ultimately, increased concentration and consolidation is likely to continue, and in some ways this means less choice for investors. However, asset managers able to demonstrate a strong value proposition, in terms of both cost and investment returns, will continue to attract funds from savvy investors. Any group along the value chain with a strong business model and demonstrable track record should be sustainable, or will continue to have the option of joining with others.

The real challenge for the asset management industry is to communicate our value proposition to not just potential clients, but also the industry at large.

And that's something we all need to focus on.

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