This analysis is by Bloomberg Intelligence Senior Industry Analyst Kevin Ryan and Industry Analyst Lento Tang. It appeared first on the Bloomberg Terminal.

A combination of inflation and the incremental cost of more ESG-related fund offerings could likely trim investment-manager margins in the coming years, while ESG overlays may become more mainstream for all funds. Our analysis sees costs rising sharply in absolute terms, with earnings progress dependent on managing them and market levels. DWS Group and Abrdn appear particularly vulnerable as corporate restructuring continues.

Operating expenses remain under upward pressure

Expenses have a natural tendency to increase across all businesses and fund management is no exception, with companies adopting reduction strategies. Operating expenses in 1H rose 9.5% at Amundi and 5.5% at DWS, yet Janus Henderson achieved a 5.9% decline. There are two unhelpful elements asset managers face: inflation and ESG. Inflation is likely to add momentum to the natural trend of mounting expenses, while the cost of applying ESG principals to more of the funds managed appears to represent a paradigm shift upward in fixed costs.

Cost-to-income ratios need to fall

The challenge for all asset managers is to become efficient, which the added expense of the trend for rolling out ESG principals across the business demands. Amundi is the clear winner in our assessment of five asset managers and we suspect that having a ratio near 50% is likely to be a prerequisite if earnings progress is to be achieved. Asset managers that appear to be the most vulnerable in this respect are Abrdn and Janus Henderson.

It’s not clear that clients are prepared to pay more for ESG, but it does seem likely that there’s an increased expectation that the business and its funds will be guided by an ESG approach.

ESG is likely to drive all costs higher

As the adoption of ESG expands from specific funds to being a more general development, our scenario analysis suggests this will have the effect of pushing costs significantly higher on an ongoing basis. The Social and Governance parts of ESG require skilled personnel who need to interact with the companies in which the fund invests, and as the process is so labor intensive, it limits what a single person can accomplish. This is exacerbated by the absence of a single ESG template.

Asset managers are therefore likely to need to employ more people to cover all angles to avoid “greenwashing” claims. The 24 bps we estimate for ESG compliance in the exhibit is likely to be a minimum, with associated fixed costs mounting over time.

Margin pressure likely to steadily build

The cost of running assets, especially with an ESG overlay, is largely fixed and likely to trend up naturally. This may accelerate as more funds adopt an ESG approach — with the “S” and “G” components involving burdensome fixed costs and a higher level currently in the interaction between the fund and the entity it invests in than has been historically the case. This assumes that asset managers will find it challenging to increase fund charges. It’s not yet clear whether clients will be prepared to pay for the extra costs involved in running an ESG fund.

We suspect that a mix of client reluctance and competitive pressure will constrain fund fees for asset managers. Any market correction or significant rise in costs could trim already modest margins.


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