Pensions Perk for Asset Managers

LONDON -- Auto-enrollment starts this month.

Between now and 2017, pensions auto-enrollment will be phased in until all employers will be required to automatically enlist qualifying workers into a pension scheme, unless the employee positively elects to opt out. The employee's mandatory contribution, starting off at 1% of salary, will be matched by the employer.

The programme has been designed to encourage pensions savings, but in the process should prove a welcome fillip to the asset management industry.

At least one FTSE 100 (UKX) firm, investment manager Hargreaves Lansdown, is hoping to benefit. The company, best known for the execution-only retail platform that contributes three-quarters of profits, is targeting opportunities in occupational pensions arising from auto-enrollment as an area of growth alongside private pensions.

Asset management is traditionally a cyclical sector whose fortunes rise and fall with markets. So, unsurprisingly, the sector is under pressure as investors are reluctant to commit funds to volatile and risky markets. Fund managers have mostly been reporting flattish growth in funds under management, a principal driver of profit. They have responded by cutting costs, and there is talk of consolidation in the industry.

Few expect markets to bounce back this year, and perma bears such as me are too fearful of an implosion in the eurozone to stake much on financial sector companies. But markets will recover eventually and some in the industry, including Schroders' (LSE: SDR.L) CEO Michael Dobson, anticipate that investor demand could turn quickly, and as early as next year. So the asset management sector is well worth watching as a geared play on recovery in market sentiment.

The poor state of markets is compounded by structural changes. Low returns have encouraged retail investors to look more closely at costs, provoking a shift toward passive investment products such as ETFs, low-cost trackers and self-management via execution-only platforms: all bad news for traditional asset managers' margins.

In the U.K., the Retail Distribution Review (RDR) starts to bite next year. It will outlaw the paying of commission to independent financial advisors, so the IFAs will have to earn their living by charging fees.

It's widely anticipated that many private investors will balk at paying fees, leading to a sizable percentage of IFAs leaving the industry. More investors will either self-manage, or go to discretionary fund managers. That's likely to stimulate growth in execution-only platforms and greater marketing by fund management groups direct to consumers.

The three assets managers in the FTSE 100 all stand to benefit from cyclical improvement in markets and, possibly, these structural changes.

With its strong retail brand and reputation for service, Hargreaves Lansdown is well placed to attract investors switching to self-management. The 26 billion pounds of funds it administers are dwarfed by the 195 billion of funds managed by Schroders, and the 184 billion pounds managed by the third FTSE 100 firm, Aberdeen Asset Management (LSE: ADN.L) , underlining the potential that just a small shift in market structure could deliver.

But its success in gathering new customers to its platform has translated into a 50% rise in its share price this year, and its shares are trading on an expensive forward price-to-earnings (P/E) ratio of 22.

Schroders and Aberdeen Asset Management are more traditional asset managers, with a more international business compared to Hargreaves Lansdown's U.K. focus. 60% of the funds Schroders manages are for institutions, with most of the remainder coming through intermediaries, including 19 billion pounds from U.K. IFAs. Nevertheless, it expects to be a net beneficiary from RDR and is launching low-cost RDR-compliant funds.

With over 3 billion pounds of net cash on its balance sheet, Schroders is perhaps best placed to benefit from industry consolidation or expansion into emerging markets: It acquired a 25% stake in an Indian fund management company in April. Alternatively, it may return surplus cash to shareholders.

Strong investment performance and a strong position in Asia Pacific have bolstered Aberdeen Asset Management, with the result that its shares too have seen a near 50% rise this year, but they trade at a more reasonable (for a cyclically low stock) prospective P/E of 16, just above Schroders' 15.

An alternative play on asset management recovery, with a safer downside, is insurer Prudential, whose fund management group M&G manages 204 billion pounds of assets.

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Tony does not own any shares mentioned in this article. The Motley Fool owns shares in Hargreaves Lansdown.