Shrink or Grow? Choose your reality

Industry outlooks suffer from a split-personality syndrome

December’s final week is a weird one for journalism, because papers focus on the exact opposite of news. You get recaps of the year just gone, or forecasts of the year to follow. Looking forward to a well-earned break, everyone is angling for nothing to happen in the present.

The investment management industry recaps were a jolting experience, though. They seemed to suggest two entirely opposed versions of reality. According to one version, this has been another terrible year:

UK fund launches hit a 20-year low, the lowest number of launches since 2003, during the aftermath of the dotcom crash; T Rowe had the heaviest year of outflows in its history; For the third straight year, there was growth in the share of investment managers expecting their revenue to deteriorate. And so forth and so on.

But then another set of stories, often in alarming proximity to the first batch, paints the rosiest picture imaginable:

The ETF industry is skyrocketing, ending 2023 with 55 consecutive months of net inflows; the industry shattered its launch records, and 75% of new products are actively managed ones; AUM growth is spectacular across markets: up 24.6% in the US, 28.6%  in Europe, and 90% in Asia Pacific ex Japan. (Data was provided by ETFGI.)

Industry insiders will have polar opposite experiences depending on where they fall in the divide. If Abrdn is cutting 100 funds out of its range and slashing employee benefits, its employees are obviously not going to whoop for Vanguard having another stellar year.

Yet, these aren’t two different industries, just one industry in a state of flux. Also, an industry that is, on the whole, growing. When the focus changes from choosing a side to the flux between sides, an altogether more interesting story emerges.

For example, the shift to ETFs is definitely transferring AUM from one set of dominant companies to another, but concerns have focused on how concentrated this new group is. In 2023, BlackRock, Vanguard and State Street Global Advisers (SSGA) controlled a combined total of 72% of the US ETF market. What is also true, though, is that the level of concertation has been falling:

In a single year, BlackRock's market share fell from 33.7% to 32% (it was 39% five years ago). SSGA dropped from 17% to 15%. JPMorgan and Dimensional Fund Advisors went from near zero in 2018 to 3% of the market.

And product lifetimes are shrinking, as evidenced by some of 2023’s less-discussed ETF records. ETF closures were the highest they’ve been since the record set in 2020. Also, seven of the products that launched in 2023 also closed this year. Having the time to build a 3-year track record is no longer taken for granted.

Overall, demand for investment products is up. Demand for marketing investment products is up. Things are changing, but they’re not looking bad.

---

Treasure Corner: SEO for Funds

Clients can’t buy if they’ve never even heard of you, so obviously awareness plays an essential part in flows. What’s perhaps less known is that lack of awareness comes with very real costs.

The Investor Recognition Hypothesis, originally proven true for stocks, says that in markets where investors aren’t aware of all securities, a stock with low investor recognition needs to offer higher returns. Empirical evidence shows the same applies for entire portfolios.

But that means an odd trade-off is happening: more awareness (a factor an investment manager can control) trades off with better performance (a factor that an investment manager can’t control).

When researchers ask why that would be the case, one answer they come up with is that products with higher investor-recognition lower customers' search costs. By 'search', they typically mean discovery efforts, but one study took it to its literal extreme:

A 2023 research titled 'OK Google': ETF’s Online Visibility and Fund Flows, authored by Olga Obizhaeva from the Stockholm School of Economics, looked at three channels of online visibility: Organic or “free” search, paid search, and website referrals. It found that ETFs with webpages ranked higher on Google attracted higher flows. It also found that funds engaged in search engine marketing, and those with webpages referred to by more websites had higher fund flows.

---

Also Happening

Asset managers are facing a talent shortfall in selling alternatives. In their effort to move away from mutual funds, asset managers are beefing up their product range in alts, including in credit, private equity and real estate. We recently talked about this trend and said:

"Really, this is a question on whether asset managers are capable of managing and communicating the topic of illiquidity, considering so much of the products the industry offers are linked with very liquid investments."

The struggle being reported here is finding salespeople that not only understand these products, but are able to communicate them. Also, they’ll need to know martial arts? According to Franklin Templeton:

“In the wealth channel, is a blocking and tackling game,” said Jenny Johnson, the chief executive of Franklin Templeton. “You have to get the right product in the right vehicle, then convince each gatekeeper to put it on their platform while educating your own salesforce.”.  She added: “Then it is hand-to-hand combat as you educate each financial adviser on how to handle it in their portfolio.”

AllianceBernstein secured a license for a wholly-owned business in China.  China agreed to remove foreign-ownership caps in its mutual fund industry in 2020, but some managers have since decided to quit the market, including Vanguard and Van Eck. Irrespective of their presence in China, investors have pulled out $33 billion out of Chinese equities this year.

SpaceX broke its previous launch record, completing 96 successful rocket launches in 2023. Its previous record was last year, with 61 launches. Admittedly, I haven't been paying any attention to space news. The FAA certainly has, though, what with all these rocket launches increasingly crowding the skies, mostly in sunny, tourist-friendly Florida.

That I’m imagining how the FAA coordinates zooming rockets with zooming planes shows I hang out with kids. But it also hints at what’s to come, as other industries wake up to space progress. Even something as simple as sector classification: SpaceX and its competitors are private; were they to list, what sector would they fall under? Aviation? But StarLink does satellites, so Telecoms? A little further down the line, possibly Mining?

One incredibly fundamental assumption has been that businesses take place on Earth, and fall into neat categories accordingly. Quietly, that assumption is starting to wobble.