Like many others in the financial services industry, my career over the years has encompassed a fair share of mergers and acquisitions involving the firms for which I have worked. However, it appears that the level of activity we can all look forward to will make the past decade or so seem like a period of calm, even boring, stability. That, at least, is the conclusion of a report published last week on the global financial services industry. The extent of the restructuring likely to take place could transform the shape of the businesses for which many of us work.
The PWC/Economist Intelligence Unit survey of financial services firms concluded that mergers and acquisitions and restructuring would be the focus of attention as the first decade of the new millennium unfolds. The twin challenges of more demanding customers and increased competition seem set to introduce a shake-up of hitherto unparalleled properties. Given the news emanating from America on the mutual fund front – and the heightened interest of the regulators in comparable practices in this country – the consolidation of this part of the industry seems increasingly likely. Those businesses which have suffered as a consequence of recent investigations could well be seeking stronger, untainted partners.
However, one reason for expecting consolidation in the fund management business was apparently ignored by those practitioners who responded to the survey. It is the likelihood that margins will be squeezed as investment returns regress to the long-term average. When high inflation was assisting stockmarket returns, total expense ratios of 2.5 per cent could be tolerated. If the best we can hope for is an average of 7.5 per cent or so, then the costs of running funds must come down – and that means lower management fees.
A quarter of a century ago, the charges that could be applied to unit trusts were capped at 0.375 per cent. Artificiality seldom works for any length of time but the coincidence of deregulating this aspect of the market and two decades of above-average stockmarket returns allowed fund managers to raise charges steadily, justifying their action by the profits that investors were making. Even today, some fund management groups are pushing their charges up, no doubt to raise revenue to cover increasing costs. Yet the truth is that investors will become less inclined to pay higher charges if their returns are more modest. Fund fees are, after all, a tax on performance.
It is not just in the unit trust industry that this applies. Insurance companies have also maintained high charging levels, in part to support the heavy sales and marketing expenditure that is deemed necessary to acquire new business. Again, these practices must be under threat if investment returns remain stubbornly low. The greater transparency that is increasingly demanded for insurance products will make the extent of charging that much clearer.
The Government's attempts to introduce a 1 per cent cap on fund charges have been widely criticised. The reality is that the 1 per cent world may develop as a reflection of how little investors might be prepared to pay managers to look after their assets in a low-return environment. It may be that the competence of the managers will encourage differentiation in the charging market. The financial services industry could look for guidance from elsewhere.
One of the more entertaining stories last week was the news that a leading supermarket group was to insure the tastebuds of their wine buyer for the biggest sum ever, in terms of the value placed upon a part of the human body. This buyer has succeeded in developing the supermarket's wine business to where it is the envy of its rivals. There will be some fund managers with similar reputations. It is hard to imagine which part of their body might be insured but their documented success could help justify higher charges.
The Bank of England decided to leave interest rates unchanged and many will be breathing a sigh of relief. Look at poor old Australia, where interest rates are firmly fixed on an upward path. Australia has been one of the higher-yielding stockmarkets in the world. There can be little doubt, though, that the interest rate trend is changing around the world. Those with big mortgages will be concerned. Investors should be thankful that it is a sign that economic activity is once again on the up.