Asset managers brace for tough year of cost-cutting in 2023
Long-delayed reckoning comes after falling markets hit both management and performance fees last year
Global asset managers are facing a long-delayed reckoning in 2023 as falling assets force them to cut costs and make tough decisions about where to invest for growth.
Revenues were down across the industry last year, after a record 2021, as falling markets across almost all asset classes hit both management and performance fees. In the US, total assets in mutual and exchange traded funds dropped 17 per cent between the start of 2022 and the end of October, the most recent figures available from the Investment Company Institute showed.
At the same time, most money managers are under pressure to find money to upgrade their technology and win new customers. As a result, they are squeezing personnel costs through hiring freezes and bonus cuts in the hope of avoiding mass job losses. Consultants also reported a sharp uptick in requests for advice on “efficiencies”.
“There has been a lot of complacency. A lot of players now really need to get their act together,” said Markus Habbel, a partner at Bain who focuses on the sector. “If you don’t have scale, it is getting tougher.”
While the initial reaction to this past year’s turmoil has largely been generic belt-tightening measures and small across-the-board cuts, industry analysts predict that the coming year will require more strategic decisions.
“The temptation is to take a little bit off everything. In reality it doesn’t move the dial,” said Julia Hobart, partner in the wealth and asset management practice at Oliver Wyman. “Managers will need to decide what they will and won’t focus on. Big structural changes will need to be made to take costs out of the business.”
Jeremy Taylor, who heads Lazard Asset Management’s UK-based business, added: “What does an asset manager do as revenues go down? You tend to do less of what hasn’t worked over the past three to five years and put greater scrutiny on things that haven’t grown . . . you don’t give up on any scale product.”
In fact, the stronger asset managers are keen to press for gains while their weaker rivals are making cuts. “We continue to invest through the market cycle into long-running trends that are strategic priorities for us, including sustainable investing, alternatives, active management and exchange traded funds,” said Patrick Thomson, chief executive for Europe at JPMorgan Asset Management. “If you invest significantly into those trends through a downturn, it puts you at an advantage where others may have to cut back.”
Many asset managers are hopeful that bond funds, which saw big price drops and massive outflows as interest rates rose, will start to recover in 2023. “This is a mixed blessing for asset managers because you’re going to see flows come out of other higher-margin asset classes to lower-margin fixed income,” said Tom Mills, who analyses the sector for Jefferies, the boutique bank.
Some asset managers also predict the downturn will accelerate the shift by clients from traditional mutual funds and brokerage accounts to newer ways of investing, including ETFs, separately managed accounts and model portfolios.
“Whenever there are super shocks in the market, people make big changes to their portfolios. This is when people do deferred maintenance,” said Martin Small, who heads BlackRock’s US wealth advisory business and is the incoming chief financial officer. “In US retail markets, there is a move from brokerage accounts to fee-based advisory, that means more model portfolios and more ETFs.”
Asset managers spent 2021 and early 2022 snapping up providers that specialised in private markets and alternative investments, but dealmaking largely dried up amid the market turmoil. Share prices in the sector are sharply down: the S&P Composite 1500 Asset Managers index has dropped 23 per cent since the start of the year. Sellers are reluctant to accept those prices and potential buyers are not willing to pay more.
Philipp Koch, head of McKinsey’s European asset management practice, thinks continued pressure on costs might change the calculus, particularly in the second half of 2023. “Some players may conclude their business models are no longer sustainable and entertain more creative solutions for consolidation and M&A,” he said. “Most asset managers were on the buyer side . . . there were very few sellers — that might change.”
The pressures may simply be too much for some longtime players. “Whenever there’s a downturn, if it is a deep downturn, the players with weak hands get flushed out,” said Cyrus Taraporevala, who just stepped down as chief executive of State Street Global Advisors. “That’s just normal.”
US junk loan investors brace for increase in downgrades and defaults
Lower demand for risky corporate debt could threaten companies’ ability to refinance
The biggest buyers of US junk loans are expected to shrink their exposure to the $1.4tn market in 2023, as the Federal Reserve’s campaign of interest rate rises sparks rating downgrades and defaults.
Collateralised loan obligation vehicles own roughly two-thirds of America’s low-grade corporate loans — but may be forced to reduce their exposure because of credit downgrades, which could unsettle the markets and make it harder for companies to obtain financing.
CLOs, which package up such loans into various risk categories before selling the slices on to investors, have performed well during tough economic times, but analysts say mechanisms designed to protect investors holding higher-quality tranches could reduce the vehicles’ appetite for loans to risky, highly-indebted borrowers.
US CLO issuance ballooned during the depths of the pandemic, reaching an unprecedented $183bn in 2021 as near-zero borrowing costs sparked a broader explosion of capital market activity. Even as the Fed tightened monetary policy last year to tackle inflation and other parts of the global fixed-income market stuttered, CLOs raised a further $126bn — the third-largest annual figure on record, according to data from Refinitiv.
But CLOs have caps on how much very low-grade debt they can hold, with a typical threshold of 7.5 per cent for so-called “CCC” buckets containing highly risky loans carrying ratings near the bottom of the quality spectrum.
Against a backdrop of higher borrowing costs sparked by Fed rate rises and fears of recession, analysts are warning that those limits will be breached. When these protective switches are tripped, cash flows to investors holding the riskiest CLO tranches, known as “equity”, can sometimes be cut off, redirecting payments to investors higher up the pecking order.
Such a situation could also potentially curb demand for fresh leveraged lending just as many riskier borrowers start to think about how to refinance themselves after a burst of debt issuance during the cheap money days of the Covid crisis.
“Leveraged loans, the underlying collateral in CLOs, are expected to face increased stress, as interest costs are rising and earnings are likely to drop simultaneously,” analysts at Barclays wrote in December. “In our view, issuers will likely face cash flow pressure, eventually resulting in rising downgrades and defaults.”
For some CLOs, that would mean an uncomfortable overflow of CCC buckets and a desire to reduce exposure to corporate borrowers at risk of downgrade.
“We’re not talking about breaching the 7.5 per cent threshold by just a little bit,” said Steve Caprio, head of European and US credit strategy at Deutsche Bank Research. “We’re talking about CCCs potentially going as high as 12 to 15 per cent in the worst-case scenario.”
Analysts at Bank of America expect CCC buckets to increase to “8-10 per cent in a stress and potentially even 15 per cent in a severe stress scenario”, noting that the peak Covid CCC concentration in CLOs was 10 per cent.
Swiss bank UBS also believes “a surge in leveraged loan credit deterioration should increase CCC holdings in CLOs to [about] 15 per cent, drying up demand from CLOs”.
Caprio added that it would be “difficult to entice a new investor” to wade into the lowlier-rated CLO tranches when the risk of having regular payments turned off is “actually quite elevated”.
CLOs’ risk exposure varies, and many managers have built up protection against overflowing low-grade debt buckets. The share of CCC-rated loans in CLO portfolios has fallen to around 4 per cent, Barclays said. “Thanks to CLO managers’ active trading, defaulted assets in CLO portfolio has always been lower than the broader leveraged loan default rate.”
“There’s a lot of cushion before it really is a problematic dynamic for CLOs,” said Jeff Stroll, chief investment officer at Post Advisory Group.
Stroll added that to reach a situation where cash flows are diverted from the riskiest CLO tranches there would need to be “a lot of downgrades”. “In our deals, we’d probably have to see close to 20 per cent CCC baskets.”
Still, “there has been this kind of sentiment shift you can feel towards proactively trying to manage this as best as possible”, he said.
Concerns about overflows of low-quality loans in CLOs were “probably more valid for pre-Covid and especially vintages from the 2016 commodity crisis”, said Rishad Ahluwalia at JPMorgan. “The CCC ratios in the last two to three years of CLOs are a lot lower than the average.”
Ahluwalia said CLOs are now also buying fewer loans from the ratings category just above CCC out of concerns that if they are downgraded, they will move down a notch and count against the threshold.
Anticipating “very, very elevated” downgrade rates for B and B-minus rated loans into CCC buckets, Caprio concurred that CLO managers “will probably try to avert the problem” of breaching 7.5 per cent thresholds by reducing their demand for loans ranked just above this level.
But “that in and of itself, before the problem emerges, will actually cause some issues within the loan market”.
The pace of CLO issuance has slowed in recent months, while leveraged loan sales were last year just over a third of what they were in 2021. Even at the top of CLOs’ capital structures, demand has weakened.
“The US big banks have really pulled back” from the top AAA tranches of CLO debt this year, Stroll said, “and have basically been out of the market for a host of reasons”. That “buyer base on the AAAs is just much, much smaller and so the ability to get transactions done is much more difficult”.
Many corporate borrowers refinanced and issued new loans when interest rates were low, loading up on cash and pushing out debt maturities. However, “it is critical to note the majority of US and EU loan demand originates from CLO managers”, Deutsche Bank said in a report last month.
“CLO formation depends on the availability of investors to buy tranches ranging from AAA-rated to B-rated credit quality. And that demand for BBB-rated tranches and below in particular will be severely tested in the next recession.”
Commodities trading boom raises fear of big losses among retail investors
Experts warn of market volatility as trading volumes of gold, oil, silver and copper have surged
Growing numbers of retail investors are being drawn into commodity trading after two consecutive years of bumper returns, despite concerns that they could suffer huge losses or disrupt the complex and volatile markets.
Retail trading volumes in commodity futures and the largest commodity-focused investment funds surged in 2022. But while activity has been spurred by commodities’ much better recent record than that of stocks and bonds, some market participants and analysts have voiced fears about retail traders wading in to a highly volatile market dominated by specialised players.
Daily average trading volumes in CME’s micro contracts for gold, crude oil, silver and copper — which it uses as a proxy for retail activity — were up 93 per cent year on year as of the end of November.
Trading volumes in Invesco’s $6bn PDBC ETF — the largest broad-based commodities fund which is popular with retail investors — jumped more than 60 per cent and were almost three times as high as in 2020. Volumes across its broader suite of commodities funds climbed 50 per cent.
“We got everyone’s attention last year because people were nervous about inflation,” said Kathy Kriskey, commodities ETF strategist at Invesco. “And then after the invasion of Ukraine, that’s when people started focusing on geopolitical risk [too].”
The burst of trading activity came as the S&P GSCI index of raw materials prices jumped almost 9 per cent last year as the war in Ukraine restricted supplies, drawing a stark contrast to the more than $30tn in losses for equities and bonds.
Commodities have been the best-performing major asset class for each of the past two years, according to Bank of America, and were one of just two asset classes to make gains in 2022 alongside cash. Commodity-focused companies were also the only subsector of the US stock market to advance, with the S&P 500 energy sub-index advancing 54 per cent as of December 21.
However, while full-year returns have been strong, commodity trading remains risky, with markets liable to extreme swings that can catch retail investors off guard. In April 2020, for example, the main US oil contract traded below zero for the first time. Many retail traders and platforms had not considered the possibility of negative prices, and the retail brokerage IBKR lost $88mn covering margin calls for customers caught out by the price collapse.
Trabue Bland, senior vice-president for futures exchanges at Intercontinental Exchange, cautioned at a recent industry conference that “these are very sophisticated markets where you can lose . . . whatever you put up with your [broker] in a matter of minutes”.
Besides the risks for retail traders themselves, Bland said he was also concerned about the impact they could have on other market participants, from airlines to farmers.
“People rely on us for those prices. Building retail products around something that people are making multibillion decisions on . . . is not something you should do lightly. People don’t want to see betting on what is essentially their livelihoods,” he said.
Modern indices such as Invesco’s have updated their strategies to avoid some of the problems that afflicted early commodities funds, which sometimes lost money even when prices rose due to quirks in the pricing of futures contracts.
“We’ve made a huge effort to educate the investor base because . . . either people have never touched commodities and don’t understand them, or they knew them 10 years ago,” said Kriskey at Invesco.
She stressed that “you don’t need a lot for [commodities] to be impactful in your portfolio . . . we talk a lot about a 5 per cent exposure, we don’t want investors coming in and saying ‘I’m 15 per cent commodities’”.
Some companies have encouraged riskier bets. Hong Kong-based fund provider CSOP Asset Management announced late last year it would start offering retail traders leveraged exposure to an index of large oil and gas stocks. Leverage allows investors to multiply their potential gains, but can also quickly erase capital when share prices fall.
ProShares, one of the most popular tactical ETF providers with retail investors, operates eight funds giving leveraged exposure to commodity futures. Its leveraged short exposure natural gas ETF is down more than 93 per cent since the start of the year.
Exchange traded products offering inverse exposure to oil and gas have been hard hit, down almost 90 per cent since the start of the year as prices have risen because of the Ukraine war, according to Morningstar.
“Commodities can spike or crash without investors being prepared, more so than equities,” said Todd Rosenbluth, head of research at VettaFi. He said retail investors deserved to have the same options available to institutional investors. “But is it good for everyday investors to have exposure, and to have to manage the roll costs and volatility that come with commodities? That’s a fair question.”
Winklevii vs Silbert
Crypto kicks off 2023 with a bang
Individual crypto businesses and their (cough) related parties often have more than a whiff of the ouroboros about them. But the industry as whole mostly resembles the spidermen circle of blame meme these days.
The latest example came earlier today, when Cameron Winklevoss of Gemini published an “open letter” to fellow crypto baron Barry Silbert of Digital Currency Group about $900mn that Gemini users are owed by DCG’s Genesis unit, which suspended withdrawals last year.
Aside from performative hand-wringing about Gemini customers like the “single mom who lent her son’s education money to you” and a “father who lent his son’s bar mitzvah money to you”, the most incendiary bit was this (FTAV’s emphasis below):
The idea in your head that you can quietly hide in your ivory tower and that this will all just magically go away, or that this is someone else’s problem, is pure fantasy. To be clear, this mess is entirely of your own making. Digital Currency Group (DCG) — of which you are the founder and CEO — owes Genesis (its wholly owned subsidiary) ca $1.675 billion. This is money that Genesis owes to Earn users and other creditors. You took this money — the money of schoolteachers — to fuel greedy share buybacks, illiquid venture investments, and kamikaze Grayscale NAV trades that ballooned the fee-generating AUM of your Trust; all at the expense of creditors and all for your own personal gain. It is now time for you to take responsibility for this and do the right thing.
Sound familiar?
Silbert understandably couldn’t let the thinly-veiled FTX innuendo pass, and responded on Twitter inside the hour.
Silbert has already revealed that DCG has borrowed $575mn from Genesis “in the ordinary course of business” and “always structured on an arm’s length basis and priced at prevailing market interest rates”.
The disagreement seems to come down to how one views the $1.1bn promissory note due in 2032 that DCG issued to Genesis when the parent had to step in to assume liabilities related to the implosion of Three Arrows, a crypto “hedge fund” Three Arrows. On this topic it’s worth reading Kadhim Shubber, Nikou Asgari and Josh Oliver on the “delicate links” between the various parts of the struggling DCG empire.
In related news, DCG’s flagship crypto product — the Grayscale Bitcoin Trust — now trades at a 45 per cent discount to its net asset value. That means that its market value
As long as you’re not one of the crypto bros directly affected by the shenanigans, it’s all very grimly amusing.
Crypto Magnates Cameron Winklevoss and Barry Silbert Trade Barbs
Mr. Silbert’s Genesis is a lending partner of the earn program at Mr. Winklevoss’s Gemini
Tensions between crypto magnates Cameron Winklevoss and Barry Silbert erupted into an open dispute on Twitter at the start of the new year, with Mr. Winklevoss accusing Mr. Silbert of “bad faith stall tactics” that are hurting rank-and-file customers.
The back-and-forth on Monday deals another blow to a sector struggling for credibility, especially since the collapse of FTX and its affiliated trading firm, Alameda Research. The fall of the two companies led to outflows from other crypto exchanges and the near-erasure in value of coins tied to FTX and Alameda, domino effects in a closely linked industry.
Crypto investors are closely watching the negotiations between the Gemini exchange, which was founded by Mr. Winklevoss and his brother, and the lender Genesis Global Capital. Last year saw the bankruptcies of multiple crypto firms, capped off with FTX. Traders are going into the new year wary of further turmoil.
Genesis, the lending unit of Mr. Silbert’s crypto conglomerate Digital Currency Group, halted loan originations and redemptions on Nov. 16 after it couldn’t meet client withdrawal requests. Genesis cited the demise of FTX. The Wall Street Journal previously reported that Genesis had loans outstanding to FTX’s sister trading firm.
Genesis is a lending partner of Gemini’s earn program, which allows retail users to lend out their cryptocurrencies in exchange for annual interest rates as high as 8%. Gemini paused customer withdrawals from the earn program on the same day that Genesis made its announcement. Gemini’s 340,000 earn users have deposited more than $900 million in the earn program, according to Mr. Winklevoss.
Crypto exchange Gemini has banded together with other creditors of Genesis to find a way for the crypto lender to return owed assets.
In an open letter to Mr. Silbert on Monday, Mr. Winklevoss said Genesis creditors have repeatedly tried to get together with Mr. Silbert and sent multiple proposals to him, including one delivered on Christmas Day.
“Despite this, you continue to refuse to get into a room with us to hash out a resolution,” Mr. Winklevoss wrote. “Every time we ask you for tangible engagement, you hide behind lawyers, investment bankers, and process. After six weeks, your behavior is not only completely unacceptable, it is unconscionable.”
Mr. Silbert responded on Twitter, saying his company had delivered a proposal on Dec. 29 “and has not received any response.”
Mr. Winklevoss also said that Mr. Silbert’s parent company DCG owes $1.675 billion to its subsidiary Genesis. Mr. Silbert replied on Twitter that DCG didn’t borrow $1.675 billion from Genesis and is current on all loans outstanding.
Mr. Silbert said in a letter to investors in November that DCG owes Genesis about $575 million that is due in May 2023, in addition to a $1.1 billion promissory note to Genesis due in June 2032.
Earlier this year, DCG took on liabilities from Genesis after the crypto hedge fund Three Arrows Capital defaulted on the $2.4 billion in loans it took out from Genesis, prompting the issuance of the $1.1 billion promissory note while DCG tries to recover assets from Three Arrows’ liquidation proceedings.
Spokespeople for Gemini and DCG declined to comment beyond Mr. Winklevoss’s and Mr. Silbert’s tweets.
This isn’t the first dispute between crypto titans to spill onto Twitter in recent weeks. Sam Bankman-Fried of FTX and Changpeng Zhao of Binance sniped at each other shortly before FTX imploded in November.
Mr. Bankman-Fried is likely to appear in court Tuesday to enter his plea to fraud charges by U.S. prosecutors. He is likely to plead not guilty, the Journal reported.
Get Ready for the Richcession
Well-off Americans could get hurt more than usual in the next downturn
Economic downturns are usually horrible for poor people, bad for the middle class and an inconvenience for the rich. But if the economy enters a recession in 2023, or even if it manages to narrowly evade one, it might be the well-heeled who take a bigger hit than usual.
Call it the richcession.
Other than a small number of ascetics, nobody likes being poor. Doing without, living with so little savings that setbacks such as illness or job loss can be debilitating, is an ever-present source of stress. But for many poorer people, the years since the Covid crisis struck have been a bit easier financially than the years that preceded it. Several rounds of government relief helped them weather the early stages of the pandemic, and now a tight job market is providing them with wage gains that are reducing inflation’s bite. Federal Reserve figures show that the net worth of households in the bottom fifth by income was 42% higher in the third quarter than at the end of 2019, and up 17% from the end of 2021. A wage tracker developed by the Federal Reserve Bank of Atlanta shows that the 12-month moving average of annualized monthly wage growth for workers in the bottom quartile by income was 7.4% as of November.
With the important caveat that they were starting off from much higher bases, percentage gains for the rich have been more muted. Household net worth for the top fifth was 22% higher in the third quarter than before the pandemic, and was down 7.1% from the end of 2021—a consequence of the falling stock market. Paychecks haven’t risen as much, either, with the Atlanta Fed measure showing average annualized monthly wage growth for workers in the top quartile was 4.8%.
Recent layoffs have also inordinately affected higher-income workers. Many of the tech companies that have made headlines with layoff announcements pay extremely well. Securities filings show that the median worker at Facebook parent Meta Platforms made $295,785 in 2021, for example, while the average worker at Twitter made $232,626. And layoffs at those places where the typical worker is less well paid, such as Amazon.com, have largely been aimed at white-collar workers.
The consolation for higher-income workers who are laid off is that it should be relatively easier for them to find new work than it is for poorer people who lose their jobs. That is because the job skills of the more highly educated are generally more transferable than the skills of other workers. But they will still be in for a period of belt tightening, and they might not get paid quite so well at their new jobs as they were at their old ones.
Meanwhile, even though big-company layoffs have been making headlines, so far they haven’t made much of a dent in overall employment statistics. This is in part because industries that aren’t as well-represented in the stock market, and that typically employ more lower- and middle-income workers, are still straining to hire workers. In November the leisure and hospitality sector was 980,000 jobs short of its February 2020 employment level. Employment in healthcare and social assistance only recovered to its prepandemic levels in September. This is a job category that, in part because of the needs of an aging population, grew even when overall U.S. unemployment shot higher after the 2008 financial crisis. To return to its growth trend over the decade preceding the pandemic, it would need to add about 1.1 million jobs.
That need for workers—especially as more Americans engage in services such as dining out—is part of why even among those economists expecting a recession in the coming year, many don’t think the job market will take a severe hit. This makes poorer Americans better positioned than usual to handle a weak economy. Not only are their finances in relatively good condition, they might be less likely to experience severe job losses.
Heading into the new year, businesses that cater to the well-off might be in for disappointment, while those that favor the hoi polloi over the hoity-toity might do better. And if there is a recession, the economy could be on much more equal footing as it begins to recover than is usually the case.
Moderna/BioNTech: cancer vaccines will show mRNA not a one-trick pony
Success in battle against Covid does not ensure success against tumours, but should narrow the odds
After riding high for much of the pandemic, mRNA vaccine pioneers came down to earth in 2022. By mid-June, the share prices of both Massachusetts-based Moderna and Germany’s BioNTech had more than halved. But investors’ excitement was rekindled a few weeks ago when Moderna and partner Merck published a promising set of melanoma trial results. After five decades of failed attempts, cancer vaccines are set for a breakthrough.
Unlike normal vaccines, these shots will treat, not prevent, the disease. Using mRNA technology should prompt the immune system to destroy mutated cells, often by tailoring them to the recipient’s tumour. That is the case in the Moderna melanoma trial. Its mRNA vaccine, combined with Merck’s immunotherapy, cut the risk of later-stage melanoma recurrence or death by 44 per cent in high-risk patients compared with immunotherapy alone.
The 27 per cent — or $16.8bn — jump in Moderna’s market value over two days following the announcement reflected investors’ wider hopes for cancer vaccines. Assuming a 50 to 75 per cent probability of success, the later-stage melanoma treatment market is worth up to $5bn to the company.
That would be worth $9 to $15 a share, says Jefferies. The figure is conservative. If the technology worked against other tumours, the value would be multiples of that.
Against this, there is no guarantee that the next phase of the clinical trials will be as encouraging as the last. Even if the vaccine proves its worth against melanoma, it might fail to work against other types of tumours.
Success in the battle against Covid-19 does not ensure success against cancer, but should narrow the odds. While many innovative biotechs are struggling to raise funds, a successful coronavirus vaccine has left Moderna with about $7bn of net cash. BioNTech has double that. They gained cash and knowhow in the pandemic. That can now be applied to other urgent medical needs.