OREANDA-NEWS. Fitch Ratings has completed a peer review of seven rated traditional investment managers (IMs). Based on this review, Fitch has upgraded the following Long-term Issuer Default Ratings (IDR): Affiliated Managers Group, Inc. (AMG) to 'BBB+' from 'BBB' and Man Strategic Holdings Ltd. (Man) to 'BBB+' from 'BBB'.

The Long-term IDRs of the remaining IMs included in the review have been affirmed as follows: Aberdeen Asset Management PLC (AAM) at 'A', AllianceBernstein L.P. (AB) at 'A+', Amundi Group (Amundi) at 'A+', Invesco Ltd. (IVZ) at 'A-' and Schroders Plc (Schroders) at 'A+'. The Rating Outlook for IVZ has been revised to Positive from Stable. The Outlooks for the remaining IMs are Stable.

Today's upgrades and Positive Outlook revision primarily reflect company-specific improvements, notably in leverage and assets under management (AUM) diversification. Please refer to company-specific rating action commentaries, also published today, and available on Fitch's website, for details.

Strong Operating Environment
On balance, traditional IMs continue to benefit from a strong operating environment, with increasing asset prices and solid net fund inflows boosting AUM levels and improving operating margins through economies of scale. These dynamics leave IMs well-positioned from the perspective of their current financial conditions, but future financial performance remains susceptible to declines should markets reverse course. This cyclicality in traditional IMs' business models is a key rating constraint in Fitch's opinion.

Positively, traditional IMs have further diversified their product base with the aim of achieving a more balanced AUM mix to moderate the effects of declines in individual asset classes. Cost control has also generally remained a focus and the firms' fairly flexible cost structures - which are partly linked to asset performance - provide some protection for the IMs' profitability, should asset valuations reverse.

EM Products Still Out of Favour
One notable exception to the generally benign operating environment has been emerging markets (EM) where portfolio flows remain volatile and generally below the long-term average. As a result, IMs with above-average exposure to EMs, notably AAM, have underperformed the peer group in terms of net fund flows.

Opportunistic Leverage Reductions
Most rated traditional IMs have used surplus cash flow generated from higher AUM to repay outstanding debt and reduce their cash flow leverage (gross debt divided by EBITDA). As a result, interest coverage (EBITDA divided by interest expenses) has improved and the net debt positions of most IMs are negative, further enhancing their solid liquidity profiles.

Sensitivity to Interest Rate Increases
Rising interest rates are a key sensitivity for all rated traditional IMs, albeit to varying degrees. IMs with a disproportionately high exposure to fixed-income products such as AB or Amundi are likely to be more directly affected by net funds outflows following interest rate increases. However, not all fixed-income AUM are expected to perform similarly, with more credit- sensitive fixed-income funds being less directly impacted by rate increases.

Ultimately, the impact of increased interest rates on IMs will depend on the magnitude of the rate increase and the relative sensitivity/performance of the IMs' fixed-income products. At a minimum, market value depreciation or outflows as a result of rising rates would reduce management fees and thus increase cash flow leverage. It could also create reputational risk for managers if performance is materially worse than peers. However, in the long term, rising rates accompanied by sustained economic growth should benefit equity assets and flows.

Fee Pressure Expected to Continue
Increasing AUM volumes, backed by strong equity markets globally, have helped traditional IMs offset management fee margin pressure. Traditional IMs continue to face these pressure as higher-margin products (such as guaranteed funds) fall out of favour, and, more importantly, with the rise of indexing and passive investment strategies including exchange-traded funds (see also "Fitch: Valuations Offset US Active Manager Pressures, For Now", 1 June 2015).

Some traditional IMs have reacted to the rise of low-cost passive and indexing competition by diversifying their product offerings to include passive funds, improving the relative performance of their key active strategies and by maintaining cost discipline. While IMs in this peer group all have sufficient scale and diversification to withstand further fee pressure, ratings could come under pressure if the shift towards passive investing results in more material AUM outflows, reduced fees/margins or increased cash flow leverage.

Regulation: Funds/Firms
Regulatory dialogue with respect to the potential systemic impact of IMs and/or their funds remains heightened, although the magnitude of ultimate regulatory change remains unclear. Potential regulatory initiatives include the designation of the largest IMs or their funds as systemically-important and, in Europe, stricter capital requirements.

To the extent that IM firms (not just their funds) become subject to additional liquidity and/or capital requirements, Fitch believes that this would be positive for IM counterparties and debt holders in the long-term. However, profitability could come under pressure as a result of higher capital and/or liquidity requirements at the fund or firm level. Funds with illiquid strategies with daily or weekly redemption would be particularly affected. Increased compliance and reporting requirements could also contribute to earnings pressure.