OREANDA-NEWS. The strong profitability among European asset managers in recent years is unlikely to be sustainable in the medium term, partly due to many consumers' preference for investing through pensions or insurance products, which typically generate lower fee income, rather than directly via mutual funds, Fitch Ratings says.

Total assets under management in the sector hit a new high in 2014, helping drive industry profits back to around their pre-crisis peak. But the underlying data from Eurostat for eurozone households shows investments in insurance and pensions grew at a compound annual rate of 6% in 2008-2014, double the 3% rate for mutual fund investments.

This trend is gradually increasing asset managers' reliance on institutional mandates from insurers and pension funds, which have significantly lower fee margins than retail mutual funds. Strong inflows from offshore investors have helped delay the impact of this trend on overall profitability, but we still expect it to become more visible over the coming years.

Reduced fee income, either through lower fees on funds or fewer assets under management for managers that fail to win institutional mandates, may mean that asset managers cut costs to support profitability. But asset managers typically compete for institutional mandates on the quality of their 'solutions' businesses, which can entail significant cost. Cutting costs out of the institutional side of the business could therefore materially dent an asset manager's future prospects in an ever more institutional world.

Cost-cutting measures that go beyond efficiency savings and affect a firm's investment in areas such as the control framework, investment resources, middle- and back-office functions and IT resources could negatively affect Asset Manager Ratings and credit ratings, even if they also strengthen profitability and financial flexibility. Our Asset Manager Ratings provide an independent assessment of an asset manager's investment and operational platform relative to institutional investors' standards, while credit ratings reflect our assessment of an entity's vulnerability to default on its financial obligations.

But positively for asset managers, institutional investors tend to allocate large amounts and to stick with the same asset manager for a long time. The institutional trend is Europe-wide, but the scale and speed of change can vary. For example, the swing to insurance and pension funds has been more pronounced in France than in Germany, suggesting French asset managers will feel the effects sooner.

The effect of this trend on fund flows would be in addition to the more widely discussed potential pressure on fees from retail and institutional investors switching to passive funds from actively managed ones. Some active asset managers have been able to maintain fee levels, despite the rising popularity of low-fee passive products, but in light of international regulatory efforts to improve fee transparency, active asset managers' high retail fees may come under pressure.