One of the biggest casualties from the post-Brexit fallout has been those fund managers that have exposure to international equity markets.
As highlighted in the comparison chart below, prior to today's bounce, all of the big-name fund managers had significantly underperformed the broader market irrespective of their exposure to the UK and Europe.
BT Investment Management Ltd (ASX: BTT) and Henderson Group plc (ASX: HGG) are the two worst performers which is unsurprising considering they both have a much larger exposure to the region compared to Magellan Financial Group Ltd (ASX: MFG) and Platinum Asset Management Limited (ASX: PTM).
There are two big reasons why Brexit had such a large impact on these companies including:
Unfavourable currency movements
When the British pound plunged against a basket of other currencies last Friday, the value of the assets held in pounds immediately fell also.
This unfavourable currency movement has two immediate impacts on any fund manager. Firstly, the value of their funds under management (FUM) follows the currency lower, compared to assets denominated in other currencies. This is obviously undesirable as the manager earns a fixed management fee on the level of its FUM as well as a performance fee. Put simply, lower FUMs means lower fees and lower profits for shareholders.
The second issue that arises from unfavourable currency movements is the negative impact on investors when earnings are translated into the shareholders' domestic currency.
For shareholders of BTIM and Henderson in particular, the drop in the value of the British pound means the value of those earnings generated in pounds will now be worth less when translated into Australian dollars.
Volatility and falling markets
Successful fund managers thrive on their ability to outperform the rest of the market and attract new fund inflows.
When markets are volatile and falling, fund managers have at least three big problems. Firstly, investors are less likely to put new funds into equities and existing investors are more likely to withdraw their funds. As mentioned above, lower FUMs equal fewer fees and profits.
Secondly, volatile markets can make it more difficult for the manager to generate the necessary outperformance required to earn lucrative performance fees. Furthermore, without this history of outperformance, the manager will also struggle to attract new funds inflows.
Finally, the value of the managers' FUM immediately takes a hit when markets fall and this obviously has a negative impact on the ability of the manager to earn fees.
Is this a buying opportunity?
I'm a big fan of the asset management sector because it utilises a business model that benefits hugely from economies of scale. Most managers' cost bases do not change significantly when their FUMs increase and the benefit of this flows directly to shareholders through higher profits.
Nevertheless, as we have seen from the events of recent days, fund managers are often the first targets to be hit when asset markets take a tumble and this can have a lasting impact on share prices.
Although we are seeing a rebound in prices today, I'm not totally convinced the fallout from Brexit is over and I wouldn't be surprised if we have further volatility in the short term.
If this is the case, there could be better buying opportunities to come and investors may prefer to wait until global equity markets become less volatile.
