Stephen Hughes is a Senior Investment Advisor with Zurich based Investment Management Group Dynapartners

So does the increase in fund inflows as investors chase returns. Finally, the market may well place a higher valuation on the income stream of an asset management company as a bull market develops.

Such an environment does not apply today. Growth in the industrial world is still modest, which has implications for profits and stock prices. Bond yields, meantime, are at record lows. With investor returns much below those in (say) the 1990s, it is no surprise that fees are under pressure.

A growth business

However, it is generally better to make investments when the business environment is problematic than when it is perfect. Moreover, ageing populations and the increase over time of savings and wealth mean that asset management is a growth business.

It is also one with some powerful inherent attractions. Established firms require relatively little capital, have high margins, high incremental returns on capital and strong free cash flows. This fourth attribute enabled some US asset management companies to award significant special dividends last December amid general anxiety that US tax rates would rise this year.

Absence of balance sheet pressure

Not only have independent asset managers emerged from the 2008/9 crash as relatively scandal-free, the low capital requirements and high profitability of the established players compare favourably with the growing capital intensity and low returns of many banking businesses. Indeed, the absence of balance sheet pressure might in time attract some external buying interest. Also, asset managers have considerable flexibility in adjusting to changing markets.

In this, they contrast with many industrial companies which are identified with particular products and markets. Unfortunately, several of the very best businesses are private but the fact that this is so is an indication of the potential long-term worth of an equity investment in the industry. So is the solid profitability of the established companies.

Powerful franchises

Two additional factors are worth mentioning. First, the asset management industry is one in which some independent companies have been able to build powerful franchises. These franchises can be extended into new markets and form the basis of sustainable, above average returns.

A key element in building a successful asset manager franchise is the ability to attract and retain talented staff while still rewarding shareholders. In this, the leading companies compare favourably with, for example, the investment banks where returns go overwhelmingly to a small group of employees.

Diversified business model

The second has to do with the inherent flexibility of the business model. Thus, asset managers can often adapt quickly to economic developments and changes in the market and regulatory environment. Specialist firms can provide exposure to a specific investment theme although several established asset managers operate a diversified business model which in turn provides protection in the event of unexpected moves in the markets.

Our preference, however, is for asset managers with an equity bias. Slowly, the central banks are turning investor expectations towards reflation. Keeping bond yields very low is part of this process. Now that an economic recovery is getting established, equities should outperform bonds. In time, the leverage in the asset manager business outlined at the start of this piece will come into play.