OREANDA-NEWS. Despite a number of potential headwinds looming for investment managers (IMs) globally, Fitch Ratings' 2016 rating and sector outlooks for traditional and alternative IMs are stable, according to the 2016 outlook report published today. The stable outlooks reflect continued growth in assets under management (AUM), greater investor demand/allocation, variable cost structures and generally strong margins.

Fitch-rated IMs also tend to be among the largest and most diversified IMs in the world, leaving them better positioned than smaller peers to absorb likely periods of market volatility, evolving investor preferences and growing regulatory compliance costs. Among the potential headwinds facing the IM sector in the coming year are potential weakening investment performance, fee pressure, regulatory knock-on effects and modestly increased leverage.

After an extended period of generally rising asset prices, Fitch expects investment performance to be more challenged in the coming year. Potential areas of pressure include energy, emerging markets and high yield bonds/loans to name a few. Rising interest rates also remain a potential headwind, particularly for traditional IMs with high exposure to fixed income AUM. Alternative IMs could also be challenged as higher rates could pressure repayment capacity for borrowers in underlying funds and equity market valuations.

IMs have continued to generate strong operating margins despite fee pressure from investor allocation to passively managed products (for traditional IMs) and expansion into lower fee strategies (for alternative IMs), due to growth in scale, variable cost structures and product rationalization. Average F/EBITDA margins for both groups typically range from 25% - 45%, which compares favorably to other financial institutions.

Relative to their bank counterparts, IMs have experienced less direct regulation. However, knock-on effects of broader market regulation include on-going discussion around the systemic importance of IMs and/or their largest funds, increased disclosure/reporting requirements and potential reductions of secondary market asset liquidity during periods of stress. European IMs have also become subject to minimum capital requirements. These dynamics continue to evolve, but at a minimum, introduce additional costs for IMs and their fund investors.

Leverage has ticked up for alternative IMs, as many have taken advantage of low rates to lock in long-term financing and/or to fund acquisitions. Fitch expects a meaningful portion of the debt proceeds will be deployed into cash flow generating opportunities, which will normalize leverage ratios. Traditional IMs continue to operate at modest leverage levels; however, their cash flow and leverage remain more sensitive to market value declines.