Mutual Fund Industry Update Presented to Mutual Fund Directors Forum Date: December2014
Topics Where We Are Where We re Going Q&A Page 1
Asset Management Industry Trends 1. Retirement still represents one of the largest opportunities in global asset management In North America, DC assets grew by more than 4% annually from 2007 to 2012 outpacing 2.5% and -0.2% growth rates for retail and institutional, respectively IRA rollover market is today larger than the defined contribution segment 2. Exchange-Traded Funds (ETFs) continue to grow at a torrid pace ETFs have grown at an explosive annual rate of more than 30% over the past decade, demonstrating access to an array of asset classes and strategies, such as commodities and foreign currencies, that were once too expensive» $1.4 trillion AUM, over $200 billion in flows in 2013¹ 3. The next wave of alternatives growth is set to break Alternatives category has more than doubled in size over past decade, with global AUM standing at $7.1 trillion; since 2005, alternatives have grown three times faster than traditional investments; impractical for retail and small institutional investors to own 4. Fixed Income is down, but hardly out While the decades-long bull market is fixed income clearly began to lose momentum in 2013, the use of liability-driven investing among both pension plan sponsors and insurers with large asset bases increased 1) Morningstar 2) Money Management Institute Page 2
Asset Management Industry Trends Where We Are Today 5. Solutions are reshaping the way money is managed, but most asset managers are struggling to capitalize Solutions broadly defined as products engineered to help clients address specific opportunities ore need have quickly gained traction in the asset management industry will support demand for bonds» Managed Accounts are $5 trillion and capture 2/3 of investable asset flows²» Rep as PM programs are $1 trillion in AUM 6. Emerging markets are generating the vast majority of global organic growth, as flows stagnate in many developed markets From 2007 to 2012, AUM in emerging regions grew at an annual rate of 8% - well above the 1% annual growth in developed markets 7. Registered liquid alternatives captured 25% of 2013 flows and are the fastest growing segment of the fund industry¹ 1) Morningstar 2) Money Management Institute Page 3
Where We Are Today! Mutual funds remain the preferred investment packaged solution but mounting usage of alternative structures! Continued lowering of fees! Continued dominance of Vanguard Funds but a fragmented market! The shift from active to passive in the market recovery has continued! Revenue sharing over the top but in SEC bulls eye! It s still about retirement! Growing substitution of ETFs into portfolios! Rise of ETF specialists/strategies! Rise of liquid alternatives and smart beta! Evolution of target date to open architecture! Fixed income continue run, given Federal intervention! Shift from funds to CITs in IODC! M&A pace accelerating Page 4
U.S. Sales & Asset Trends (L-T MFs) Sales $B Assets $B Source: FUSE, ICI Page 5
Overview: Size of Mutual Fund Industry US is largest MF market and has the largest opportunity for asset managers Equities remain largest asset class with over 50% Worldwide MF Assets by Region¹* Asia and Pacific 14% Europe 34% Africa 1% United States 42% Other Americas 9% Worldwide MF Assets by Region²* Muni Bond 6% Taxable Bond 27% Alternatives 1% Balanced 10% Sector Stock 3% Commodities 1% Intl Stock 15% US Stock 37% Shorter Last 5 Years Avg. MF Retention Rates (20 Yr Analysis)³* 3.3 3.1 4.4 Equity Fixed Income Asset Allocation ¹ Source: ICI 2014 Investment Company Fact Book ² Source: Cerulli US Monthly Product Trends March 2014 ³ Source: DALBAR Quantitative Analysis of Investor Behavior 2012 * Excludes Money Market Page 6
Overview: Demand for MFs and U.S. Demographics Demographics factor into growth opportunity of mutual fund investor pool! Baby Boomers entering retirement By 2030, 18% of the nation s population will be at least 65 or older compared to 13% today Older demographic maintains higher propensity for less risky investment solutions including mutual funds On retail front, retirees and near retirees are increasingly seeking out solutions like guaranteed income & principal protection! Growing Savings Market US savings rate has rebounded to 4.6% from a low of 0.8% in 2005! Shift from institutional Defined Benefit (DB) plans to individual Defined Contribution (DC) plans Flows concentrated among providers of solutions products (target-date funds; allocation funds)» Expected gains in excess of $1 trillion over next 5 years Acceleration of IRA rollovers and need to address post target date» Expected new revenue of $2 billion in coming years! Global growth of emerging economies represent growing investor pools Page 7
Where We Are 1 Year Flows & Asset Trends (as of October 2014) Source: Morningstar Direct Page 8
Category Net Sales: Active / Passive Open- End Funds (in Millions as of May 2014) Assets Under Management NNF Trailing 12mo Rank Category Total Ac9ve Passive % Passive Ac9ve Passive 1 Large Blend $ 1,603,200 $ 665,118 $ 938,082 59% $5,404 $39,058 2 Large Growth $ 1,176,729 $ 1,141,074 $ 35,656 3% ($33,860) $2,263 3 Intermediate- Term Bond $ 953,888 $ 728,107 $ 225,782 24% ($91,648) $11,030 4 Large Value $ 845,522 $ 791,332 $ 54,190 6% $14,993 $5,119 5 Foreign Large Blend $ 730,643 $ 529,032 $ 201,611 28% $38,544 $24,774 6 Moderate AllocaRon $ 485,744 $ 463,099 $ 22,645 5% $14,101 $605 7 World Stock $ 394,220 $ 391,850 $ 2,370 1% $14,750 $606 8 World AllocaRon $ 319,379 $ 319,378 $ 0 0% $18,282 $0 9 Diversified Emerging Mkts $ 297,350 $ 232,184 $ 65,167 22% $16,168 $5,615 10 High Yield Bond $ 289,919 $ 289,919 $ - 0% $6,864 $0 11 Mid- Cap Growth $ 289,287 $ 285,922 $ 3,366 1% ($1,358) $412 12 Short- Term Bond $ 276,816 $ 249,425 $ 27,392 10% $7,520 $6,190 13 Mid- Cap Blend $ 225,587 $ 94,028 $ 131,558 58% $5,589 $8,351 14 Mid- Cap Value $ 206,679 $ 200,134 $ 6,545 3% $3,533 $938 15 ConservaRve AllocaRon $ 205,719 $ 204,102 $ 1,617 1% $10,969 $280 16 Small Blend $ 201,559 $ 126,564 $ 74,995 37% $387 $6,725 17 World Bond $ 192,414 $ 153,285 $ 39,128 20% ($8,764) $10,789 18 MulRsector Bond $ 184,890 $ 184,890 $ - 0% $453 $0 19 Foreign Large Growth $ 179,918 $ 179,819 $ 98 0% $8,533 $69 20 Small Growth $ 176,179 $ 164,449 $ 11,729 7% ($216) $689 21 Foreign Large Value $ 159,408 $ 133,583 $ 25,825 16% $12,565 $2,983 22 NontradiRonal Bond $ 148,282 $ 148,253 $ 28 0% $53,207 $28 23 Bank Loan $ 142,547 $ 142,547 $ - 0% $41,812 $0 24 Muni NaRonal Interm $ 125,702 $ 125,304 $ 398 0% ($10,559) $219 25 Muni NaRonal Short $ 104,622 $ 102,594 $ 2,028 2% $2,174 $402 Sources: Grail Partners, FUSE, Morningstar Page 9
Top 10 U.S. Mutual Fund Families (ex-mmf & FoF) as of October, 2014 Source: Morningstar Page 10
Asset Growth with ETFs MFs = $12.8T ETFs = $1.7T Assets $B Source: Grail Partners, FUSE, ICI Page 11
ETF League Table As of August 15, 2014 Sources: Morningstar Page 12
When will ETFs pass Funds? Source: Grail Partners, FUSE, ICI Page 13
Growth of Liquid Alternatives in U.S. Continues Source: Grail Partners, Morningstar Page 14
Current Landscape of Liquid Alts Es9mated Net Flows AUM 6/14 June 14 YTD 2013 Absolute Return $83,139 $1,665 $10,376 $34,754 MulR- Strategy $33,035 $275 $2,421 $6,978 Equity Long/Short $29,483 $908 $6,887 $7,368 Risk Managed Equity $17,490 $74 $461 - $257 Arbitrage $14,972 $193 $1,296 $1,602 Managed Futures $12,539 $38 $945 $1,242 Market Neutral $11,100 $48 $877 $2,038 Credit Long/Short $7,180 $108 $1,690 $4,086 $208,937 $3,310 $24,953 $57,812 Sources: Grail Partners, FUSE, Morningstar Page 15
A Flight to the Stars (Total Industry) Morningstar Overall Rating July 2014, 10-year net flows in billions 4 and 5 stars Non-rated The Overall Star Rating, a weighted average of the three-, five-, and 10-year (if applicable) ratings. Sources: Grail Partners, FUSE, Morningstar Page 16
Product Usage by Channel AUM Allocation by Product Type and Channel of Distribution Source: Grail Partners, FUSE, WealthManagement.com Page 17
Distribution has consolidated and so has Pricing Pressure Page 18
Revenue Sharing is Over the Top but Now in SEC Bulls Eye Some recent examples of disclosure of price to play! Raymond James: 14 bps on sales & 30 bps on AUM! Charles Schwab: 40-45 bps Monthly minimum per share class of $2,000! Stifel: 10 bps on sales & 8 bps on AUM! Royal Alliance: $18/sub-TA fee! Ameriprise: 25 bps! Cetera: 30 bps! Morgan Stanley: 15 bps on sales & 40 bps on AUM! Merrill: 15 bps on sales & 35 bps on AUM! LPL: 18 bps on sales & 35 bps on AUM! Commonwealth: 30 bps on sales or 15 bps on AUM Page 19
What s New! Largest asset managers almost became SIFIs! Cyber risks are escalating! Increasing pressure to restructure global banks with continued capital pressure! Alternative asset managers are becoming mainstream! Growing use of social media! Retail Funds U.S. growth of liquid alternatives 400 funds, $200B, 10% flows Active ETFs! Institutional U.S. discretionary fixed income products Multi asset solutions Outsources CIO LDI! Resurgence of Quant! Asset owners evolving into asset managers Page 20
Where We Are Going 2020 View! S&P at?! Expected bond market collapse in the foreseeable future and FI fund net outflows could have exponential impact/! ETFs replace core funds! Alts go mainstream! Discretionary multi-asset class funds become new outcome oriented solutions! Rise of Robo Advisors and integration with advisors! Secular changes reshaping intermediary distribution Page 21
Where Are We Going 2020 View China: Massive funds development Pass-porting, Hong Kong, Singapore, Shanghai Big Data: Analytics are changing the business $41B to $240B revenue Pressures on industry will rise: Pre-tax operating margin and revenue fee pressure Regulatory compliance and distribution costs rising Increasing product manufacturing and technology data management needs Page 22
Where Are We Going 2020 View Change in product needs and distribution/delivery models Maturing/ retiring Baby Boomers» De-accumulation phase» Guaranteed income Millenials» DIY social media Robo Advisors - smart devices Continued demand for solutions» Target date, 1% to 22% DC assets 2005-2013 going to 50%» Liquid alternatives in DC! Growth requires capitalizing on key trends! Continued migration from products to solutions! Continued evolution of distribution Page 23
Continued Product to Solutions Page 24
Evolution of Solutions Home Office Model s Third Party Models Customize d LDI Solutions Rep As PM Pre-Built Portfolios (CDP) Tactical Allocation Asset Allocation (Hypos) Life Cycle Funds Technology Improvements Balanced Funds 70s 80s 90s early 00s mid 00s 2005 2012 2015 2020 Source: Grail Partners, FUSE Page 25
Asset Allocation -- 2015 Risk Management 25% Growth (Alpha) 20% Market Participation (Beta) 10% Principal Protect 15% Income 30% Source: Grail Partners, FUSE Page 26
Future of Product Products as Components of the Solution Required to Demonstrate Alpha Alternatives Require Proven Expertise Passive Investments Gain Share Shares Classes Unwind Active ETFs Fail to Match Hype Focus on Product Line Profitability Sources: Grail Partners, FUSE Page 27
Distribution Developments Page 28
Evolution of Distributors Third Party Models Home Office Tools & Solutions Rep as PM WRAP & SMAs In-House Model Portfolios Financial Advisors Proprietary Products Third Party Funds Schwab OneSource Brokers 1970s 1980s 1990s 2000s 2010s 2020s Source: Grail Partners, FUSE Page 29
Where Are We Going- 2020 View Expect new entrants from non-traditional financial channels that will be disruptive to supply chain Changing distributions model Commission going away Unbundled fees / lower expenses New platforms Page 30
Questions & Answers Page 31
Grail Partners LLC Darlene T. DeRemer Managing Partner 1 International Place, 46 th Floor Boston, MA 02110 Tel: 617-292-1877 Mobile: 6 17-901-5695 DDeRemer@GrailPartners.com www.grailpartners.com Page 32