asset management1

US AssetManagementThe State of the Industry

June 2011

www.pwc.com/us/assetmanagement

Contents

Executive summary 1

Topical issues in asset management 2Product innovation and management

Evolving investor demands

Mergers and acquisitions

Managing global tax risk

Global sourcing

Tax optimization

Performance measurement

Talent management

Regulatory change

Mutual fund industry overview 9Market size

Competitive environment

Product offerings

Earnings drivers

Exchange traded funds

Money market redemptions

Expense ratio pressures

Regulatory challenges

Alternative fund industry overview 12Regulation

Hedge funds: Market size and performance

Private equity deal activity

Commercial real estate industry overview 15Performance, fundamentals and pricing

Real estate transactions

Capitalization rates

Real estate capital markets

Lodging sector

Conclusion 18

Contacts 19

June 2011 US Asset Management | The State of the Industry 1

Nevertheless, key industry findings fromPwC’s recent Global CEO Survey revealedthat “asset management CEOs areamong the most optimistic” of theexecutives surveyed, though theirconfidence is “tempered by a keenawareness of the challenges of increasingregulation, competition for talent andevolving investor expectations.”1

Faced with recovering but volatilemarkets and regulatory change, assetmanagers are striving to maximize theperformance parameters they cancontrol. With asset flows generallyimproving, firms are focused onoperational excellence, growth,performance, people-related issues,governance, risk and compliance.

The Dodd-Frank Act has ushered in anew regulatory framework designed toidentify and mitigate systemic risks inthe financial system and prevent futurecrises. The asset management industryhas begun to assess the impact of thenew regulations. Responding togrowing demands from investors, asset management firms arestrengthening their focus ontransparency and risk management.

The Foreign Account Tax ComplianceAct of 2009 (FATCA) will also have asignificant impact on the assetmanagement industry. FATCA adds anew chapter to the Internal RevenueCode that is focused on strengtheninginformation reporting and withholdingcompliance with respect to US personswho invest through and/or in non-USentities. For many organizations, theAct will require extensive modificationto internal customer information andreporting systems.

Product innovation has become animportant priority as a generation ofBaby Boomers approaches retirementand their focus shifts from assetaccumulation to asset preservation andpayout. New investment vehicles suchas exchange traded funds (ETFs)continued to grow in popularity andare now considered to be viablealternatives to traditional mutual funds.

Mergers and acquisitions (M&A)remain an avenue of growth for assetmanagement firms. The recent focus is on acquiring organizations thatspecialize in certain client segments or particular products.

With the media and investorsscrutinizing the industry’s taxpractices, many asset managersrecognize the need to incorporateglobal tax risk management into their investment strategies. They also continue searching for ways to optimize tax processes toenhance after-tax returns andminimize investors’ potential future tax exposures.

In the aftermath of the financial crisis,regulators and asset managers arefocused on the use of standardized,transparent performance metrics.Alternative fund managers arepursuing Global InvestmentPerformance Standards (GIPS) as away to build investor trust.

As the economy recovers, firms areinvesting heavily in talentmanagement. A stricter regulatoryenvironment and greater investorscrutiny is causing asset managers torethink their traditional rewardsystems. Firms may have to promotenon-monetary rewards in order torecruit and retain top talent.

Executive summary

The chaos of 2008 and early 2009 yielded to relative financial stability and modesteconomic recovery in 2010; however, marketvolatility and regulatory reform continue topressure asset managers in 2011.

1 PwC, “Gearing up for renewed growth: Asset management industry summary,” Key industry findings from 14th AnnualGlobal CEO Survey. Available at http://origin-pwc.pwc.com/ca/en/investment-management/publications/gearing-up-renewed-growth-asset-management-industry-summary-2011-03-en.pdf.

2 US Asset Management | The State of the Industry June 2011

Product innovation and management

With a wave of Baby Boomersapproaching retirement, many investorsare shifting their focus fromaccumulating assets to assetpreservation and payout. Impendingretirement and the erosion of portfoliovalues in recent years has increasedinvestors’ demand for a renewed focuson risk management and guaranteedminimum payouts.

In this environment, product innovationhas become increasingly important.New investment products, notablyETFs, are being developed to meetinvestors’ shifting needs and investmentpreferences. As demand for overseasinvestment opportunities increases, US-based asset managers areidentifying opportunities to expandtheir global footprint through localproducts and offices.

With retirees drawing down assets andfirms under continuous pressure toreduce their fees, asset managers arestruggling to maintain a baseline of

assets under service and compensate for declining fee revenue. Some assetmanagers have expanded theirservicing capabilities to take advantageof asset flows into new product lines,such as ETFs.

Asset managers also continue to focuson product management. Significantconsolidation in the industry since2000 has led to the elimination of manyredundant funds, through mergeractivity or shutdown. Firms that havegrown through acquisition will want toconsider how the products acquired willfit into their existing brands. Further,they will have to close or consolidateredundant funds post-merger, a processthat can be challenging, time-consumingand costly.

Evolving investor demands

The complex demands of the globalmarketplace and financial turmoil ofrecent years have bred a new awarenessand sophistication among investors andother stakeholders. Some investors intraditional funds are expecting feereductions to offset diminished returns.Regulators and investors also aredemanding greater fund transparency,assurance of reporting accuracy, andbetter accountability and governancefrom fund managers.

In this environment of changinginvestor demands, asset managers havethe opportunity to strengthen theirbrands by proactively addressingstakeholder concerns. Asset managersthat provide additional reporting(including third party assurancereporting), offer greater transparency,and change their policies andprocedures to meet the newrequirements of investors andregulators have the opportunity to gainan advantage in an increasinglycompetitive marketplace.

The asset management industrycontinues to grapple with a number ofdifficult issues, from regulatory changeto talent management. Following arewhat we believe to be among the keychallenges facing the industry.

Topical issues inasset management

Mergers and acquisitions2

M&A continues to be an avenue forgrowth for asset management firms.Growth in M&A activity in 2010 wasdriven primarily by the desire ofacquiring companies to grow theirproducts and asset bases as well as toexpand their geographic footprints.Both deal volume and values improvedby 20% compared to the previous year(excluding BlackRock’s landmarkacquisition of Barclays Global Investorsin 2009, for $13.3 billion). Whilediversification activity by banks andinsurance companies has slowed,independent asset managers aregradually returning to the market inhopes of finding buyers to help themwith distribution capabilities and withmanagement of the increasing cost of compliance.

M&A activity has been focused on pureplay asset managers looking to acquiresmall to medium size firms that serve aspecific client segment or specialize in a particular product. Alternativeasset managers have continued to drive M&A volume, particularly in the hedgefund, fund of hedge funds andcollateralized loan obligation/collateralized debt obligation spaces.

Deal activity started out slow in the firstquarter of 2011. While we see anincreasing number of interested buyersand sellers, the gap between buyers’and sellers’ valuations created bydiffering expectations of future assetflows and fund performance is resultingin failed deals. In addition, regulatoryuncertainty and the impact of new taxregulations may continue to depressdeal activity in the remainder of 2011. However, continued recovery in the

economy, improving deal valuationsand an increasing number of willingbuyers and sellers should offset these negative trends.

For companies that are interested indoing acquisitions, it is important tohave a clear understanding of why apotential target is a good fit with theexisting business. Implementing a wellcoordinated due diligence effort thatuncovers risks, particularly aroundquality of assets under management(AUM) as well as tax and regulatorycompliance issues, will be critical toavoid overpaying for an acquisition.Realizing the potential efficienciesidentified before a deal is completedwill require rapid, seamless integrationof the acquired company posttransaction, with service lines workingtogether to integrate operations.


Deal environment firming: Dealvolume in 2010 increased over thelevels of 2008 and 2009, with 117transactions completed (an 18%increase over the previous year), butactivity remained well below 2005-2007 levels. With the global economybeginning to stabilize, deal activity isexpected to accelerate.

Fewer megadeals announced: Onemegadeal was closed in 2010—the UK-based Man Group’s acquisition of GLGPartners for $1.5 billion. This was adecline from the three megadealscompleted in 2009, includingBlackRock’s landmark acquisition of Barclays Global Investors for $13.3 billion.

Deals for alternative investmentmanager targets drive activity:Approximately three-fourths of dealactivity related to alternativeinvestment manager targets, with thelargest share of activity relating tohedge fund managers.

Valuations improve: Both EBITDAmultiples and overall EBITDA levelshelped to improve valuationscompared to the levels of 2008 and 2009. However, valuationsremained depressed relative to pre-financial crisis levels as well asagainst public company multiples. In order to address valuation gaps,potential acquirers are developingcreative structures.

Cross-border activity aids in therecovery: Cross-border M&Aaccounted for 61% of total deal valuein 2010, with the UK, UAE, India,Switzerland and Hong Kong being thedominant cross-border investors. US-based investors continue to eyeemerging markets such as Brazil, India and China, and investors fromthose countries are looking to enterthe US market.

*Source: Thomson Reuters

Snapshot:M&Aactivity*

2 PwC analysis, based on data from Thomson Reuters.


Managing global tax risk

Governments worldwide areintroducing legislation and standardsthat require funds to provide greatertransparency in their financialreporting, and they are focusing on taxstrategies to minimize taxes in theirjurisdictions. The media and investorsalso are scrutinizing asset managers’ taxpractices. Major newspapers have runfront page headlines about fundstargeted for tax avoidance, andinvestors are asking more sophisticatedquestions about how funds investinternationally and manage their globaltax risk exposures.

In this environment, the tax functioncan no longer focus solely on taxcompliance. Fund managers may wantto proactively consider current andpotential future tax risk management asa key component of the fund’s overallinvestment strategy. The way in whichan asset management firm manages itsglobal tax risk can affect not only itsfinancial performance but its reputation.

In response to increased scrutiny, seniorexecutives of funds are attempting togain deeper insight into tax exposuresthat could have a material impact onfinancial statements and the investmentfirm’s reputation. Increasingly, CFOsare requiring their tax leadership totake ownership of tax risks and internaltax controls globally. A systematicapproach, with strong information andcommunication procedures, will beneeded to manage global tax risks. Weview this as one of the more seriouschallenges for the tax function over thenext few years.

Global sourcing

For asset management firms, the recentfinancial crisis resulted in poorinvestment performance, which led todeclining AUM. The reality of dwindlingresources has led to underinvestment intechnology infrastructure. Now firmsare evaluating their infrastructureoptions, and deciding whether topursue significant internal developmentor outsourcing. Many are choosing thelatter option, as outsourcing allowsfirms to leverage third party serviceproviders’ technology investments,reduce costs and receive high quality,specialized levels of service.

Some firms are moving in-housefunctions to third parties, establishingor expanding their existing offshorelocations, and/or consolidating selectbusiness operations into shared servicecenters known as “centers of excellence.”

The potential for outsourcing extendsbeyond back office operations toinclude core functions such as productdevelopment and research. Assetmanagers that choose to outsourcethese functions can tap into significanttalent, particularly in Asia and to alesser extent, in Latin America, but will require changes to existingoperating models.

Tax optimization

Competitive pressure has forced assetmanagers to optimize their operationsby implementing technology, workflowand process integration solutions. Aspart of this effort, tax departments havebeen given optimizationresponsibilities, ranging fromredesigning inefficient processes tomanaging the complex tax risksassociated with multinational funds.The goal of tax departmentoptimization is to support and enhancea fund’s after-tax returns and minimizeinvestors’ potential future tax exposures.

The tax optimization process will varyconsiderably among funds, dependingon factors such as the fund’s strategyand types of investors, where the fundmanager is based, and whereinvestment strategies are deployedthroughout the world.

When determining how to optimize afund’s tax position, asset managers canbegin by analyzing how much time thetax function spends on identifying anddelivering value-enhancing strategies,how to improve the efficiency of taxcalculations and compliance processes,and how to better integrate the taxteam into the business. Asset managersmay want to consider devotingresources to keep up with the rapidlychanging global tax landscape.


Product innovation and management: Many investors are nearing retirement andshifting their focus from accumulation ofassets to asset preservation and payout. Thisshift is spurring the development of newproducts, such as emerging market fundsand other alternative investment vehicles.

Evolving investor demands: Investors in traditional funds aredemanding fee reductions to offsetdiminished returns and are expectinggreater transparency of financialinformation. Firms that proactively addressinvestors’ growing demands will be betterpositioned to succeed in a highlycompetitive environment.

Mergers & acquisitions (M&A): Deal activity improved over 2009 butremained well below the levels experiencedbetween 2005 and 2007. Growth was drivenprimarily by asset managers seeking toexpand their product lines and globalfootprints. We believe that assetmanagement M&A is poised to gainmomentum, despite the fact that activity inthe first quarter of 2011 started out slow.Continued uncertainty related to newregulations and a valuation gap betweenbuyers and sellers continue to slow downthe pace of recovery in deal activity.

Managing global tax risk: In an era of heightened governmentscrutiny, the tax function can no longerfocus solely on tax compliance. Fundmanagers may want to be proactive inconsidering current and potential future tax risk management as a key component of the fund’s overall investment strategy.The way in which an asset management firm manages its global tax risk can affect not only its financial performance but its reputation.

Global sourcing: Coming out of the market downturn, assetmanagers are investing less in their in-housesupport infrastructure. Many are turning tooutsourcing to reduce costs while leveragingthe scalable technology investments andexpertise provided by third parties.

Tax optimization: Asset managers, feeling competitivepressure to optimize their operations, aregiving tax department directorsresponsibility for optimizing theiroperations, from redesigning inefficientprocesses to managing complex tax risks.The goal is to increase the efficiency of thedepartment while enhancing the fund’safter-tax returns and minimizing investors’potential future tax exposures.

Performance measurement: The latest version of GIPS became effectivein January 2011. While many mutual fundmanagers have long complied with thestandards, managers of alternativeinvestment funds also are considering GIPScompliance as a vehicle for building investortrust and assuring independence ofperformance reporting.

Talent management: As signs of market recovery continue, assetmanagers are once again investing heavilyin recruiting and retaining talent. They facemany challenges in this area, from dealingwith regulatory, investor and media scrutinyover compensation to preservingshareholder returns in the face of increasingpayroll expense.

Regulatory change: A number of new laws affecting assetmanagers were enacted in 2010. For manyorganizations, the passage of legislationsuch as Dodd-Frank, FATCA and the RICModernization Act will require extensivechanges to operational processes andgovernance models.

Topical issues in asset management

Performance measurement

In the wake of the financial crisis,managers and regulators continue tofocus on the use of standardized,transparent performance metrics in theasset management industry. The mostwidely recognized and commonly usedtool is the Global InvestmentPerformance Standards (GIPS). Assetmanagers leverage GIPS to calculateand report on their performance.

Most traditional managers have longcomplied with GIPS. More recently,managers of alternative investmentfunds have become interested in GIPScompliance as a source of independentassurance of performance reporting.3

Compliance with GIPS standards canhelp alternative funds to reinforceinvestor trust and build newrelationships with prospective clients.Compliance also can help to establish a more consistent set of procedures for calculating and reporting oninvestment performance.

The latest version of the standards,GIPS 2010, became effective January 1,2011. Some provisions of the revisedstandards, including changes tovaluation practices and reporting ofcarve-out returns, will require someasset managers, including smallerfirms, to modify their operations toaccommodate new valuation practicesand reporting requirements.

Talent management

As the market continues to recover,asset management firms are once againinvesting heavily in attracting andretaining talent. The changingregulatory environment, whichdemands a greater focus on riskmanagement and increasingtransparency, will have significantimplications for talent management.

With pressure to increase base salaries,asset managers are challenged topreserve shareholder returns in the faceof rising payroll costs. They also aresearching for ways to redefine the overallcompensation package, taking intoaccount pressure from employees andscrutiny from shareholders, regulatorsand the public over incentive outcomes.

Regulatory guidance on incentivecompensation arrangements has spreadfrom the banking and capital marketssector into asset management as aresult of the Capital RequirementsDirective III in Europe and the Dodd-Frank Act in the US. Guidance issued todate will require greater disclosure ofincentive compensation and governanceprocesses. The largest firms (over $50billion in balance sheet assets) also maybe subject to specific rules on deferralof incentives and the use ofperformance adjustments during thedeferral period. The evolving regulatoryenvironment will accelerate efforts toevaluate overall compensation mix(base salary, annual incentive, long-term incentive) for key positions withinasset management firms.

Regulatory restrictions (e.g.,prohibition of proprietary trading andincreased demands for transparency)could drive talented risk seekers to setup their own investment or privateequity firms or even choose to leave theasset management industry, impactingthe supply of top talent in the industry.In addition, the “Volcker Rule”prohibiting banks from sponsoring or managing hedge funds will have an impact on human resources, asbanks spin off their alternativeinvestment operations.

The more restrictive regulatoryenvironment will require a rethinking of traditional reward systems. To recruit and retain top talent, assetmanagers may have to promote non-monetary rewards, such asopportunities for professionaldevelopment and global deployment as well as cross-functional experience.

Regulatory change

The speed of regulatory change hasasset management firms struggling toassess the impact of anticipated newrequirements and expectations fromregulators and investors. Asset managersare rethinking their operationalprocesses and governance models inresponse. A number of key regulationsimpacting the asset managementindustry are highlighted below.

Dodd-FrankAmong other things, Dodd-Frankimposes new oversight of firms andactivities deemed “systemicallyimportant” and impose entirely new


3 There are other paths to third party assurance as well, including independent examination of a manager’s investmentperformance, performed under the attestation standards of the American Institute of Certified Public Accountants (AICPA)and International Standards on Assurance.

regulations over derivatives trading. Italso requires advisers to private funds—previously exempt from registration—toregister with the SEC as investmentadvisers, comply with requirements ofthe Investment Advisers Act of 1940, andto file new information with regulators.For advisers to private funds, becomingregistered requires adopting andimplementing a formal complianceprogram, designating a chief complianceofficer, performing testing and ensuringstrong compliance controls.

Dodd-Frank contains other newrequirements that may have a collateralimpact on asset management firms,including requirements related toincentive compensation, asset-backedsecurities, credit rating agencies, andincentives for whistleblowers. The Actalso provides for a potential newstandard of care for broker-dealers andthe possibility of a changed regulatoryoversight structure.

Dodd-Frank requires that regulatorspropose and adopt a myriad of rules forimplementing the Act. Assetmanagement firms have been workinghard to assess the potential impact ofDodd-Frank on their organizations,provide comments to regulators, andmake plans to comply with its manyprovisions. That requires, among otherthings, determining how best toorganize the cross-functional resourcesneeded to implement the newregulations. Having a dedicatedcapability that is empowered andaccountable for implementation on anongoing basis can help to ensurecontinued compliance.

FATCAThis regulatory framework was enactedin March 2010 as part of the HiringIncentives to Restore Employment(HIRE) Act. Beginning January 1, 2013,FATCA will impose a 30% USwithholding tax on any US-sourceddividends, interest, rents and otherinvestment income, gross proceedsfrom the sale of US stocks andsecurities, and payments on certain USequity swaps paid to foreign financialinstitutions (FFIs) and non-financialforeign entities (NFFEs) that fail todisclose US ownership.

FATCA has significant business and taximplications for asset managementfirms. It imposes new operationalrequirements and costs on offshorefunds with underlying US investments,their service providers andcounterparties. For many organizations,the Act will require extensivemodification to internal customerinformation and reporting systems.

FATCA’s tax provisions will compelmost offshore funds that havemeaningful direct or indirect USinvestments, including certain syntheticinvestments (e.g., through equityderivatives), to enter into FFIagreements. Otherwise, the 30% tax ongross proceeds from the disposition ofinvestments, regardless of whetherreceived directly through withholdablepayments or deemed to have beenreceived indirectly through passthrupayments, will make most USinvestments uneconomical. If a fund hasany material turnover, the tax couldreadily exceed the fund’s net asset value.

Every asset manager will need tounderstand the legal, tax, regulatoryand systems implications of FATCA.While final guidance has not yet beenissued by the IRS, the timeline forcompliance is aggressive, leading manyorganizations to plan ahead forcompliance. Offshore funds withunderlying US investments, and theirservice providers, can begin by assessingthe business and tax risks arising fromFATCA and outlining a plan to limit riskexposure and implement acomprehensive compliance solution.

FBAROn February 24, 2011, the federalgovernment published new regulationsrelated to Form TD F 90-22.1, Report ofForeign Bank and Financial Accounts,commonly referred to as “FBAR.” Thenew regulations, which becameeffective March 29, could affect asignificant number of US persons with afinancial interest in, or signatureauthority over, foreign financialaccounts (FFIs) reported on FBAR.Changes to the FBAR rules may requireofficers and employees who previouslyhad no FBAR reporting obligation withrespect to their employer’s foreignfinancial accounts to file an FBAR byJune 30, 2011.

RIC Modernization ActThe Regulated Investment CompanyModernization Act of 2010 was passedinto law in December 2010. It is theculmination of efforts by the mutualfund industry in recent years tomodernize various tax rules applicableto regulated investment companies(RICs). The Act contains 17 provisions


that collectively are among the mostsignificant to affect RICs since the TaxReform Act of 1986.

Prior to passage of the RICModernization Act, RICs faced anumber of potentially severe taxconsequences for inadvertentcompliance oversight errors. The Actmodifies some of these rules, reducingthe tax risks faced by RICs. Forinstance, it will allow RICs to payfinancial penalties rather than lose RICtax status for qualification violations.The Act also presents newopportunities. Among other things,funds of funds will be able to owninternational and municipal bond fundsand pass through foreign tax creditsand tax-exempt income from thosefunds to fund of funds shareholders.

For tax service provides, a first step incomplying with the RIC ModernizationAct involves managing transition risk—understanding how and when funds areimpacted, assessing state taxconsequences, and keeping current onemerging questions and uncertainties.Other compliance activities includeassessing the changes required toexisting policies and procedures,managing calculation risk, andcoordinating with and educating otherimpacted parties.

A broad range of groups that provideservices to RICs will see theirresponsibilities affected by the RICModernization Act. That includes notjust fund management and tax serviceproviders, but also personnel in thefund reporting, marketing, transferagency, information technology andcompliance functions. Managementmay want to consider assembling a task force to analyze the Act and assess its impact on the fund’s variousservice providers.

Other proposed or enacted regulatory change

Distribution and management The SEC has proposed new rules toreplace the existing regulationsgoverning mutual fund distribution andmarketing fees, including so-called“12b-1 fees.” The proposal calls forcapping fund sales charges, improvingtransparency through disclosure,encouraging retail price competition,and modifying the oversight role ofdirectors. The new rules, if adopted,will have far reaching consequences onhow distribution deals are negotiatedand how much can be charged. The SEChas indicated its intent to addressdistribution issues in 2011.

Revised SEC Custody RuleThe SEC revised the “Custody Rule”

(Investment Advisers Act Rule 206(4)-2) effective in March 2010, to providegreater transparency to clients andregulators, improve oversight throughindependent testing, and increase thecontrols for registered advisers thatmaintain custody of client assets. Those private fund advisers that mustregister with the SEC face newreporting and audit requirements under the Custody Rule.

“Pay to play”New rules adopted by the SEC prohibitan investment adviser from providingadvisory services for compensation(directly or through a pooledinvestment vehicle) for two years, if theadviser, or certain of its executives oremployees, makes a politicalcontribution to an elected official whocould influence the selection of theadviser (Rule 206(4)-5 under theAdvisers Act). These new requirementscreate significant recordkeeping andcompliance obligations.



Mutual fundindustry overview

Recovering from the financial crisis, themutual fund industry has seen continuedgrowth in AUM, while investors continueto look for ways to maximize returns.Following are highlights of the state ofthe mutual fund industry.

Market size

US AUM increased during 2010 acrossall fund types except money marketfunds, which have experiencedsignificant declines since 2009.Investors appear to be globalizing theirallocation models, given the increase indemand for international and emergingmarket equities as well asglobal/international fixed incomefunds.

Competitive environment

The mutual fund industry remainshighly competitive, despite a significantamount of M&A activity over the pastfew years and a long-term consolidationtrend. Through the financial crisis, anumber of firms reduced operatingexpenses while shoring up their balancesheets, emerging with an improved

financial position. Now firms arelooking to make strategic acquisitions in order to boost market share, createsynergies, and expand their investment capabilities.

Product offerings

Mutual fund offerings continued todecline in 2010, while the number ofother investment vehicles, especiallyETFs, increased in response to changinginvestor demands. The main driversbehind the decline of mutual fundproducts were mergers and liquidationsof funds as managers attempted tocreate economies of scale, cut costs, and reduce the overlap in their fundline-ups. Product innovation continuesin response to increased investorinterest in ETFs, absolute return funds,and alternative investments.

Earnings drivers

AUM continues to be the key driver of earnings.While mutual fund assets remain below pre-crisislevels, other fund assets continue to reach newhighs. Since the crisis, mutual fund AUM increased15.9% and 6.2% in 2009 and 2010, respectively.Through the end of 2010, equity fund assetsincreased 14.2%, bond fund assets grew 18.1%,and hybrid fund assets increased 15.6% from theprior year. Money market fund assets declined15.5% through the end of 2010, as investors soughtout higher-yielding asset classes. Assets invested inother investment vehicles, such as ETFs, UITs, andclosed-end funds, continue to reach new highs,primarily due to the growth of ETFs.4

Achieving top-line growth requires asset managersto capture investor flows and consider the makeupof AUM. Earnings are driven by the optimal mix ofasset classes and related fee structures. Forinstance, equity products are associated withhigher fees and margins relative to fixed incomeand money market products.


Mutual Fund Net Assets by Category

3 086653

713

494641 741

10 00012,00014,000

ns

3,684 4,384 4,940 5,911 6,5213,708 4,960 5,666

1,2481,290 1,357

1,4941,679

1,5672,206

2,6052,052 1,913

2,0412,354

3,086

3,8323,320

2,804430 519

567494

02,0004,0006,0008,000

10,000

US$

Bill

ion

2003 2004 2005 2006 2007 2008 2009 2010

Equity Bond Money Market Hybrid

Exchange traded funds

With close to $1 trillion in AUM as of December 2010, the ETF sector has experienced tremendous growth in the last decade,becoming a strong competitor to traditional mutual funds. Competition in the ETF market remains highly concentrated, withthe top five managers controlling approximately 90% of assets.5 As new ETFs with lower fees are introduced to the market,existing ETF products face the risk of downward pressure on fees.

ETF Assets and Number of Funds

800

1000

1,000

1,200

$423

$608$531

$777

$992

400

600

800

400

600

800

umbe

r of F

unds

US$

Bill

ions

$66 $83 $102 $151

$228$301

0

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

200N

ETF Industry Assets Number of Funds

4 Investment Company Institute.

5 Investment Company Institute, Strategic Insight, Simfund.

Source: Investment Company Institute

Source: Investment Company Institute, Strategic Insight, Simfund

Money market redemptions

In 2008, the Federal Reserve reducedshort-term interest rates to essentiallyzero. In response, investors soughtalternative ways to earn higher yields,primarily by redeeming or exchangingtheir money market funds foralternatives such as short-duration andintermediate-term fixed income funds.Money market net outflows through theend of 2010 totaled $511 billion,slightly surpassing the total amount ofnet outflows in 2009 ($507 billion).6

For the better part of 2010, fixed incomefunds continued to capture the majorityof long-term fund flows. However, in thefourth quarter of 2010, investors shiftedtoward equity funds. For the year, netnew flows into equity funds totaled $134billion—a sharp increase over the 2009level of $15 billion.7

Expense ratio pressures

Fees and expenses continued theirdownward trend in 2010 due toindustry competition and investors’

migration to cheaper funds. Expenseratios vary by fund type, with higherratios for equity funds, especially thosewhich focus on a particular sector or oninternational equities. Larger mutualfunds generally offer funds with lowerexpense ratios, as they benefit fromsignificant breakpoint fee reductions.

Regulatory challenges

Regulators and market participants arecontinuing to evaluate the regulatoryframework for money market funds.New regulations for these funds wentinto effect in 2010, including rulesrelated to enhanced credit quality andnew filing requirements for publicdisclosure of shadow pricing. UnderDodd-Frank, regulators are alsoevaluating ways to reduce reliance oncredit ratings. If new rules are adoptedas proposed, money market funds andother funds and their boards ofdirectors would not be able to rely uponcredit ratings in making assessments of creditworthiness.

FATCA will also change the way thatmutual funds operate. To comply withthe new regulation and avoid the 30%withholding penalty for nondisclosure ofUS ownership of certain investments,many funds will have to make significantmodifications to their customer datagathering and reporting systems.

Mutual funds may also be impacted bypossible changes to distributionrequirements under Rule 12b-1 thatwould limit fund sales charges andincrease fund disclosure aboutdistribution fees, among other things.In addition, mutual funds and otherasset managers that have distributionrelationships with broker-dealers maybe impacted by a potential change to thestandard of care owed by broker-dealersto retail investors. Finally, regulatorshave signaled a greater focus onenforcement efforts related to the mutualfund industry, particularly with respectto fund fees, insider trading, riskdisclosures and compliance programs.


Market size: US AUM increased during2010 across all fund types exceptmoney market funds, which haveexperienced significant declines since2009, as investors sought to earnhigher yields elsewhere.

Competitive environment: The mutualfund industry remains highlycompetitive despite significant M&Aactivity over the past few years. Thelong-term trend of consolidation isexpected to continue.

Product offerings: Mutual fundofferings continued to decline whilethe number of other investmentvehicles, notably ETFs, increased. The ETF sector remains highlyconcentrated and continues toaccumulate assets.

Earnings drivers: AUM continues to bethe key driver of earnings. Whilemutual fund assets remained belowpre-crisis levels, other fund assetsreached new highs.

Money market redemptions: In thelow interest rate environment,investors pursued higher-yieldalternatives to money market funds,such as short-duration andintermediate-term fixed income funds.

Expense ratio pressures: Mutual fundexpenses were pushed lower due toincreased industry competition andinvestor demand for lower fees.

Snapshot:Mutual fundindustry

6 Strategic Insight, Simfund.

7 Ibid.

Regulation

Alternative asset managers will soonhave to comply with new regulations,oversight, and enforcement actions inthe United States and abroad. Thefollowing pieces of legislation (amongothers), in the US and Europe, will havea significant impact on the industry:

Dodd-FrankAs a result of Dodd-Frank, a significantnumber of private fund advisers,including advisers to hedge funds,private equity funds and real estatefunds, are subject to the oversight of theSEC for the first time. Dodd-Frankrequires advisers to private funds,which previously were exempt fromregistration, to register with the SEC asinvestment advisers, comply withrequirements of the InvestmentAdvisers Act of 1940, and file newinformation with regulators.

For advisers to private funds, becomingregistered requires adopting andimplementing a formal complianceprogram, designating a chiefcompliance officer, performing testing,and assuring strong compliancecontrols. For many alternative fundmanagers, becoming registered requiressignificant changes to operations,controls, staffing, recordkeeping anddisclosures. While no conclusivenumbers are available, thousands ofadvisers, including those based in theUS and advisers based elsewhere thathave US investors, will be impacted.

FATCAFATCA compliance by offshore fundsfocused on alternative investments willpresent substantial business andoperational challenges, from theidentification and documentation ofinvestors, to the fund’s portfolio and ITsystems, which may affect multiplefunctions (tax, legal, back-officeadministration, operations, IT, etc.)

AIFM DirectiveThe EU Directive on AlternativeInvestment Fund Managers (AIFMDirective) will bring about sweepingchanges to the alternative assetmanagement industry. The Directivewill impact hedge funds, private equityand venture capital funds, real estatefunds, and investment trusts. It wouldregulate all AIFMs distributing in the EU, whether they manage fundswithin the EU or in other countries.Complying with the new regulationswill require stronger controls, reportingand recordkeeping.


Alternative fundindustry overview

Driven by market performance and investorinflows, hedge fund assets reached $2.47trillion by the end of 2010. The demand byinvestors and regulators for more oversight,transparency, and enforcement will have asignificant impact on alternative fundmanagers. Following are highlights of thestate of the alternative fund industry.

Hedge funds: Market sizeand performance

Hedge fund assets reached $2.5 trillionby the end of 2010, a slight increasefrom the beginning of 2010, driven bymarket performance and investor netinflows. Fund of hedge funds assetswere $948 billion at the end of 2010,an increase of approximately $62billion from the start of the year.8 Thechange in asset levels in 2010 wasdriven primarily by performance ratherthan positive net flows.

The Hedge Fund Aggregate Index andFund of Funds Aggregate Index werepositive through the end of 2010. As in2009, emerging market countryaverages, with the exception of China,outperformed the US.

Institutional investors account for morethan half of hedge fund industry assets.These investors remain optimistic.9

They continue to increase their

allocations towards hedge funds tomeet the need for higher returns and diversification. In 2011, 85% of institutional investors plan toincrease or maintain their allocations to hedge funds.10

While institutional investors areoptimistic, many countries arereconsidering their regulatoryrequirements for alternative funds.Asset managers will likely face stricter rules in the coming years andwould do well to prepare for a morerestrictive environment.


Hedge Funds and Fund of Funds Annual Returns

20%

30%

-10%

0%

10%

-40%

-30%

-20%

-50%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Hedge Fund Aggregate Average Fund of Funds Aggregate Average S&P 500

Single Manager Hedge Fund Assets

15%3.5

15%-10%-5%0%5%10%

1.0

1.5

2.0

2.5

3.0

US$

Tri

llion

s-25%-20%-15%

0.0

0.5

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

8 HedgeFund.net (HFN), Channel Capital Group Inc.

9 Preqin Research Report, “Are Interests Aligned? Fund Terms Investor Survey Results,” September 2010.

10 Preqin Research Report, “The Next 12 Months: Institutional Appetite For Hedge Funds,” August 2010.

HedgeFund.net (HFN), Channel Capital Group Inc.

HedgeFund.net (HFN), Channel Capital Group Inc.


Private equity deal activity

The global private equity market is beginning to show signs ofimprovement, but it remains well below pre-crisis levels, asmeasured by deal activity and values. In 2010, the number ofUS deals increased 38% and the number of non-US dealsincreased by almost 40%.11

Fundraising declined over the previous year. The fundraisingmarket continues to be challenging for asset managerscurrently seeking commitments. A number of firms areexploring new fundraising methods and are offering morefavorable terms to attract investors.

Regulation: Alternative assetmanagers face new regulatoryrequirements in the US and Europe.Dodd-Frank and the AIFM Directivewill have a significant impact on theindustry.

Market size: Hedge fund assets stoodat $2.5 trillion at the end of 2010, upslightly from the start of the year.Fund of hedge funds assets increasedby $62 billion during the year,reaching $948 billion.

Performance: The HFN Hedge FundAggregate Index and HFN Fund ofFunds Aggregate Index were positivethrough the end of 2010.

Institutional investors: Theseinvestors, which account for morethan half of hedge fund industryassets, remain optimistic and continueto increase their allocations towardshedge funds, to meet the need forhigher returns and diversification.

Private equity deal activity: The globalprivate equity market is beginning toshow signs of improvement, but dealactivity and values remain well belowpre-crisis levels. Fundraising declinedin 2010 and the fundraising marketcontinues to be challenging for firmscurrently seeking commitments.

Snapshot:Alternative fund industry

Private Equity Deals

1,200

1,400

200,000

225,000

250,000

800

1,000

125,000

150,000

175,000

00,000

ber o

f Dea

ls

$ M

illio

ns

200

400

600

25 000

50,000

75,000

100,000

Num

b

US$

00

25,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US Deal Value Non-US Deal Value # US Deals # Non-US Deals

11 Thomson Reuters.

Source: Thomson Reuters

Performance, fundamentals and pricing

Both direct and indirect real estate investments have shown strong signs ofrecovery since the credit crisis. Equity REITs were the top performers in2010, exceeding pre-recession levels in the fourth quarter. The NationalCouncil of Real Estate Investment Fiduciaries (NCREIF) benchmark wasonly 12% short of its pre-recession peak.

Rental rates for office properties have begun to show signs of recovery inselect prime markets. Other property types continue to struggle. For thenear term, the priority is to maintain occupancy—at almost any cost. As aresult, owners and managers are focused on cementing tenant relationships.More tenants have begun to renew and extend their leases, signalingconfidence that they can sustain their businesses and have a desire to takeadvantage of lower rates. Forecasts do not show any upward pressure oncommercial rents until 2012, and few expect rents to spike anytime soon.


Commercial real estateindustry overview

Commercial real estate markets showed signsof recovery in 2010, but the fragile state ofthe economy continues to create uncertaintyabout the future of the industry. Followingare highlights of the state of the industry,

Index Total Returns

120

140

NCREIF NAREIT Equity S&P 500

80

100

2006 Index = 100

40

60

1-Year Total Returns:NCREIF 13.11%NAREIT Equity 27.95%

20

2006 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10

NAREIT Equity 27.95%S&P 500 15.06%

Source: NCREIF, NAREIT, Standard & Poor’s

Real estate transactions

Transaction activity in 2010 was a story ofquality over quantity. For healthy properties—those in attractive sectors with high tenantinterest located in strong markets—pricingtrends exceeded the average for the commercialreal estate sector. Pricing trends for distressedproperties, in contrast, were weaker due tooversupply, limited availability of financing,high vacancy rates and general investor caution.

Transaction activity lagged at the start of 2010,but for the year, the volume of transactions wasdouble the number for 2009. Prices fluctuatedthroughout 2010, and this pattern is likely tocontinue until investors have a clearer vision ofwhere the economy is headed. In 2011, moneyhas been flowing into REITs, which raised themost capital in the first quarter.


Capitalization rates

With signs of a strengthening US economy evident indeclining initial jobless claims, rising business and consumerconfidence, and growing employment figures, thefundamentals of the commercial real estate industry areimproving and attracting much attention from investors, whoare eager to deploy capital as the industry moves past thebottom of the cycle.

Strong buyer interest, combined with the reopening of thedebt markets and interest rates that remain low, continues toput downward pressure on overall cap rates, especially forcore, stabilized assets. The first quarter 2011 issue of the PwCReal Estate Investor Survey reports that the average overall caprate, a reflection of an investment’s anticipated ownershiprisk, decreased in 27 of the 31 markets surveyed. The highestquarterly decreases occurred in regional apartment markets,where average cap rates compressed between 39 and 73 basispoints this quarter.

Commercial Real Estate Transactions (US $ Billions)

30

20

25

Closed Sale New Offerings

5

10

15

0

09S O N D 10J F M A M J J A S O N D

Capitalization Rates – Commercial Real Estate Markets

7.58%

8.08%7.63% 7.53%

8.17%

9.15%

7.98%8.0%

9.0%

10.0%

7.58%

6.51%

5.0%

6.0%

7.0%

1.0%

2.0%

3.0%

4.0%

0.0%Regional Mall Power Center Strip Shopping

CenterCBD Office Suburban Office Flex/R&D Warehouse Apartment

2Q07 4Q09 4Q10

Source: Real Capital Analytics http://www.rcanalytics.com. Based on properties and portfolios $5 million and greater

Source: PwC Real Estate Investor Survey

Real estate capital markets

Debt and Equity Forecasts More than 55% of respondents to thePwC Emerging Trends in Real Estate2011 survey12 see equity capital asmoderately to substantiallyoversupplied for 2011—a reaction tothe recent investment surge into a few24-hour cities and into the multifamilysector. Survey respondents view thisactivity as a leading indicator of thedepth of sidelined equity that is slowlymaking its way back into the market.

Real Estate Investment Trusts US REITs raised $47.5 billion in 2010,in more than 170 IPO, initial debt, andequity capital offerings.13 Total capitalraised during the year exceeded therecord setting pre-crisis levels of 2007.

Investor appetite for both REIT equityand debt deals remains strong. ManyREITs are still offering attractive yieldsrelative to US ten-year Treasuries andproviding a liquid allocation for realestate investments.

Commercial Real Estate: CMBS MarketAs of March 2011, year-to-date CMBSissuance had reached $8.9 billion, wellon track to surpass the 2010 total of$11.6 billion. While market activity hasaccelerated in 2011, issuance is notexpected to reach the peak level seen in 2007. Underwriting standardsremain tight, with most loans in the 60-65% loan-to-value (LTV) range and lenders enforcing stricterunderwriting standards.14

Lodging sector

Hotel operating performance remainedcyclically depressed in 2010, but thesector made substantial strides towardrecovery. Performance gains werestrongest in major markets, particularlyBoston, Denver, Miami, New York, andNew Orleans. Meanwhile, nationalsupply growth slowed. This combinationsets the stage for improvements inpricing, which are important to completethe recovery of revenue per availableroom (RevPAR) to its long-term,inflation-adjusted average.


Performance, fundamentals andpricing: Economic drivers continue todepress underlying fundamentals andrents. The apartment sector and REITsare on track for the quickest recovery.The multifamily sector is showingsigns of improvement in select primemarkets, but performance in the retailsector continues to lag.

Real estate transactions: Transactionactivity lagged at the start of 2010 butfor the year, the volume oftransactions was double the numberfor 2009. Pricing trends for healthyproperties (those in attractive sectorswith high tenant interest located instrong markets) were better than theindustry average.

Capitalization rates: Overallcapitalization rates continue to trenddownward for deals in betterperforming markets and for the best,

well leased assets in the industry. Thisis due to strong buyer interest, debtavailability, and low interest rates.Some of the cap rate compression isrelated to apartment assets.

Real estate capital markets: Capitalmarkets continue to improve, butmore flow is coming from the equityside than from the debt side in 2011.We expect lenders to increase theiractivity in 2011, but low LTV ratiosand a dry CMBS market will remainmajor concerns for the market.

Lodging supply and demand: Hotelsare experiencing a stronger thanexpected rebound in demand, andfurther growth is anticipated.Occupancy recovery is expected tohelp drive pricing gains in 2011,which will be particularly importantfor hotels in the upper tier segments.Supply growth remains suppressed.

Snapshot: Real estateindustry

12 Available at http://www.pwc.com/us/en/asset-management/real-estate/publications/emerging-trends-in-real-estate-2011.jhtml.

13 NAREIT.

14 Commercial Mortgage Alert (CMAlert.com).


Conclusion

The US asset management industry is facinga new and more challenging environment ofstricter government regulation and greaterinvestor scrutiny. The major regulatorychanges of 2010, from Dodd-Frank toFATCA, are fundamentally reshaping theindustry and their impact will be felt formany years. The growing demands fromregulators, investors and the general publicfor greater transparency, accountability,and risk management represent a new factof life for asset managers. “Business asusual” has been redefined.

The brave new world of asset managementpresents significant challenges but alsooffers a major opportunity for firms todifferentiate themselves. How quickly andeffectively asset managers adapt to the newenvironment will help to determine whetherthey lead or lag in the coming years.

© 2011 PwC. All rights reserved.”PwC” and “PwC US” refer to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm ofPricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only, andshould not be used as a substitute for consultation with professional advisors.

Contacts

For more information about any of the issues discussed here, please feel free tocontact your local PwC representative, or any of the Asset Management practiceleaders and partners listed here. Thank you.

Barry Benjamin US & Global Asset Management Leader 410 659 3400 [email protected]

Gary Meltzer US Asset Management Advisory Leader 646 471 8763 [email protected]

Tim Conlon US Real Estate Leader 646 471 7700 [email protected]

Paula Smith US Assurance Leader for Alternative Investments 617 530 7906 [email protected]

Paul Ryan US Tax Leader for Real Estate 646 471 8419 [email protected]

Will Taggart US & Global Asset Management Tax Leader 646 471 2780 [email protected]

Mark Casella US Alternative Investment Leader 646 471 2500 [email protected]

Shawn Baker US Tax Leader for Traditional Funds 617 530 7340 [email protected]

Peter Finnerty US Assurance Leader for Traditional Funds 617 530 4566 [email protected]

www.pwc.com/us/assetmanagement

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