Is this asset class doomed?

You don't have to go far these days to read about the rapid rise of passive investing and the massive outflows from actively managed funds, and the lower fees across the industry these index funds are causing. While this is undoubtedly good news for retail investors, what does it mean for some of London's largest public fund managers such as Schroders (LSE: SDR) and Jupiter (LSE: JUP)?

///>

While no asset manager is completely free from the relentless rise of index funds, Schroders is better protected than many of its peers. That's because the company has a well-diversified mix of clients, including institutional (pension funds, sovereign wealth funds, endowments), intermediary (independent financial advisers, banks) and high net worth individuals.

Nine months to September 2016

However, as this table shows, the intermediary category, whose end users are largely retail investors, has seen net outflows as investors spooked by turbulent markets and/or high fees pulled money from the company's actively managed funds. A further worry is that Schroders' overall net operating revenue margin decreased from 57 basis points in 2011 to 51 basis points in 2015. This was due both to downward pressure on fees and an increasing reliance on institutional clients, who due to their size can negotiate lower fees than retail investors.

How has this affected Schroders' bottom line? Pre-tax profits did fall from £438.9m to £436.2m year-on-year in the first nine months of 2016, but this could have been much worse if the company hadn't increased its fee base by drawing in significant institutional funds.

However, the fees asset managers charge clients are unlikely to halt their downward spiral any time soon, so if Schroders is going to thrive in the coming decades it will need to continue diversifying its asset base and moving into new markets such as the US at faster clip than fees fall.

Unfortunately Schroder's smaller competitor Jupiter doesn't break out AuM by client type, but it doesn't hide the fact that small investors remain its bread and butter clients. Yet, as we see in the chart below, Jupiter has so far escaped the problems Schroders has with these investors pulling their money from funds.

Annual results through December 31

This dependence on retail investors is something of a double-edged sword for Jupiter. On one hand they offer quite high margins, with overall net management fees averaging 87.6 basis points in the first half of 2016. This figure will reduce in the coming years as Jupiter shifts towards lower fee products such as bond funds and targets more institutional clients, but it's still quite impressive.

On the other hand, there's always the risk that Jupiter's expensive funds will one day lose their lustre for retail investors. This has already happened to many other fund managers, particularly in the US, and if it happens to Jupiter, expect fees to come down in a bid to retain customers. Well run and profitable asset managers such as Jupiter and Schroders aren't likely to go the way of the dodo soon, but that doesn't mean passive investing and lower fees won't take their toll eventually.

Asset managers are still highly profitable but the relentless downward pressure on fees and the cyclical nature of the industry don't make those shares the kind you buy and hold forever. If long term is what you're thinking, I recommend checking out the defensive giants profiled in the Motley Fool's free report, Five Shares To Retire On.

Each of these shares has handily outperformed the FTSE 100 for years due to wide moats to entry, incredible pricing power and ever-increasing dividends.

To discover these market-trouncing companies for yourself, simply follow this link for your free, no obligation copy of the report.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.