Ronald O'Hanley set for 'more difficult job' at State Street Global Advisors

Big challenges await Ronald O'Hanley as the incoming chief executive of State Street Global Advisors, the $2.45tn asset management arm of State Street.

Mr O'Hanley, a former head of asset management at Fidelity Investments, is set to succeed Scott Powers, who is retiring later this year after leading SSgA since 2008.

He will take over with SSgA facing tough competition from larger rivals (such as BlackRock and Vanguard) that have invested more aggressively in their exchange traded funds businesses, as well as from banks that are aiming to expand their asset management operations.

Dick Bove, an analyst at Rafferty Capital Markets in New York, says Mr O'Hanley will face "a more difficult job" than his predecessors.

"Every major bank operating in North America, including the Canadians and the Swiss, is charging into asset management and wealth management. Competitive pressures are far greater than before," says Mr Bove.

He notes that asset managers are being forced to change their pricing for large clients, which are demanding lower charges, so revenue streams are likely to be under more pressure.

SSgA played a vital role in the early years of the ETF industry, launching the first such US vehicle in 1993. It was the world's largest ETF manager until 2003 when it was overtaken by iShares, then owned by Barclays Global Investors.

This January, SSgA surrendered its second-spot ranking (in terms of assets under management) to Vanguard, which has cut its fees repeatedly and enhanced its reputation as a low-cost provider among the retail investors and financial advisers who have been turning to ETFs in growing numbers.

"SSgA was the first mover into ETFs, which provided a competitive advantage. But this position was easy for rivals to attack as its ETF range was straightforward to replicate and vulnerable to price competition," says Brennan Hawken, an analyst at UBS in New York.

SSgA's ETF assets stood at $457.4bn at the end of March. But asset growth in recent years has been handicapped by substantial redemptions from the SPDR Gold Trust (at one time the world's second-largest ETF) and the large fall in the gold price since its peak in 2011.

The position of SSgA's most famous product, the SPDR S&P 500 ETF, as the world's largest such fund was threatened by competing products from BlackRock and Vanguard.

For several years, ETF providers on both sides of the Atlantic have been engaged in a price war, using fee cuts to win investor loyalty. SSgA has only joined this fight belatedly. Fee cuts for 41 listed US ETFs were announced in February following reductions in charges in its European range in 2014.

BlackRock and Vanguard, which moved earlier to reduce fees, have attracted higher annual inflows into their ETF operations than SSgA since 2010.

Observers say there are issues beyond ETF price competition for Mr O'Hanley to address.

Luke Montgomery, an analyst at Bernstein Research, says: "Despite being a pioneer in the ETF business, historically SSgA has underinvested in its ETF platform."

Deborah Fuhr, co-founder of ETFGI, a consultancy, says SSgA has fewer dedicated ETF staff outside the US than its main competitors.

"If they had more dedicated people selling ETFs, then they would be able to compete more effectively," says Ms Fuhr, emphasising that SSgA is a global provider, unlike some of the other US-based managers.

"But the question [for Mr O'Hanley] is what is the right organisational structure, product strategy [and] staffing levels to maximise ETF sales in different regions," says Ms Fuhr.

Although its SPDR brand is recognised among ETF investors worldwide, Ms Fuhr says SSgA has lacked a focus in Asia, where its team is relatively small. It has also neglected to build a presence in Latin America, where there are numerous regulatory changes benefiting ETFs that it should be able to take advantage of.

Mr Hawken says SSgA's ETF operations have scale, but it needs to be more innovative.

"A key challenge is to come up with more innovative products that are more resistant to fee compression," he says, applauding the launch in February of an actively managed bond ETF that resulted from a new partnership between SSgA and Doubleline Capital, a US hedge fund manager. Mr O'Hanley has already said that developing more fixed income ETFs will be a priority.

Another challenge will be to improve SSgA's profitability. Mr Montgomery says this has been "lower and more volatile" than that of its peers even though profit margins for institutional indexing and ETFs can be among the highest in the asset management industry, approaching 70 per cent or more for large-scale providers.

There is no simple explanation for SSgA's low profitability as it is unclear how operating costs are allocated between State's Street's main custody business and the asset management operations, says Mr Montgomery.

However, SSgA is among the few large fund companies that manage most of their client assets in index-based or cash strategies. Many of these index-based strategies are highly commoditised and easily replicated, which means competition on pricing is one of the few ways to distinguish itself from rivals.

It is unclear whether SSgA's massive scale in these strategies will be enough to offset these commodity pricing pressures and generate a competitive operating margin, says Mr Montgomery.

Mr Bove echoes these comments, saying that SSgA should "strive for more scale" while aiming to reduce its operating costs, a challenge given that personnel costs are likely to rise.

In 2011, Trian, the hedge fund house led by Nelson Peltz, published a white paper calling for a reorganisation and restructuring of State Street that included a sale of SSgA.

Trian's intervention pushed State Street into making substantial cost savings and staffing reductions with almost 2,900 jobs lost.

Observers say it is unclear whether Trian's objective was to force State Street to sell SSgA or simply to drive an improvement in profit margins and a re-rating of the Boston-based bank's share price.

Mr Bove says he believes that it is unlikely that the question of State Street selling SSgA will resurface as there are valuable synergies between its asset servicing and asset management operations.

"The costs of running both [the asset servicing and asset management] businesses would rise in the event of the sale of SSgA so I think it is not a realistic option," said Mr Bove.

Mr Montgomery echoes this view. "Could another player do a better job of running SSgA? I'm not convinced," he says.

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