With assets under management (AUM) for Europe’s traditional asset managers declining in the first half amid a rise in market volatility, Fitch Ratings sees the potential for industry consolidation to pick up in the months ahead.

Average AUM among European asset managers declined by 2% in the first half, as positive net flows partially offset the negative effects of market turmoil, the rating agency said.

This decline in assets, and negative markets, are threatening to weaken the sector’s profitability and could ultimately help drive industry M&A, Fitch said.

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While it doesn’t see these pressures leading to credit rating downgrades in the short term — as most of the traditional European managers have low leverage, high margins, and large, diverse franchises — smaller, more leveraged or concentrated firms “could face profitability challenges if equity and fixed-income markets remain volatile,” it noted.

As a result, Fitch expects industry consolidation to pick up in the second half of this year and into 2023, as firms “seek to improve their scale and diversification to counteract the difficult market conditions.”

Larger firms can mitigate the pressure on assets by attracting investors to passive products that are increasingly popular with investors, and to alternative strategies “that can command higher fees, with less competition from passive products,” Fitch noted.

At the same time, investment performance will remain paramount, it said.

“Regardless of strategy, performance against peers and competing passive products will be essential. Underperformance could lead to outflows and, ultimately, franchise impairment,” it said.