It used to be that asset managers, primarily trust company advisors, constructed portfolios for somewhat higher-net-worth clients – those who could afford to divert some savings from their bank accounts. Stocks were for speculators, at least the ones that didn’t pay regular dividends.
But those asset managers also attracted savings from pension funds, as fiduciaries. Then came a loosening of the regulations, regarding what a trusted person could do with other people’s money. There was no lessening of trust, merely a wider investment universe.
So asset management moved from a known universe – a comfortable world of bonds and mortgages and dividend paying stocks with calculable maturities even if default rates were unknown – to something else: risk-adjusted performance, tracking errors, excess returns over a benchmark.
The evolution continues, new measures, new risks. But where are the new opportunities for investment firms that have built out their portfolio and trading capabilities? A report by McKinsey & Co. suggests a limited range of possibilities for the 110 U.S. asset management companies it benchmarks.
The reasons are manifold. There are growing regulations; there are declining channels to distribute products; there are also fewer profits to be made. So where to turn? The McKinsey study suggests: “retirement, international, sovereign wealth, exchange-traded funds (ETFs) and alternatives.”
But there’s a long path to get there. First, there’s the overcoming of 2007-2009 meltdown. “While almost all firms faced steep declines in assets and revenues, a group of ‘Decisive Operators ‘ (20% of firms surveyed), whose revenues declined by more than a third since 2007, chose not to waste a good crisis. They seized the opportunity to restructure their operating models, cutting costs by 35 to 40% over the last two years. To achieve such dramatic reductions, these firms pulled many of the levers we described in our 2009 report, Recovering From the Storm: exiting unprofitable investment strategies and teams, sometimes even entire asset classes, as part of strategic repositioning; redesigning compensation models; restructuring sales and marketing; and embarking on the lean redesign of middle back-office processes and consolidated enterprise support operating platforms.”
That’s not true of everyone, and overall costs have increased slightly, despite falling assets under management. A significant number of firms are in denial, McKinsey says: they saw profits fall less dramatically, but they also witnessed modest cuts in costs – around 5%.
Intriguingly, the price gap between institutional and retail management is compressing – from 26% to 10%. However, McKinsey reports, “Most retail managers, however, have not fully internalized the implications of supporting large and expensive retail sales and marketing groups at increasingly institutional prices.” And institutional prices have fallen because investors flocked to fixed income during the financial crisis. Still, “[t]he long-term pricing and yield trend here is mixed: investors will continue to shift to lower-fee fixed-income products, largely as a result of liability-driven investing and passive investments; at the same time, however, we expect institutional appetite for higher-fee alternatives to recover.”
Over the next three years, asset growth is expected to be at just over half its long-term average of 11% a year. And most firms are not investing in the “growth pockets” but concentrating on their existing business.
“Given that the majority of future capital formation is expected to occur outside the U.S., all asset managers need to decide if they will participate directly in international and emerging markets or remain ‘U.S. specialists,’ McKinsey writes. That’s one challenge. Another is how to position themselves in the DC marketplace: going after big plan sponsors or mid-level plans, and whether to focus retirement income solutions.
In addition, sovereign wealth funds are slated to become the biggest source of institutional assets. However, “most asset management firms are still finding their feet, and treating SWFs as a ‘hobby’ rather than making a true strategic commitment.”
ETFs are also seeing strong growth; however five firms have a lock on the market with 90% of the assets. “Given the daunting competitive barriers in the passive part of the market, many firms are looking at active ETFs as a potential game-changer,” McKinsey says, but is dubious about their short-term prospects. It could take over a decade to develop that market.
Finally, alternative assets are set for a rebound. “However, institutions now expect their biggest increases in allocations will be to ‘real assets,’ including private equity, infrastructure and real estate. Hedge funds will also benefit from a pick-up in demand, as institutional investors look to close their asset/liability gap and seek equity and fixed-income exposure.” While there will be asset growth in alternative investments, the revenue growth is not likely to be what it was in the mid-2000s. Investors are demanding lower costs.
As is true for investors, it is possible to find opportunities in market environment. But McKinsey adds a disclaimer: “The asset management industry routinely warns its clients that past investment performance is no guarantee of future results. While the industry remained resilient through one of the worst financial crises in generations, management teams would be wise to keep this warning in mind for their own business performance.”