07/08/18

Asset Managers Can No Longer Ride An Easy-Money Boom

 

(Forbes) -- The asset management business may be riding a rising tide of wealth, but this ship could easily founder on reefs hidden just below the surface.

True, financial wealth is on a strong growth trajectory worldwide, and investors everywhere are delegating more decisions to professional managers. Yet the business is less stable than it appears. The easy money boom that began in 2012, marked by low interest rates and economic recovery in many countries, masked deeper trends. Customers have become more cost-conscious, sophisticated about investment strategies, willing to make more stringent comparisons of products and services and less trusting of actively managed products. At the same time, regulations such as the Markets in Financial Instruments Directive in Europe have prompted firms to raise spending on compliance.

These trends have put pressure on profits. Although asset management companies enjoyed an average 7% combined annual growth rate (CAGR) for revenues per asset under management since 2012, their profits per asset under management decreased by a 2% CAGR, Bain & Company estimates. Looking ahead through 2022, our model projects just a 4% CAGR in revenue and the profit pool shrinking even more sharply, at -7% CAGR. That would leave profit margins at just 8.3 basis points, below the trough of 2008.

Stronger firms, we believe, will seize a growing share of the market and the profit pool. Weaker firms, meanwhile, will find it harder to realize their desired price or to keep a lid on costs. We estimate that the gap in profits between the top and bottom 10% of companies will rise from 10 basis points today to 13 points by 2022. That will translate to a roughly €400 million profit difference for a mid-sized manager handling €300 billion in assets. Moreover, the estimated profit pool in 2022 of €81 billion will be no greater than in 2007.

In this less forgiving environment, asset management firms should reassess their strategy. In particular, a collapse of plain-vanilla, smaller or mid-sized firms with no cost or competitive advantage—which we estimate represents about half of assets under management—figures as a highly likely scenario. Captive mid-field players relying on the distribution network of their bank or insurance parent have lost market share and are bound to lose more. Winning firms with a few distinctive characteristics will benefit disproportionally from the shift of assets away from the middle.

The collapse of the middle leaves firms with two viable directions as a means of escape from this “valley of death”.

One route involves going big: Large-scale companies such as BlackRock and Amundi spread their costs over more assets to achieve a stronger economic position. BlackRock, for instance, has taken advantage of the rise of passive assets, becoming the largest provider of exchange-traded funds (ETFs). It has used M&A to acquire selective capabilities such as ETF market entry with its iShares acquisition. Smaller investments in recent years have selectively improved the firm’s technology position and expanded its offerings.

BlackRock also uses technology to help the process of scaling up. It has focused on increased automation in portfolio investment to cut costs, and more efficient product selling via platforms, which are cheaper, faster and more convenient for clients. The firm’s Aladdin risk management software has become a powerful tool for portfolio managers as well as an income generator through licensing to other asset management firms.

Many investors, however, still seek out active management. Amundi, based in France, has mastered three factors crucial for success with this model: M&A, operating model, and distribution. For example, it acquired Pioneer Investments, Europe’s largest asset manager, in 2016, diversifying its customer base toward retail customers and achieving cost synergies of €150 million.

A viable operating model requires a low cost base for continued scalability, supported by outsourcing of non-core, low-value processes. In this regard, Amundi has developed a highly efficient model, with a cost-income ratio of just 52%, compared to 73% for the industry average.

And in distribution, Amundi has recognized the trend of diversification away from captive assets toward open architecture, and now has more than 1,000 third-party distributor partners.

Taking a different route, firms can develop highly differentiated offering that justify the premium fees customers are willing to pay. Three product niches currently stand out as good opportunities: themed multi-asset funds investing in such topics as mobility and clean technology; socially responsible investments; and alternative investments such as hedge funds, infrastructure and real estate. All of these can command higher fees if executed well.

Nordea, for example, has built a strong position based on its attention to products and employees. Its product fall into two lines, active alpha and target return. Increasingly, Nordea has nurtured multi-asset outcome strategies, with predefined targets that outperform market benchmarks. The Nordea 1—Stable Return Fund closed to new investors after €10.5 billion in inflows.

Asset management firms can exploit the power of star managers as long as they take a few steps to manage star risk: Tie compensation to investment or distribution success, or ownership tie-in; and employ supporting managers to ensure continuity. To that end, Nordea 1 Stable Return has been overseen by three star managers since inception, with the risk minimized through a team approach should one manager leave the firm.

Key questions for planning the battle

Whether they choose to pursue the scale or niche route, asset managers will need a clear-eyed view of where they should play and how they will win in future. Questions to plan the battle include these:

 

•           What is the most attractive set of investors and products for us over the next five years?
•           What key factors will likely effect our asset growth?
•           What do our customers say are their highest priorities? Which elements of value matter the most to them?
•           How do they view our performance across these elements?
•           Which capabilities are essential for successfully serving this market and how do we perform on those capabilities?
•           How do we measure up in cost relative to core peers in this market?

 

 

 

 

 

 

With the easy money gone, firms don’t have the luxury of delaying their next moves, as forward-looking competitors have already planned and started to execute their new strategy. Identifying and clearly defining a distinct strategy and focus—what to do and what to stop—will be instrumental to success in this market. For firms that do get it right, the rewards will be highly attractive: an ever-growing share of the world’s expanding wealth.

Matthias Memminger and Mike Kuehnel are partners and Cyrosch Kalateh is a manager with Bain & Company’s Financial Services practice. They are based, respectively in Frankfurt, Frankfurt and Düsseldorf.