On the surface, the asset management industry might not seem under pressure. Assets under Management (AuM) have been rising rapidly. PwC predicts global AuM will grow from US$84.9 trillion in 2016 to US$112.2 trillion by 2020, and again to US$145.4 trillion by https://www.forbes.com/sites/forbesfinancecouncil/2018/07/06/how-asset-managers-can-tackle-growing-pains-of-rising-aum/#166ce1977fcd. And most asset managers continue to be profitable.
However, the devil is in the detail. Markets that march ever upwards - and over the last decade most have - boost AuM even as investors exit mutual funds in unparalleled https://www.businessinsider.com/stock-market-mutual-fund-outflows-data-moodys-2018-8 . But markets will not rise forever, as volatility reminds us with increasing frequency. The industry will not be able to count on the same support from asset price growth in the future.
At the same time, asset managers are facing a new reality in which fees are lower and costs are higher. Firms must invest heavily in technology and innovation to remain competitive, while legal and compliance costs have shot up as managers deal with greater regulatory challenges as well as the implications of increasing product complexity.
Meanwhile, fee pressures will only intensify. Like the genie that cannot be returned to the bottle, low-cost index-tracking strategies are here to stay and will continue to grow in number, popularity and sophistication.
Arguably, asset managers should bear some responsibility for their current plight. Their long-standing dominance led to a degree of industry-wide complacency. Managers have not typically excelled at articulating the value of what they do and exactly what clients are paying for. Now that investors have multiple options and greater transparency on price, they will naturally gravitate towards the cheapest alternative if they believe the outcome will be largely the same - even if that is not always the case.
Amid a ‘race to the bottom’ in fees, rising costs, and the spectre of artificial intelligence (AI) encroaching on traditional business models, questions around the future shape of the industry have certain existential undertones. Yet, with around 66 per cent of global financial assets still outside industry management (including bank deposits, individual securities and assets managed internally by institutions) there are opportunities The Best of Times, the Worst of Times. McKinsey&Co, 2017.
Asset managers must be prepared to rethink the way they do business to ensure they continue to meet the varied needs of investors. As the world of investing, and its associated risks, expands in range and complexity, client engagement and service will be more important than ever.
Some managers will seek to mitigate margin pressures through building scale, most obviously through acquisitions. A CFA Institute survey found Investment Firm of the Future, CFA Institute, September 2018 https://futurefirm.cfainstitute.org/overview/ of respondents expected industry consolidation to accelerate in the next 5-10 years. There will be some mega-deals in the coming decade, resulting in a handful of industry giants each boasting over US$1 trillion in assets.
However, bolt-on or capability-driven M&A will be more commonplace. As firms seek to develop their technological infrastructure, offer expertise in areas where demand is growing (such as for quant strategies, alternatives and multi-asset offerings), and build a full-service model, they will cherry-pick businesses, or parts of businesses, that provide the skills and resources they themselves lack.
Not all managers will have the capacity to scale up, or have the characteristics of an attractive acquisition target. They will struggle to stay competitive and profitable, so might be forced to shut up shop altogether.
Partnerships over competition
With or without consolidation, asset managers will have to consider how best to re-structure or evolve their business models in a cost-conscious environment to remain both viable and relevant. Identifying exactly what clients value and will therefore pay for is crucial. Anything outside this will become increasingly commoditised. Some firms will unbundle their services and specialise in certain segments of the supply chain - for example in research, execution, technology, or reporting - and save costs by outsourcing or leasing various other operational functions.
In some instances, companies will forgo competition in favour of partnerships, in which they collaborate with others on specific projects and swap or share functionalities, such as technological infrastructure. This is not without precedent elsewhere. Many technology firms, particularly in the software and AI fields, work like this, with open-source products and co-ordination between otherwise separate companies.
Service at the core
Asset managers which remain focused solely on products will not prosper. At one end of the spectrum technology will remove many of the layers between investors and their assets. Robo-advisors and other wealth-management type services will allow people to take more control of their own portfolios. No one will want to pay for what they believe they can do themselves.
Other large asset owners, intermediaries and sophisticated wholesale clients will become increasingly asset-class agnostic in their search for solutions to specific financial goals, whether it is decumulation in retirement, liability matching, inflation protection, absolute return or something else entirely. Equities, fixed income, alternatives, real assets, quant-driven strategies, active or passive – investors will be increasingly indifferent, as long as their portfolio is designed with a particular objective at its core and can consistently deliver on it at a reasonable cost.
As the universe of investible assets grows in both size and complexity, investors will value firms that provide a one-stop shop, offering advice, education, bespoke solutions, portfolio construction and a suite of product options, as well as ongoing innovation and support. In adopting a full-service model, asset managers will need to develop a more open and consultative approach to fully understand their clients’ needs.
Niche sources of funding which circumvent capital markets, such as peer-to-peer lending and crowd-sourcing, while illiquid and higher risk, could become increasingly acceptable sources of long-term returns in some broader diversified portfolios. Asset managers who are nimble and innovative could find a role for themselves here too, whether by developing access platforms or assembling syndicates of investors.
A client-centric approach
Consolidation, innovation, service-driven business models…these are hardly new ideas. However, they are trends that will accelerate in the coming decade. Some firms are further along in their uptake than others as they grapple with the new normal of lower fees, higher costs and the threat of technology-driven dislocation. There will be some who fail to meet shifting industry standards, as well as opportunities for others who have positioned themselves well.
There will always be those with excess capital to employ and those who need it. However, technology is shrinking the chain of entities between the two. Operationally, it’s possible the chain is removed entirely - in the case of crowd-sourced funding, for example. Meanwhile, investors might not need a ‘middle man’ to provide them with a representative market portfolio when technological advances create increasing opportunities to access securities and indices directly.
More and more, investors will value holistic assistance and education, as well as solutions to their specific financial concerns or objectives. And this is what asset managers should aim to deliver. To do so, they must be prepared to overhaul their business models to keep pace with changing client demands, not just for products, but relationships too.
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