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Industry profitability challenges grow: Firms must learn to push against profit headwinds
Asset management firms collectively have achieved consistently high margins and decent growth for many years. But future business conditions in developed markets look much more challenging for both margins and growth, reflecting fee pressures, lower inflows, and clients switching to lower-fee products. Leaders cannot rely on the tailwind conditions of the past and must adapt to headwind conditions.
KEY POINTS
- Asset management firms need to recognize and respond to deteriorating sector fundamentals. Some may simply accept the tougher conditions and lower their profit expectations. We see this narrative as a reasonable outcome for clients. Alternatively, firms can cut costs and try to consolidate. In this narrative, they risk harming their client base.
- The biggest single reason for this deterioration is that asset owners are increasingly fee resistant amid likely lower returns, from which fees are extracted. This trend is extremely disruptive for the industry. As Future State of the Investment Profession describes in the Lower for Longer scenario: “Costs are seen as an unacceptable drag on returns precipitating transitions to lower-cost, higher-tech investment solutions.”
- Top-line global revenues for the asset management industry ($275 billion in 2017, according to Boston Consulting Group 2017 and author calculations) are very likely to drift sideways in the next 5–10 years or to increase only slightly. The Boston Consulting Group report suggests the revenue trends will be derived from gains from market value growth (producing, say, 4% per annum [pa] revenue increases) and low net new flows (say, 2% pa revenue increases) but losses from fee pressure (reduced fees on the same product, say, 3% pa revenue decreases) and fee product drift (movements from products with higher fees to lower fees, say, 1% pa revenue decreases).
- The trends at work in the business models of more-profitable firms are as follows:
- Indexed and factor-based products grow, funded by reduced active core mandates.
- Alternative asset mandates grow, but with capacity constraints.
- Private wealth firms grow faster than asset management firms.
- So, there is little likelihood of resuming the trend of old, whereby revenues climbed comfortably ahead of global GDP (the past 10-year compound annual growth rate in global revenues has been 6% pa, according to Boston Consulting Group 2017). Revenue growth seems more likely to be around 1%–3% a year.
- Costs still rise in a number of areas. Innovation and new products, technology, compliance, and service all demand bigger budgets, and net costs are set to grow in line with recent experience at around 3%–5% pa.
- Net margins look set to be shaved by around 1–2 percentage points annually from the attractive levels of recent years (around 35%–40% of revenues). This margin contraction will emerge in an uneven shape but is potentially transformative.