By Emma WallisInsight & Content Strategist

The investment sector is facing a profitability crisis.

Continued asset growth may have lulled firms into a false sense of security, yet revenues have not kept pace with AUM[1], so profit margins are shrinking, even for firms reporting net inflows and positive returns.

A quarter of asset management firms risk becoming unprofitable by 2028 unless they dramatically cut costs, grow revenues, or both, according to a white paper from Casey Quirk entitled ‘Industrial Evolution: Securing profitable growth in tomorrow’s asset management industry[2].

In North America, asset managers’ profits fell by almost 4 per cent last year due to fee compression and anaemic net flows, McKinsey reported this month[3].

Globally, 2018 operating margins fell back to levels seen just after the financial crisis[4].

PwC expects price competition, digital innovation and a renewed focus on investment performance to spark further consolidation, wiping out 20 per cent of asset and wealth managers through acquisitions or closures[5].

“Managers who have not yet made drastic changes to their operating models will need to do so to win, or even to survive, especially if there is a sustained downturn in markets,” argues PwC Partner Robert Mellor[6].

Fees are falling across the board, with a race to the bottom for passive strategies, epitomised by Fidelity Investments launching no-fee funds. PwC predicts that active management fees will fall from 0.54 per cent in 2017 to 0.44 per cent in 2025, and that revenues per AUM for traditional long-only managers will decline from 0.40 per cent in 2017 to 0.31 per cent by 2025.

MiFID II disclosure requirements have shone a spotlight on charges, increasing scrutiny and empowering asset owners and fund buyers to negotiate more aggressively.

At the same time, costs are escalating due to regulation and compliance, as well as the requirement to invest in technology and in client service.

All these pressures have been keenly felt by start-up investment boutiques, many of whom are struggling to gather assets and build brand loyalty, according to a report published this month by CFA UK, ‘Start-ups in UK Asset Management: A Study of Barriers to Entry & Success’[7]. Fortune does not favour the brave in asset management, so much as larger well-established managers with distribution networks, long track records, and respected brands.

“It isn’t difficult to start up new investment management businesses, but the fact that this is such a scale and track record dependent business means that many start-ups struggle to grow beyond the entry-and-survival phase to reach sustainable profitability. That’s worrisome,” said Will Goodhart, CEO of CFA UK. “There’s already a high level of concentration in passive management and it appears that we are heading the same way in active.”

Yet with threats and challenges come opportunities: 30 per cent of firms have emerged as clear winners in recent years, enjoying a median of 4.6 per cent organic growth annually between 2014 and 2017, alongside 12 per cent revenue accretion, against cost expansion of 7 per cent annually. Alpha generators, distributors, solutions providers and scale manufacturers have all beaten their competitors.

McKinsey recommends that asset management executives consider taking four categories of actions in their strategy and competitive positioning:

  • Realign resources to the areas experiencing the greatest growth in demand
  • Reinvigorate alpha by improving investment processes through technology, advanced analytics, and data
  • Reinforce distribution efficiency, for instance by forming strategic partnerships; and
  • Re-architect operating models for scale and speed.

The most innovative firms are likely to thrive  ̶  those who can deliver alpha, develop new investment strategies, leverage technology, expand into new distribution markets, and revamp their operating models.

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[1] Global AUM increased by 53.7 per cent between 2012 and 2017, but revenues rose by only 38.5 per cent.

[2] Over a third of managers (almost 35 per cent) saw no organic growth between 2014 and 2017. These firms experienced a median of 7 per cent annual revenue growth, but that was more than offset by annual cost hikes of 8 per cent on average, according to Casey Quirk’s paper: https://www2.deloitte.com/us/en/pages/financial-services/articles/securing-profitable-growth-asset-management-industry.html

[3] North American managers’ AUM edged up nearly 7 per cent on average in 2018 to an aggregate total of $43 trillion. However, the investment industry’s aggregate revenue pool gained just 1 per cent. Profits fell nearly 4 per cent as costs escalated. Net flows for the year were anaemic, and the drop in both equity and bond markets late last year made for a weak Q4 and a challenging start to 2019, McKinsey explained: https://www.mckinsey.com/industries/financial-services/our-insights/beyond-the-rubicon-asset-management-in-an-era-of-unrelenting-change

[4] In 2018, operating margins for global asset managers fell to 29 per cent, down from 31 per cent in 2017, close to 2009 margins of 28 per cent.

[5] https://www.pwc.com/gx/en/asset-management/asset-management-insights/assets/pwc-awm-revolution-pressure-on-profitability.pdf

[6] https://www.ipe.com/reports/special-reports/asset-managers-the-profitability-time-bomb/www.ipe.com/reports/special-reports/asset-managers-the-profitability-time-bomb/10029263.fullarticle

[7] https://www.cfauk.org/media-centre/investment-start-ups-struggle-to-succeed-in-uk-market