McKinsey: Asset Management’s Problems Are Here to Stay

As asset management firms get cleared away by another 20 years of dim business prospects and pricing pressures, only the best fund shops will survive, the consulting firm says.

Jason Alden/Bloomberg

Jason Alden/Bloomberg

The future of the asset management industry is bleak – but the top asset managers still have room to grow, according to McKinsey & Co.

In a new report, the consultanting firm warned that aging demographics, paltry returns, and the cost pressures of passive investments will weigh on the industry for the next 20 years. It’s a reversal of fortune for an industry that has had easy growth since the 1980s as new capital flooded in and markets delivered double-digit returns that boosted managers’ bottom lines.

“This year and last year were the first years where markets went up and profit margins went down,” said Ju-Hon Kwek, a partner at McKinsey and one of report’s the lead authors.

But according to the consultants, the best asset managers have an opportunity to increase their market share as these challenges force more mediocre players to close up shop or get acquired.

[II Deep Dive: Report: Asset Managers Face a New Threat]

The report details a widening gap between the best asset managers and the worst when it comes to profitability, with the difference now amounting to 42 percentage points, up from 36 three years ago. Meanwhile, operating profit for the industry as a whole dropped for the second year in a row, with profit margins at 30 percent in 2016, down from 31 percent in 2015.

“The pace of change is relatively unprecedented,” said Onur Erzan, a senior partner at McKinsey and one of the report’s lead authors. “The difference between the top performers and the bottom quartiles has never been this wide. Passive has the highest penetration ever, and the industry has the lowest realized revenues as a percentage of assets globally.”

While there continued to be downward pressure on price tags, passive funds were the main target. Between 2013 and 2016, revenue margins for all funds declined by 5 percent, but margins for passive equity funds and passive fixed-income products fell by 14 percent and 27 percent, respectively. Meanwhile, core equity revenue margins increased by 3 percent and specialty fixed-income margins grew by 15 percent.

According to the report, there were more funds closed or merged than launched last year. In addition, McKinsey expected further consolidation among fund companies to come, though it said transactions won’t necessarily be driven by scale. Instead, small, medium-size, and large asset managers will purchase rivals that offer specific skills, such as investing in alternatives.

McKinsey said the asset management squeeze is being driven by fundamental changes in how individuals and institutions invest, including the increasing popularity of factor-based funds and risk-based asset allocation.

“We’re increasingly living in a world where alpha is incredibly scarce, making the industry even more competitive,” Kewek said. “In that world, the bar gets higher, particularly for active managers.”