Asset Management’s Gatekeepers Grow More Powerful

The growing influence of distributors and intermediaries is forcing managers to make concessions — and harking back to an earlier era for the industry.

Illustration by Jeremy Leung/II

Illustration by Jeremy Leung/II

Asset managers are fighting to keep control over their relationships with investors amid what consulting firm McKinsey describes as “a power shift in favor of distributors and intermediaries.”

The firm’s 2019 report on the North American asset management industry depicts an industry in which gatekeepers like advisors and outsourced chief investment officers have taken on more influence. Advisors are increasingly being relied on by retail investors for model portfolios, while institutions are outsourcing or employing larger in-house asset allocation teams, according to McKinsey. This bigger role for gatekeepers has empowered them to force concessions from asset managers on everything from transparency to fees.

“I think it’s less of a power struggle, but rather it’s a race to the client,” McKinsey partner Ju-Hon Kwek said in an interview. “From a client’s perspective, the need for advice has never been greater, whether it’s a U.S. pension system trying to meet obligations in a falling rate environment or a small foundation questioning whether a classic 60-40 portfolio will provide the right outcome.”

The question comes down to who provides the most unique service to the client, Kwek explained. “There’s also the realization that the source of value for clients is at the portfolio level rather than the product,” he said. “I can be the best equity manager on the planet, but if I’m one of ten managers in a client’s 30 percent equity allocation, then I’m not moving the needle much.”

The shift toward intermediaries has a few implications for asset managers, who end playing a smaller role, according to Kwek.

“Number one, somebody else controls the philosophy of how to manage the portfolio,” he said. “You’re just a product provider.” Plus, when large intermediaries are making decisions for hundreds or thousands of investors, they’re buying in bulk. “So the bar for performance and pricing rises,” he said.

[II Deep Dive: McKinsey: Asset Management’s Problems Are Here to Stay]

The McKinsey report also acknowledged how continued pressure on fees has led to introduction of zero-fee funds. But the “real story,” the report said, is the underlying business models which support these loss-leader products. According to McKinsey, the industry is getting more vertically integrated — jargon for one firm providing a broad range of products. In the 1980s and ‘90s, vertical integration occurred as large firms sold their own products through their own distributors, but that broke down amid criticism of the conflicts of interest, and distribution and manufacturing were largely separated.

Now it may be coming back, albeit in a different form, according to the report.

“With zero fee funds everyone said it’s a price war,” Kwek said. “But we said no, it’s shift in the business model and the rise of vertically integrated players who can use pricing as a strategic lever for customer acquisition.” He explained that firms offering zero-fee funds, for example, can make up the revenue loss at the portfolio level, with cash management, or by offering other banking services. “It’s a ‘re-verticalization,’ a reintegration of some of these models,” he said.

What’s happening in the industry now is different from 15 years ago, according to Kwek. The investment environment is far more complex, asset managers offer low-cost index funds, and technology allows firms to do mass customization, or essentially tailor portfolios for large groups of investors.

“In the last generation of vertical integration you didn’t have cheap building blocks like passive,” Kwek said. “There is a next generation of vertically integrated firm that is emerging that avoids some of the conflicts of the old model, like putting expensive active funds in. Here you’re saying, ‘Build a portfolio of low-cost passive funds, and do that in a scalable way.”

McKinsey’s report also covered fee declines, which reached a record high in 2018. The consultant said the average fall in management fee rates over the last five years is now between 6 percent and 9 percent. Increased demand for separately managed accounts, model portfolios, and sub-advisory mandates “created additional structural sources of pressure” on fees, according to the report.

The market is waking up to the pressures on managers. Last year stock prices of publicly traded asset managers fell to what McKinsey said are historical lows in both absolute and relative terms, with managers trading around 10 to 12 times earnings. Over the past ten years, according to McKinsey, asset managers have traded at valuations of 14 to 18 times earnings.

These valuation pressures highlight the need by asset managers to confront old business models, according to McKinsey.

“Quite simply, the industry failed to take advantage of the ‘seven years of plenty’ that followed the global financial crisis to restructure itself for the needs of the market and to redefine its narrative of growth in favor of new markets and new sets of client needs,” the report concluded.