The past 18 months have ushered in a “new abnormal” for the North American asset management industry, in which neither growth nor profitability is a given, according to recent article by analysts at McKinsey & Co.
Several factors are casting a pall over industry players: low returns, lower flows, pricing pressure, performance challenges, a big shift to passive investing, increasing costs and margin compression.
Some bright spots exist, according to the report’s authors: Pooneh Baghai, a senior partner in McKinsey’s New York and Toronto offices; Onur Erzan, a senior partner in the New York office; and Ju-Hon Kwek, a partner in New York.
The difference in profitability between the top- and bottom-quartile managers stands at 42 percentage points. Last year, the top quartile of managers’ revenue grew at a 5% rate, above the industry’s average negative 2% average, and operating margins were at or above historical highs.
The authors note that clients want yield and are open to innovations that cut across asset classes. Shifts in asset allocation are putting massive amounts of money in motion, mediocre performers are falling by the wayside and technology is providing new sources of competitive advantage.
“In short, there is a massive opportunity to gain market share,” they write. “Even in the severely challenged active equities space, top-performing managers are finding ways to thrive.”
According to the article, passive investments in North America have enjoyed massive flows. Passive’s market share grew from 12% in 2010 to 18% in 2016. At the same time, its share of industry revenues held steady at 3%, with growth accompanied by (“and arguably driven by”) aggressive price competition.
The authors say the move away from traditional actively managed assets has been gradual, but is likely to accelerate as investors embrace two trends that are increasingly influence portfolio construction: factor investing and risk-based portfolio construction.
This will result in blurring of the line between active and passive, as smart beta employs both active and passive methods.
Areas of Intense Activity
Traditional active investing has felt pain across nearly every major active equity strategy. The McKinsey analysts say the closing and merging of laggards that accelerated in 2016 will continue, resulting in a smaller, better-performing active industry.
This is already happening. They note that amid active asset outflows, the top performing active funds are enjoying success: for example, 55% of 1,157 fixed income funds had positive flows of some $258 billion last year, and the top 20 funds generated 34% of this total.
In addition, the authors write that their expectations for the rise of alternative investments have been realized, as these have become a $7.5 trillion industry, accounting for some $2.3 trillion of new money over the past five years.
However, a wide performance gap has emerged between the public alternative market — hedge funds — and private alternative markets. A diversified portfolio of hedge funds has underperformed a standard 65% equities / 35% fixed income portfolio every year since 2009, whereas the converse is true of the private markets.
Thanks to the outperformance, private equity funds took in $626 billion globally last year, a high unseen since before the financial crisis. The article says investors increasingly accept the category’s illiquidity as a way to diversify risk exposure and add value, and predicts private market alternatives will continue to attract a big share of investments.
Exchange-traded funds’ growth continues to exceed that of any other major asset class or vehicle. ETFs are not only taking share from active mutual funds, but are also winning new flows into asset management as a whole.
The report notes that between 2007 and 2017, two-thirds of ETF growth (as a share of household financial assets) came from attracting assets once held as individual securities.
Active ETFs and smart beta ones have grown faster than bulk beta, according to the authors, and they expect smart beta in particular to continue to be the focus of competition in coming years as factor investing takes greater hold in the North American market.
The authors predict that ETFs will continue double-digit growth over the next several years, possibly becoming a $6 trillion market by 2021, up from $2.9 trillion in 2016.
The report drew on McKinsey’s ongoing research into the asset management industry, including insights from McKinsey’s 17th Global Asset Management Survey, which gathers benchmarking data from some 300 asset managers — more than 100 from North America, representing $30 trillion, or 80%, of assets under management — as well as McKinsey’s annual Global Growth Cube data, which provides a granular breakdown of historical and forward-looking assets under management, revenue and net flow data.
— Check out ETF Assets Predicted to Surge 73% by 2020: EY Global Report on ThinkAdvisor.