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.