As recently as the period between 2011 and 2013, four in 10 of asset management firms were able to grow profitably. That’s becoming tougher in an environment of fee compression and widespread passive investing.
An industry study released Monday by Casey Quirk, a Deloitte Consulting practice, and McLagan, a unit of Aon, showed that between 2014 and 2017, only 25% of the asset management firms studied had found a way to invest in their businesses while increasing profits.
In contrast, 44% were investing in their firms but not seeing returns, and 31% were simply cutting costs and contracting.
Although revenue and profit growth are still highly correlated, increasing revenues no longer guarantee that profits will march in step, according to the study.
The study comprised 95 investment management firms headquartered in North America, Europe and Asia/Pacific, investing more than $35 trillion for institutions and individuals. The research included data from eVestment and Morningstar in addition to Casey Quirk and McLagan’s own analysis.
Profitable asset managers in the study increased median margins to 35% over the past three years, compared with their competitors’ 31%. Not only that, but the best-positioned asset managers also were often able to charge a fee premium that their competitors could not.
For example, firms that were able to increase margins and reinvest in their businesses typically commanded a 19% fee premium versus their competitors. Managers not in this group all experienced below-median fees for their products, between -2% and -7%, depending on their investment strategy.
In a statement, Casey Quirk said the asset management industry would continue to see winning firms that grow profitably and those that will lose out by only increasing revenues and not profits or by experiencing revenue contraction.
The study found that asset managers with a lower cost structure and higher efficiency per employee and that more sharply focus their efforts on in-demand investment strategies have experienced a 4.6% organic growth rate over the last three years.
In contrast, firms that have deliberately drawn down margins in order to fund reinvestment efforts have not seen any organic growth over the same timeframe. And firms that have cut costs without investing in their businesses have suffered a 2.7% decline in growth.
The study said it behooved investment management firms to carefully consider where to focus and where to invest in areas such as these:
- Accelerating investments in technology
- Prioritizing investment strategies that legitimately earn a premium fee
- Modernizing distribution by centralizing sales and compensation processes
- Investing in products that promise future growth and minimizing exposure to stagnant, legacy products
- Spending more on marketing and brand-building
- Outsourcing noncore services, such as middle- and back-office functions
Significant investments in technology can bolster many areas of the investment management business, according to the study. It found that firms that spent heavily on strategic technology to support their investment teams since 2014 had a 44% increase in profits per employee.
In addition, asset managers that invested in technology to support their sales operation during the same time period had a 40% increase in productivity per salesperson.
“Tomorrow’s successful asset managers must be nimble, willing to invest in strategically significant areas of their businesses, like technology, and outsource those skills that are not part of their core competencies, such as middle- and back-office functions,” Amanda Walters, senior manager at Casey Quirk, said in the statement.
“Coming off a healthy year for the industry in 2017, firms must reinvest some of their income if they want to transform.”
Adam Barnett, a partner at McLagan, said in the statement that winning asset managers would continue to focus on how they compensate top executives and portfolio managers.
“Their incentive plans will need to provide optimal alignment across all stakeholder groups and their broader talent management systems must deliver a compelling employee value proposition,” Barnett said.
Casey Quirk previously reported that assets under management for publicly traded firms in the study grew by 16% in 2017 to $16 trillion, while organic growth from net flows remained low at 3.4%. Their operating margins rose to 31%, up from 29% in 2016, but these factors were largely driven by capital markets appreciation.
A market downturn could significantly alter these characteristics, Casey Quirk said. The addition of private firm data does not meaningfully change the outcomes.
— Check out Why Vanguard’s Not the Only Threat to Active Managers on ThinkAdvisor.