Asset managers: The profitability time bomb
How are asset managers responding to an environment with rising costs and fee pressures?
The revolution of the asset and wealth management (AWM) industry is gaining pace. On the back of a favourable global economic environment, assets under management (AUM) have been increasing, driving revenue growth across the sector despite fee rates being under pressure. And while costs have also been growing they have not – at least until now – done so at the same rate as revenues.
To date, the expected rise in cost base has been partially offset by economies of scale and the adoption of new technologies (although this has been at a fairly slow pace). However, as investor and regulatory pressures build and companies are required to invest in infrastructure and talent, costs are likely to begin creeping up.
Against this backdrop, asset and wealth managers are experiencing significant pressure on profitability in certain regions of the world, with other regions expected to feel the impact in the years ahead. Managers are also dealing with unparalleled challenges and opportunities presented by intense fee pressure, product innovation (especially across the alternative assets spectrum), the continuing realignment of existing distribution channels, and the development of new ones.
AUM has increased faster than revenues, and managers have been feeling sustained pressure on their fees. Passives are dominating the price war with actives (and attracting assets), but active managers are striking back by reducing fees and creating new, more innovative, fee models. Despite the challenges, there are also extraordinary opportunities for talented, focused strategic managers to thrive.
The increase in AUM – which has, in turn, helped fuel revenue growth – has been driven by consistently high-performing markets and managers, new wealth from emerging markets, the growth of alternative investment strategies and positive net inflows. However, firms have not been able to consistently boost profits. Although AUM is set to grow, pressure on profitability will intensify, too. Managers who have not yet made drastic changes to their operating models will need to do so to win, or even to survive, especially if there is a sustained downturn in markets.
According to an analysis by PwC’s Global AWM Research Centre on the annual reports of 64 asset managers covering more than $40trn (€35trn) in AUM, the overall ratio of revenues to AUM declined by 9.81% between 2012 and 2017. At the same time, the average ratio of costs to AUM decreased by 15.36%, largely as volume-per-unit costs decreased because of growing AUM. This has resulted in an increase of 15.91% in average operating margins.
However, it is important to note that not all managers have experienced this rate of increase. The gains have been limited to some large managers and a broader number of niche managers. This is proof that in the coming years, only those that truly embrace a transformation agenda and create value for investors will be successful.
Fees are likely to continue to decline in coming years. This trend will be influenced by the continued rise of passives and newer low-fee products like smart beta, increased investor and regulatory scrutiny of the value for money that managers provide, and new fee models in the active space that focus on performance. In addition, we see fees across the alternative asset classes holding up and many AWMs are seeking to grow their alternative asset class offering.
“Managers who have not yet made drastic changes to their operating models will need to do so to win, or even to survive”
We have identified four foundations on which managers can build a target operating model to protect or even improve profitability:
• Articulating value for money
Investors and regulators are increasingly aligned in their views that the AWM industry should provide value for money. Transparency and investor knowledge are on an upward trend, bolstered by regulatory regime advancements. This will push managers to articulate value on the upside while also lowering costs and managing fee pressure to deliver more for less, making it imperative that managers are able to effectively articulate their value proposition.
It is remarkable that standard fee models have survived for so long. In response to price pressure, we have already seen active market leaders implementing outcome-based fee structures and expect such innovation to become more prevalent. Passive players, already beginning to feel the pressure on already-low fees, are beginning to innovate by moving into new areas, such as smart beta and active ETFs.
Although funds with lower fees will continue to draw investors, price is not always the most important factor. Managers able to provide consistently above-average returns can charge higher fees. Those that can provide new value or services will be on the track to success.
• Strategic positioning – what is the plan?
Regulatory and compliance burdens are driving up costs at the same time as investor and regulatory scrutiny is forcing fees lower. Managers need to ensure that investment products and related services are continuously updated to align with investors’ wants and needs, which forces firms to refocus on strategic positioning. In the future, we will see hugely increased investor and regulator interest in the environmental, social and governance (ESG) output from an investment strategy. Responding to this will be a key factor for success for AWMs.
Managers must decide whether they will operate as scale or niche players. Large players are getting larger, increasing their already substantial AUM, benefiting from efficiencies of scale and expanding operations but they have legacy systems, costs and overheads to contend with. Whilst organic growth will still be best for most of the largest managers, we have already seen M&A activity pick up since 2017 and we believe it will accelerate with a wave of consolidations, particularly across the alternative and ESG sectors.
At the same time, niche managers are shoring up their expertise to differentiate their offering and client base. In the coming years, we believe mid-sized firms that don’t have a specific niche will find it difficult to operate efficiently and will need to either move to a niche, join a larger platform or gain scale to survive. Either choice means changing certain things about the business – by determining the product range, target markets and distribution channels – and striving for operational excellence.
Many firms will struggle in the coming low fee/lower profitability environment, and those without a clear strategic positioning plan will be more likely to fail.
• Transform through technology or be eliminated
Advances such as artificial intelligence, blockchain, machine learning, data harvesting and processing, and robotic process automation have begun to drive real change both for AWMs and the service industries that support them. There is clear potential for these technologies to create efficiencies, speed up processes, deliver accuracy and avoid human error, undertake repetitive processes and cut costs.
Furthermore, those who make use of new technologies will be able to implement more advanced data investment strategies and bolster risk analysis and decision-making. Managers using such advanced strategies will be able to make better investment decisions and provide higher returns to their investors, thereby ensuring higher fees.
By using technology to provide value-added services to clients, players can differentiate themselves from their competitors and justify premium fees. Leading firms, from small to mega, have proven nimble. By leveraging data, analytics and various forms of AI, they are improving processes and streamlining capabilities across their firms. Those that fail to do so will fall behind.
• Fight the battle for talent
Firms need tech-savvy talent in a broadening array of positions, and younger workers increasingly want to work for companies that reflect their values, challenge them, and offer both work and life opportunities. Without good talent, you cannot transform or build for the future.
The AWM industry has long been considered male, traditional and hierarchical. As managers look to attract, train and develop talent, they will need to change both the public perception of the industry and their way of doing business. Managers need to think about themselves as technology companies that deliver a service, and to build a culture that will resonate with and attract the future workforce.
Managers will also need to replace siloed working groups, upskill their current talent and transform towards integrated, multi-skilled teams. These changes will come with costs but also will produce value in the long run.
Despite the industry’s increasing pressures on profitability, asset and wealth managers who can successfully focus on these foundations to service their clients, grow new business lines and push efficiencies while balancing costs, can look forward to a future that will look very different, but just as bright.
Robert Mellor is a partner at PwC