Although North America’s asset-management industry may be thriving, firms in that industry must prepare to transform themselves into focused, data-driven fiduciaries to prosper in the years ahead, argues a report published in late November by global consulting firm McKinsey & Co.
Specifically, North American asset-management firms are facing a “once in a generation opportunity” to position themselves for sustainable success over the next few years, the report suggests. This chance for transformation will arise, the report says, because certain key drivers – including product innovation, distribution, technology and regulation – are at an “inflection point” that will present both challenges and opportunities for asset managers.
North America’s asset-management industry, on its face, looks to be in fine health. Assets under management (AUM), revenue and profits are at record highs, the report states. Furthermore, AUM growth from 2009 through to 2014 was double the rate seen in the previous five years.
This growth is evident in Canada’s mutual fund industry, which has enjoyed robust growth in the years since the global financial crisis. Data from the Investment Funds Institute of Canada show that mutual fund AUM topped $1.2 trillion in October, up from less than $600 billion in 2008.
However, the McKinsey report points out, about 84% of the industry’s recent growth in AUM is due to strong market performance. Only 16% of the gain in AUM represents net new assets flowing into the industry, the report says, suggesting that these growth rates may not be sustainable.
Although strong markets have been driving the recent headline growth, the McKinsey report says, asset managers also are quietly undergoing a fundamental transformation: “Beyond the positive momentum of the markets, a set of secular shifts have been gradually, but definitively, changing the texture of the industry and creating new opportunities.”
Projecting five years into the future, the report adds, successful asset-management firms “will have reinvented their distribution models,” utilizing data and technology to transform both their investment processes and distribution. The report also suggests that successful firms will focus their businesses on certain core areas and abandon others, as well as embrace regulatory change.
One of the underlying trends driving the change in the asset-management industry is a shift toward passive investment strategies and away from traditional active management. The report notes that passive strategies have generated overall net new flows since 2009 that amount to more than 100% of total industry net flows.
Yet, passive investment strategies have only added 3% to overall industry revenue, the report points out: “This fact raises a deeper concern about the potential for passive products to commoditize the market and exert downward pressure on pricing across the board.”
The shift to passive strategies is coming largely at the expense of “plain vanilla” active management, such as closet indexers, the report indicates. More exotic, specialized asset categories have seen their margins hold up.
“Strategies that lack differentiation are a magnet for passive disintermediation,” the report warns. “It is not so much individual asset classes that are susceptible to displacement, but rather individual asset managers who fail to differentiate themselves from the benchmark.”
Moreover, this shift toward more passive strategies reflects rising pressure for asset managers to demonstrate they’re creating value, the report says: “Perhaps the most salient implication of the surge of passives has been an increased demand for transparency into the true returns and value-add of strategies.”
Distribution is another area in which the asset-management industry is facing fundamental transformation, particularly with the rise of “robo-advisors.” At the same time, the report says, the ever-growing volume of data, increasing computing power and enhanced analytics represent an opportunity for asset managers to use technology to gain a competitive edge in both investment management and distribution.
For example, on the investment side, firms can analyze social media traffic to create new inputs for their portfolio managers. Furthermore, the report adds, leading asset-managers also could use technology to improve distribution “by translating data on financial advisor behavior to precisely target on-the-ground retail distribution forces.”
Regulation is the other big force likely to drive change over the next several years, the report suggests, noting that the next wave of global regulation “is on the horizon.”
Although the details of these new rules and their timing are uncertain, the trend is toward increasing accountability of the asset-management industry and its responsibility to its retail clients.
The report suggests regulators will focus on pricing transparency, distributor incentive structures and fiduciary standards for advisors. These reforms have been adopted in the U.K. and Australia, and are under consideration in the U.S. and Canada.
In the U.S., the Department of Labor and the U.S. Securities and Exchange Commission are working on proposals that would introduce new fiduciary duties for investment advice.
Meanwhile, the Canadian Securities Administrators intends to make a policy decision on whether to intervene with mutual fund fee structures and/or to impose a “best interests” duty on advisors in 2016.
The McKinsey report warns: “If [new regulations are] enacted in their most stringent forms, [they] could have far-reaching effects.[Asset managers…] will need to step up their regulatory approach significantly. This means going beyond a reactive, compliance-driven approach to rethinking business models and product lineups. “
To be successful in the future, “asset managers will need to rethink their business models and product lineups”
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