Keeping pace as Europe’s asset management industry faces potential headwinds
The asset management industry has benefited from years of “tailwinds.” The background climate has been good, with the long-term decline in interest rates helping to fuel the longest bull run in history, initiated by helpful demographics, and the growth of private pension funds. Increasing sophistication of consumer investment choices created margin expansion opportunities, and in the past ten years—even in years of subpar performance—net new money continued to flow in. According to McKinsey Performance Lens data, by the end of 2018, assets under management (AUM) were only slightly lower than 2017, at €80 trillion, and the profit pool remained constant at €84 billion.
The leaders of the asset management industry have also enjoyed some schadenfreude by comparing their own fortunes to those of their peers elsewhere in financial services. As a less capital-intensive industry, in 2018 asset managers enjoyed much higher returns on equity—22.3 percent globally compared to 13.1 percent for insurance, and just 9.7 percent for banking in general.[1]They also have been far less affected by regulation. The number of large regulatory initiatives was three times less than the rest of the financial sector. Fines levied by regulators were also considerably lower—less than €5 billion in the last decade globally, compared to the €350 billion paid by banks.[2]
However, there are signs that these tailwinds are abating. Some industry observers expect asset returns to come under pressure, and outperformance to become more elusive. The average net return of 12,000 European retail mutual funds over the three years to the first quarter of 2019 was 4.99 percent (versus 5.04 percent for passive funds). This at a time when increased scrutiny means there is more focus on what is left to investors after fees. This scrutiny also implies that the industry is under pressure to take its governance responsibilities seriously, devoting resources accordingly.
At the same time, competition is increasing in a crowded landscape. Looking at European asset managers with AUM above €10 billion, the number of firms has increased 30 percent. In the last ten years, mid-segment players (those with assets of between €10 and €200 billion euros) have been struggling; indeed their average growth rate is below market, and driven mainly by mergers and acquisitions. Although the overall asset pool has continued to grow, European asset management has become a “zero sum game,” compared to other industries, with individual players growing only by stealing from others. This has led to large swings in assets under management for more than half the players.
Having said this, it could be argued that the opportunities for the industry are the best they have ever been. Asset managers have 26 percent of financial assets, but only 7 percent of the revenues. Since 2014, they have also given a better return on that portion of financial assets they manage, than that achieved by the rest. This is true for both institutional and retail. And yet their share of wallet has remained constant in institutional assets, and drifted down in retail assets.
The opportunity is real, and Europe’s asset managers should aspire for more. We believe there are three key ways for them to unlock value: better management of core businesses; redrawing the boundaries on distribution; and competing outside the asset management ecosystem. All three levers can make a significant impact.
Better management of core businesses calls for a more scientific approach to managing the bottom line. It is astonishing that almost half of European asset management firms still have cost-income ratios that are above 65 percent—a minimum target for firms to be ready to absorb a market downturn. It also means product innovation. For example, ESG investments are a fast growth area, now representing 11 percent of professionally managed assets, according to the McKinsey Global Institute. Lastly, it means continuing the quest for alpha. The best players have now introduced a more systematic analysis of the success of trades, and are using behavioral science to de-bias investment processes and deliver more sustainable alpha.
Redrawing the boundaries of the asset management industry on distribution can involve relatively simple measures. Partnering with new distributors such as private banks to do more advisory work. Investing in partners’ sales forces, and ratcheting up marketing and skills training. Or it can be bolder. Finally embracing direct sales—insurance companies have led the way here in the last ten years, and their losses to “cannibalization” have been encouragingly low (less than three percent).
The most successful asset managers will also compete outside the traditional asset management ecosystem, capitalizing on their capabilities, and on their client “footprint,” and leveraging these with the use of new technology. This might mean expanding into new areas like credit, or becoming a market maker now that EU banks are exiting this space. It could mean becoming a technology provider like BlackRock and Amundi Services or considering a deal similar to State Street’s acquisition of Charles River. Looking at the recent investment multiples applied to these businesses, the opportunity speaks for itself.
The future for the asset management industry is full of potential—and opportunities for boosts in profitability. To take advantage, industry leaders should think now about strengthening their core, and expanding into non-traditional areas.
The authors would like to acknowledge the contributions of Achim Schlitter, Violet Lentz, and Lionel Jongman to this article.
[1] McKinsey Corporate Performance Analysis Tool; Capital IQ.
[2] ORX.