The asset management industry across the globe is enjoying a successful growth story, bolstered by strong capital markets - but many managers are already feeling the pinch of fee pressures that will only strengthen over time, according to a new international survey.
Though the industry reaped 34% profit margins and global AUM rose 10.5% to $67 trillion in 2014, revenues rose only 6.3% to $319 billion, while fees dropped an average 40 basis points, says Jeffrey A. Levi, partner at management consulting firm Casey Quirk & Associates, which conducted the survey.
Levi discussed the findings with Money Management Executive and shared his observations on the challenges facing an industry grappling with change.
What survey results surprised you?
A lot of the big findings are things we've been talking about and observing over the last couple of years. What was remarkable about the findings in the study was how quickly some of these changes are manifested in themselves throughout the industry.
Please provide some examples.
One is, businesses are looking healthy. Assets are up, revenues are up, margins are expanding, but when you dig into it, the primary driver is capital markets.
It will be really interesting to see how managers continue to maintain their growth in their business investment if and when capital markets stop going up as rapidly as they've been over the last several years.
Second is this push towards new investment capabilities. We've been observing a growth in alternatives and a growth in passive and I think we're really seeing this move accelerate in terms of the transition, and in a really meaningful way.
On the active side of the business, the phrase alternatives doesn't mean much anymore. There are people who are investing because they were good investors; and new active, and it can be in a long only form, it can be in a form where there's hedged capabilities, a form where derivatives are employed, multi-asset, liquid and illiquid; but the core of the view is benchmark agnostic and it's built around generating good returns for good outcomes for investors.
On the other extreme is this desire to buy inexpensive beta. We've seen huge growth in passive and index investing, both in ETFs and non-ETF forms in the last year. I think for the U.S. retail landscape this is one of the areas where we've seen the most pronounced shifts, where last year over 90% of flow went into passive. It was a really dramatic shift.
Those are two fundamental changes, but a third would be the impact of thedecline of institutional broadly, really the decline of defined-benefit. Defined-benefit, which has historically been globally the largest channel in the world for assets, is in the slow bleed given demographic shifts, and a lot of the assets that remain in the space are moving to more immunization or liability-oriented strategies, so there's a lot of outflow.
Conversely there has been a lot of inflow, relatively speaking, into individual-led markets. So, defined contribution, potentially, and then a lot of the more traditional retail intermediated segments.
And a lot of firms are not well-positioned to make that transition, or firms that are in the retail intermediary space are seeing the new wave of competitors come in, which is making it more difficult for them to compete and stay relevant.
These are some of my broad sweeping observations that I think are really changing the dynamics and will likely reshape who is best to win in the future and ultimately who falls out of favor.
What do you think some of the main causes of growing fee pressure?
The fee pressure is being caused by several things. One is commoditization. In a world where there are too many firms trying to do the same thing, the natural response is some firms lower their price and others follow. I think that is one cause.
There is also the separation of people looking at beta as something cheap and inexpensive, and using passive to get access to that inexpensive exposure, which puts pressure on anything that is not truly different from passive. And unfortunately, most of the industry today is kind of benchmark-oriented, semi-beta (kind of closet-beta), semi-active and it kind of gets stuck in the middle and therefore there is fee pressure.
A third factor is that we're in a low interest rate environment in many manager markets and it's a lot harder to justify a high fee when interest rates are close to zero. It's much easier to justify that fee when there's an inherent return on the risk-free rate and so I think investors are taking more notice of fees and pushing them down.
I'd say a couple other factors I think we're seeing - with rising asset level comes rising scale and mandates, both because there are more assets that investors have to invest so they're giving out their mandates and in many cases investors are consolidating their manager list to fewer managers, so they're gaining more negotiating power and pushing pricing down by basically saying, "We'll give you more money if you give us greater volume discount."
But also, many institutions are asking for more service in exchange, so it's not just a fee decline. There is demand for more, for the same fee, through customization, through a different kind of relationship, through more hand-holding, and so I think the overall impact is actually broader than what just the top line figures suggest.
What should be the industry response?
First and foremost, differentiation is going to be critical.
Firms that can differentiate what they are bringing to the market in terms of unique products and unique investment leadership and building a brand around that - a differentiated distribution model, in that how they engage with clients, how they interact, what kind of business model they have to support, client service, as well as the overall interface and use of technology, quantitative tools and other resources to create a unique value proposition.
I think some firms are starting to do that but today many of the managers in the industry still look very much alike and it's very hard to justify premium pricing if there are a lot of other firms that look exactly like you.
If you look at any other industry, when there's a generic brand and a labeled brand, the generic's prices are usually lower and the branded brand usually has been set differentiated in the minds of the buyer, and I don't think many asset management firms have done a great job of really differentiating their businesses and their offerings relative to other firms.
I think it's about reviewing their investment capability and figuring out what investment offerings should they be building and how can they make their offerings distinctive, whether it's through certain kinds of products or means of managing money or how they articulate themselves. They should be building up a business but really they should hone in and serve a prioritized group of clients. That likely means migrating a business from trying to be one-size-fits-all to something that can really focus on unique client needs and build an engagement model to really service those clients in a way that is distinctive.
Were there any other fee pressure trends that your researchers noticed?
We're seeing intermediaries or distributors taking more share of investment advice revenue. So we think of investment advice revenue as the economics that accrued to financial advisors, to wealth platforms and to money managers, largely, in exchange for investment advice. Money managers' share of that was about a third in 2007, pre-crisis, and we've seen that fall roughly 28% over the last several years.
This is because distributors exert more pressure from the revenue share, in terms of the fees they're asking managers to pay for participation on a platform and sponsorship activities alike. This is just another source of pressure on asset management.
What types of ETFs could be a factor?
I think we've seen a lot of interest in migration toward ETFs. The vast majority of flows in ETFs have been passive and I think that world is really dominated by a few firms. It's going to be hard to break into. The remaining portion of ETFs, which has strong percentage growth but is still small, would be areas like smart beta, active ETFs, parts of the ETF chain that are giving exposure to unique asset classes, whether it's a cap bond fund or whatever it may be, and I think there will be a lot more innovation there. It will be interesting to see how well some of these firms execute some of these more complicated strategies in an ETF wrapper given all the restrictions.
With fees trending downward, can they be reclaimed or are they lost?
Well I wouldn't think of them as lost fees. I think if you look at the fee dynamic there are a couple things going - globally fees are going down, so one question is does passive continue to grow as it's growing, or when markets start going up, do we see a reclaimed faith in active management among some of the investors who have faith in migration to passive?
I suspect passive will continue to grow but at a not as strong cliff as it has been over the next five years, and you will see some returned to active, so that will push these fees up.
As second lever that will be played with is as institutional mandates roll off and retail mandates roll on, retail fees are typically a bit higher than institutional fees, so there is a channel orientation that can help the top rung economics for firms.
The contrary to that is retail turnovers are also higher than institutional turnover, so the net present value of those clients may not be significantly more, but their top line economics fees will potentially go up.
A third lever is the push toward higher fee products. I think a lot of firms are exploring this and looking at, what is the next generation of active management? I think this too will help maintain fee levels. I don't see this as allowing firms to significantly increase fee levels, but I think it will be more of a replacement.
For an active manager to stay relevant, they will have to evolve their investment engine. I don't know if that will allow them to necessarily charge more. I think it will more likely allow them to charge it all to stay in business.
What do you see as far as forward growth in the industry?
We think net flows into the industry have reached a new normal and will remain in the 1% to 2% range. We have been in this range now for several years, but pre-crisis levels that were 4% to 5%. That's a pretty significant change.
