- “The dogmas of the quiet past, are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise with the occasion. As our case is new, so we must think anew and act anew.”
— Abraham Lincoln
On September 18th, McKinsey & Company published a piece highlighting their views on the asset management industry for 2024 and beyond entitled “Beyond the balance sheet: North American asset management 2024.” As usually found within a McKinsey research piece, several points and observations reflecting their deep analysis and understanding of the drivers within the industry are presented, as well as several recommendations for current custodians of client assets that must be considered to remain relevant.
A few areas worth highlight within the study:
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- The markets have recovered as evidenced by strong market performance as well as material increases (8%) in the industry’s AUM ($132T as of June 2024) versus 2023.
- While revenues ($228B) have recovered, it is neutral/flat to 2023 while profits fell 5% ($73B).
What do these few high-level points tell us? While the market has recovered and the immense piles of sidelined cash ($6.3T as per Bloomberg) has begun to return to the capital markets, asset managers have struggled to capture their share of these flows while increasing or maintaining margins. As the piece highlights, cash has moved from higher fee actively managed products to lower fee ETF and index funds offered by a handful of “colossus” managers. While this is true, there are a few niche managers who are still able to attract assets by demonstrating a consistent history of investment process differentiation and alpha generation over market cycles.
So, what happens to the remainder of the industry that is offering consistent market (e.g., average) returns via higher fee, actively managed products? With continuing shrinking margins, how do they survive?
Given my experience, the following must be considered when developing a go-forward strategy.
- While there is sometimes an automatic reaction for managers to create new products (e.g., the “shiny object”) with the goal of riding the coattails of other more experienced and tenured managers, new entrants often find themselves too late to the party. Specifically, the “late arrivals” are unable to demonstrate a marketable track record, may not maintain the necessary operational sales and client service infrastructure, or are reluctant to expend capital to properly support such endeavors (especially given a shrinking margin environment).
- Firms can quicky pivot into new products via strategic (and often extremely expensive lift outs/ins) actions and/or partnerships. These opportunities are rare and not always successful due to unforeseen conflicts over culture, revenue share, and strategic direction of the business. “Integration does not constitute assimilation.”
- Managers who can demonstrate consistent alpha generation via a differentiated approach should remain focused on their skillset. Put another way, do not get distracted by what others are doing or trying to implement; rather, maintain focused on what got you there. As those on the consulting/gate keeper side are quick to highlight, style drift or other “distractions” by the manager is frowned upon as unnecessary fishing expeditions.
- While revenue and margin compression are real and destined to continue, managers must exercise caution when deciding how and where to reduce expenses. For example, the most significant cost to any business is people; therefore, an easy solution is to reduce (sometimes dramatically) for a “quick fix.” While the financials may appear better as a result, the impact of the quick fix is often not realized until later usually manifested through spikes in manual errors/losses, increases in turnover due to staffing fatigue, and client complaints due to eroding services levels. Therefore, it is imperative to immediately identify the core activities which should be removed for cost reduction consideration.
- The cost reduction effort must be well calculated, focusing on mid and long-term impact to the business, service levels, and employee resilience. Based on my experience, I often find it wise to solicit ideas from those in the “trenches” versus implementing change based solely on financial/operational reporting (e.g., the siloed corner office). Those closer to the “action” can often enlighten those who are not.
In summary, it is truly possible for firms to take share, increase AUM, and maintain (or even expand) margin without harming the overall business via new product/initiative distractions and uniformed cost reduction efforts. Maintain focus on why a firm has succeeded during market cycles (e.g., demonstrated excellence in credit selection, unique credit review process, bespoke problem solutions for clients), do not get distracted from the “flavor of the month,” and maintain a key focus on what the mid and long-term impact of cost reductions are within the business. Keeping a pragmatic focus usually leads to success over the long run.
Joe Burschinger is the Principal Consultant at WMT Advisors LLC., a financial services focused strategic, operational, and technology oriented business consulting firm.