Asset-management industry economics in Western Europe have remained relatively resilient, buoyed by the short duration of periods of downside market performance and asset values remaining near the current cycle’s highs (Exhibit 1). However, the industry is clearly continuing to contend with persistent structural shifts: lower returns due to interest-rate dynamics, the shift to passive and alternative asset classes, slowing organic growth, continued fee pressure, elusive operative leverage, and aggressive competition from within and outside the industry.
Any discussion of the state of the industry must begin with an acknowledgement of the macroeconomic environment, which is typically responsible for 50 to 80 percent of growth, and which has swung the industry between extremes over the last few years. An environment of uncertainty has prevailed, leading to market conditions that are also testing investor convictions; for example, in the fixed-income markets, where more than €7.8 trillion in European bonds are currently negative yielding. Following the exuberance of 2017, when assets under management (AUM), revenues, and profits all hit record highs for European asset management, 2018 brought more challenging conditions, particularly in the public-equities market in the fourth quarter. Market valuations have since recovered with a vengeance, as European AUM have reached a record €22 trillion, though revenue and profit pools for the year are not likely to reach 2017’s high-water mark. While year-over-year 2019 AUM is up by approximately 10 percent, we expect average AUM to be up by only 3 percent. Most important, however, we expect profit margins to be down by approximately two percentage points based on our interim estimates—the result of persistent pricing pressure and absolute cost growth, confirming the continuation of the trend in which cost growth exceeds organic revenue growth net of capital market performance.
Organic growth has slowed on a global basis, influenced primarily by Asia, and China in particular. While Western Europe also has been a strong contributor to organic growth, averaging 3 to 5 percent per year since 2014, in 2018 the net-flow effect fell to approximately 1 percent, more in line with structural economic and personal financial-asset growth in developed economies.
Pressure has been persistent on revenue yields, with fee compression responsible for about 80 percent of the decline in revenue yields year over year (asset class and style-mix shifts are responsible for the remaining 20 percent). While passives are certainly growing faster than other investment styles, the pace of the shift to passives has been more muted in Europe than in North America, with significant variance in the rate of passive adoption across markets and client segments.
While asset managers’ ongoing cost-reduction efforts have received recent press attention, sustained operating leverage has remained elusive for the industry overall. Despite diminished growth and market-performance expectations coming out of an exuberant 2017, overall spending by European asset managers grew by 2 percent year over year (though functional spending in investment management, distribution, and operations was flat to slightly below 2017 levels). As a silver lining, European managers did demonstrate more discipline than their North American peers on average, who had a cost growth that was twice as fast and increased across virtually all functional areas.
Averages aside, there remains significant dispersion in asset-manager profitability and growth across and within different business models. As McKinsey research contended last year, deliberate business-model choices and alignment of clear value propositions matter. We do not believe there are just one or two winning formulas; however, achieving disproportionate growth will require asset managers to take proactive and bold actions in response to the following forces continuing to reshape the industry ecosystem:
- Lower growth and returns. Investors face the realities of a “lower for longer” environment for global economic growth and interest rates (Exhibit 2). Consistent alpha remains hard to generate (at least without significant decreases in fee levels), and while Europe has seen a relatively lower degree of “barbelling” of investor behaviors in terms of asset mix, this could change amid sustained demand for yield-generating assets (buoying flows across fixed income, private credit, infrastructure, and real estate) and the consistently growing share of passive strategies (particularly with significantly accelerated outflows in active equities to date in 2019). Market reactions to macroeconomic shocks have also elevated the importance of portfolio construction and risk management as a source of returns and resilience.
- Growing transparency from regulatory implementation. The impacts of the Markets in Financial Instruments Directive II (MiFID II) are emerging across the industry. They include distributors narrowing manager buy lists and raising the bar on performance; fragmentation of research, with large managers driving a 20 to 30 percent reduction in broker research spending and redeploying spending to specialist research providers, contributing to alpha generation; transparency increasing fee sensitivity in the industry, amplifying product commoditization and buoying ETF growth in retail; and improved profitability of some banking captives, which are benefiting from fee unbundling and cost savings on market data.
- Competition increasing with both greater concentration and fragmentation. Growth continued favoring managers with scale and scope, and consolidation gathered steam as managers sought to build their presence in high-growth areas and invest in technology to create more efficient operating platforms. However, despite the largest managers having achieved higher AUM growth, industry fragmentation has sustained particularly amongst managers with less than €100 billion in AUM.
- Innovation outside the industry creating new sources of competitive edge and disruption. The explosion in the availability of data and new sources of insight was also fueled by growing consolidation and competition amongst financial data providers. Asset managers are just beginning to mine these data sources at scale, as middle- and back-office platforms are modernized or outsourced to innovative market infrastructure providers. These innovations include providing more integrated investment, research, trading, and analytical platforms; the continuing electronification of flow products, including corporate and sovereign fixed-income trading; and promising initial blockchain uses in investment and trade operations.
Against this backdrop, we believe there are several strategic imperatives that European asset managers urgently need to focus on, starting today.
Emerging symptoms of structurally slowing growth
The vulnerability of Europe’s asset managers to the macroeconomic environment remains elevated, as an historic asset boom powered by cheap and plentiful capital and rapid economic development in emerging markets gives way to slower structural growth and uncertainty. Market conditions are also testing historical assumptions (for example, the market value of negatively yielding European bonds reached nearly €3 trillion in 2018 and has hit record highs of nearly €8 trillion in 2019), intensifying the search for new sources of yield and diversification. In this context, client needs for investment advice and stewardship are arguably as great as they have ever been.
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Western Europe experienced challenges in overall AUM growth in 2018 (at a rate of –3.2 percent), largely due to poor market performance stemming from macroeconomic uncertainty (such as monetary policy outlook, soft corporate earnings and guidance, trade uncertainty). However, the net-flow effect remained positive at 0.2 percent, albeit at a muted rate (the second-lowest in the past decade) compared to the 3.8 percent average between 2014 and 2017.
Growth dynamics in the largest European markets paralleled those of the overall region. Uncertainty around Brexit impacted growth in the United Kingdom, which was the sole outlier with negative net-flow effect, as institutional investors adopted a wait-and-see approach.
European asset manager share of overall European financial assets was at 27 percent in 2018, with managed retail assets gaining two percentage points of share since 2014 and managed institutional/defined contribution remaining flat. As a potential offset to slower structural economic growth, there remains a massive opportunity for asset managers to increase conversion of unmanaged and internally managed assets, particularly in the institutional market, where internally managed assets reached €44 trillion in 2018, nearly three times larger than institutional managed assets.
Industry economics resilient, but vulnerable
In our report last year, we asked how asset managers would fare in a significant market downturn. This what-if scenario was tested (if temporarily) in the fourth quarter of 2018.
From a financial performance standpoint, Western European asset managers experienced a roughly 2 percent decline in overall profit pools. This decline is more muted than many have expected from the poor market performance experienced year over year.
Western Europe profit margins benefited from higher average AUM over the year. However, net revenue margins still declined by 0.6 basis points while cost margins remained flat. The key driver for the decline in revenue pools was fee compression, with revenue margins declining by about 10 percent in retail and 2 percent in institutional.
If fourth-quarter 2018 market conditions had sustained for the full year, profit pools would have declined by approximately 10 percent, reducing Western European asset-manager operating margins from about 36 percent to 32 percent.
Differentiated asset mix dynamics amid persistent fee pressure
From an asset-mix perspective, between 2013 and 2018 Western Europe did not experience the same market share displacement by passive strategies as the rest of the world (and specifically the US). Active strategies still play a relevant role in capturing net flows especially in fixed income and multi-asset.
The adoption of passive strategies varies largely from region to region, with North America, Australia, and Japan making up the majority of passive assets and growth. Western Europe passive market share lands somewhere between North America and the rest of Asia, with relatively moderate increases in share over the last five years across retail and institutional segments. Moreover, the penetration of passive assets still differs significantly by country, reinforcing the need for asset managers to consider local dynamics and not fall into painting regional opportunities with a broad brush.
As in the rest of the world, private markets continued their rise as private fundraising has remained near record levels with significant tailwinds from client demand for alternative sources of return and yield.
Even with less mix shift to structurally lower-priced passive strategies, pricing pressure remains a challenge across asset classes in Europe, with declines in yields across all strategy categories nearly offsetting market performance effect in 2018 (Exhibit 3).
We anticipate continued pricing compression in Europe driven by competitive pricing by vertically integrated business models favoring proprietary managed strategies; implications of MiFID II driving fee compression in institutional, wholesale/B2B, and increasingly even in retail; and growing aggregation of demand enabling distributors and intermediaries to flex pricing power across retail and institutional channels.
Fighting for sustainable operating leverage
Asset managers continue to struggle to improve efficiency at scale and to demonstrate sustainable operating leverage—a trend that has consistently challenged the industry to various degrees since the financial crisis. Western European managers increased overall spending by about 2 percent in 2018 despite the much more muted growth environment. This was, however, a slower cost growth rate than in prior years (such as the 5 percent average annual growth between 2007 and 2017), largely due to slower or declining functional cost growth in investment management, distribution, and operations. In comparison, North American managers fared even worse on cost discipline, with overall costs growing twice as quickly (4 percent year over year) as those of Western European managers, with significant increases in investment management (3 percent) and distribution (8 percent).
Unlocking vectors of new growth
We believe there is ample room for European managers to achieve top- and bottom-line growth, if they can execute across the following three strategic imperatives and potential levers:
Compete within the core: ‘Tighten up the ship’
1. Meet clients’ urgent needs in the “lower for longer” economic environment.
- Recast the value proposition of the product lineup to meet the changing portfolio needs of institutional clients (for example, alternative sources of yield to meet liabilities; access to private markets; more efficient vehicles with reduced drag on returns; becoming a services provider instead of only a product provider—for instance by developing portfolio construction and advisory capabilities).
- “Institutionalize” retail wholesale client offerings (for example, alternative sources of yield to meet retirement income requirements, higher margins of safety with slightly lower returns, and alternative solutions for capital-protected retail savings and products).
- Make the investment process more robust by testing successful use cases in advanced analytics (for example, de-biasing investment and trade decision making, and leveraging new sources of data to unlock opportunities such as in environmental, social, and corporate governance (ESG and thematic investing).
2. Double down on sustainability and impact investing.
- Fully integrate ESG factors in the investment process, with the adoption of the UNEP Finance Initiative and UN Global Compact’s Principles for Sustainable Investment and the introduction of metrics to assess, measure, and manage ESG risk across asset types.
- Contribute to structurally increasing the stewardship ability of the industry, to achieve impact at scale in the real economy.
- Partner with distribution networks to shape an ESG-compliant product range and contribute to embedding of ESG culture in advisory models.
- Explore possibilities to enlarge the impact-investing market as a means to further diversify portfolios and achieve outsized returns.
3. Get frontline tactics right (for example, distribution effectiveness driven by targeted training/upskilling to improve client proactiveness, client experience, B2B/B2B-for-consumer opportunities).
4. Transform your operating platform and cost structure.
- Rapidly transition middle- and back-office capabilities to meet the needs of the front office and clients (for example, technology and automation to accelerate efficiency and time to delivery and enable customization at scale).
- Radically simplify operating models, leveraging technology, data, and analytics to streamline costs, improve client experiences, and open channels to new growth.
Move the boundaries: Innovate selectively
- Realign business models to capture growth in retail “hot spots” (for example, democratizing access to high-quality products for retail investors, direct to consumer).
- Unlock the tremendous white space for growth in internally or unmanaged financial assets in institutional (for example, meeting liquidity needs of corporate balance sheets; mid-size insurers managing their proprietary books of assets and thus not benefiting from economies of scale or scope).
- Identify beneficial new partnerships in the shifting distribution ecosystem (for example, platforms that can boost the value proposition with network effects by accessing new clients and sources of growth).
Redefine the game: Become a disruptive player
- Expand beyond asset management, for instance by creating a platform or ecosystem building on privileged access to clients (such as a fund selection and distribution platform, wealth manager/credit provider, market maker, technology provider, or B2B marketplace).
- Radically innovate (for example, take the lead in using distributed ledger technology in asset management to tokenize previously illiquid assets).
Succeeding in asset management was once relatively straightforward, matching sources of structural wealth creation and growing retirement and liability needs, with sources of capital appreciation, income, and yield. However, the success factors behind the industry’s growth have become more uncertain and will continue to evolve. The asset-management industry’s current challenges must be confronted, and managers must seek a new narrative and ambition for growth. Significant upside exists, whether it be within the current scope, or through pushing boundaries and creating new opportunities. The future belongs to those who can execute to their ambitions. The gauntlet has been thrown. Will European asset managers take it up?
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