As the entire financial services industry deals with the continued response from the Covid-19 pandemic, asset managers, in particular, are facing a time of significant and lasting change. They can emerge from this crisis stronger and more resilient, but only if they can improve their agility, reimagine their operating models and provide products that truly resonate in the marketplace.
It’s widely known that asset managers were facing significant headwinds before Covid-19 occurred. There were three key challenges in particular:
Margin compression - The shift to lower-fee passive products has been the main culprit here, as assets under management (AUM) have become fundamentally decoupled from revenue. Accenture ACN analyzed 21 publicly traded asset managers and found that their 2019 AUMs were up 19% YOY and yet their revenues were flat and gross margins down 20% on average. The picture is even gloomier when you look at the last five years, with gross margins contracting by 31%.
Changing investor preferences – As mentioned, retail investors continue to embrace passive investments while institutional investors increasingly seek yield from alternative investment strategies - including private equity, infrastructure and middle market loans - rather than solely relying on low-yielding bonds. More asset managers are building out their alternative offerings, and they should, but these strategies are more costly and complex to service.
Regulatory reform – 10 years after the financial crisis, new and emerging regulations (including around consumer privacy, for example) continue to force asset managers to make costly investments in human capital, technology and data and analytics.
These factors, combined with the market impact from Covid-19, should finally force asset managers to reinvent themselves. Here are five critical moves they should make now:
1. Bend the Cost Curve
The most obvious solution will be to fundamentally bend the cost curve and revisit everything from their real estate footprint to headcount. For example, the mantra from portfolio managers that they need their people proximate to them at all times is well and truly broken. Asset managers should review their location strategies to determine their cost-effectiveness and business necessity in a post Covid-19 world.
Asset managers’ core functions - manufacturing and distributing investment products - make up only half of their cost base, with asset servicing, compliance and trade execution making up the other half. This has to change! In a similar vein, we expect to see increased merger and acquisition activity, especially if banks and insurers decide to unlock liquidity by pulling out of ownership stakes in asset managers. Those who combine and successfully integrate their firms’ operations could save hundreds of millions by eliminating duplicative costs.
2. Transform their Operating Models
Asset managers will have to balance getting their costs in order with transitioning away from outdated operating models no longer fit for the digital age. Research from the Investment Company Institute, a leading investment association, and Accenture found that more than four in 10 asset managers in North America believe that their operations and technology are not positioned to enable their firm’s overall strategy.
Technology infrastructure is growing increasingly complex even as improvements are implemented, which compounds the challenge of escaping the legacy environment and encourages asset managers to mistakenly pursue tactical changes over comprehensive operations transformations. Data, perhaps the single most scalable asset for firms, is not always managed effectively enough to spur increased automation or better organizational decision making. Asset managers have developed their data capabilities in recent years, but they’ve failed to truly integrate data across their business, culture and customer processes.
3. Embrace models and platforms to fix sales and distribution
In addition, Covid-19 should finally force asset managers to embrace models and platforms to shore up their sales and distribution. Think about the whole swath of wholesalers who couldn’t visit financial advisors during the pandemic. A leaner team that covers a greater territory and relies on more digital sales tools would be the recipe for success.
And the bottom-line cost impact of a smaller distribution force is significant. By Accenture’s analysis, if asset managers reduced their distribution costs by 25%, their operating margins would increase by nearly 20%.
4. Move from B2B to B2C
We see the asset manager of the future jumping from being a business-to-business provider to a business-to-consumer provider, allowing them to get much closer to the end client. Asset managers are increasingly venturing into wealth management as they eye higher fees and more loyal clients. But this requires an entirely new approach to products and sales and distribution to effectively reach the mass affluent customer. It will also force them to become more digital in the front-end and improve their customer-facing functions, making critical investments that could eat away at margins.
5. Rationalize product portfolios
The final piece of the puzzle moving forward is product rationalization and reinvention. Asset management products are increasingly becoming commoditized and difficult to differentiate in the market, with recent ETF closures as proof of that.
Asset managers must reassess which products they want to focus on, determine how they are differentiated from the competition and whether the profit and loss figures for each product supports its business case.
Situations such as Covid-19 are resurrecting questions around the value of active management, presenting opportunities to capture better returns and minimize losses. We’ve seen several instances of firms developing active ETFs, for example, but just because you build these products doesn’t mean that investment funds will flow in. They have to be differentiated and outperform the market.
There could also be an opportunity around the tokenization of illiquid or non-bankable assets, like real estate, art and passion assets, that could be of great value for asset managers to differentiate their investment strategies. We estimate these assets to be worth nearly $74billion, and that’s a conservative figure.
The challenges for asset managers won’t suddenly subside once the macro economy recovers from Covid-19. It’s time asset managers take a hard look in the mirror and make critical decisions to reinvent themselves for a more resilient and customer-centric future.