This article first appeared in Personal Wealth, The Edge Malaysia Weekly on July 24, 2017 - July 30, 2017

Despite a notable increase in the value of global assets under management (AUM) last year, the revenue of traditional asset managers fell worldwide for the first time since the 2008 global financial crisis as fee pressures continued to rise.

According to the Boston Consulting Group’s (BCG) Global Asset Management 2017: The Innovator’s Advantage report released on July 11, the value of global AUM grew 7% last year to US$69.1 trillion, compared with an increase of just 1% in the preceding year. This exceeds the average annualised rate of 5% from 2008 through 2014. However, the growth was largely due to asset appreciation on financial markets as the revenues did not follow suit.

Revenues declined 1% in 2016, partly resulting from the evolving mix of high-fee and low-fee products — particularly the ongoing shift from active to passive management and flows from active equity into active core fixed-income products. From 2013 to 2016, net revenues fell from 29.3 basis points to 26.7 basis points.

Even without the shift in the product mixes, margins would still decline as fees were declining for most products in the institutional and retail client segment. In the institutional segment, the decline was driven by competition among suppliers. In retail, it was a consequence of regulatory pressure for fee transparency and even a ban on distribution fees in some markets such as the UK and the Netherlands.

“High-margin products have been hard hit. The net management fees of hedge funds (in basis points) have decreased 1% per year since 2010. Over the same period, private equity fees declined at an annual rate of 1.5%; infrastructure, 3%; and commodities, 7%.

“Fees (in basis points) for equity specialities — the highest-margin active product following alternatives — have fallen 3.5% per year since 2010. Fees for some low-margin products also declined. Money market fund fees fell 3% per year; exchange-traded funds (ETFs), 3%; and liability-driven investments, 7%,” the report notes.

However, a few innovative products in demand by investors have bucked the trend, commanding higher fees. Since 2010, fees for multi-asset products have increased 2% per year; fixed-income specialities, 3%; and private debt, 2%. Although these trends showed signs of slowing down last year, it is expected as the products mature.

Growth in AUM

From a regional perspective, China and Brazil saw robust growth in AUM last year, driving a commendable increase in the value of AUM in Asia and Latin America respectively. China experienced 21% growth in AUM last year, in both the retail and institutional segments. In the retail segment, the growth was a result of high household savings rates. In institutional, it was the result of an increasing prominence of insurance companies and pension funds in the country. Because of these, Asia experienced a 16% increase in AUM value to US$6.6 trillion last year from 2015.

Unlike in China where the growth was driven by net inflows, the 17% increase in AUM value in Brazil was driven by asset appreciation in financial markets. It resulted in a 14% increase in the value of AUM in Latin America to US$1.5 trillion in 2016 from the previous year.

North America remains the world’s largest market, accounting for 48% of the global AUM. The US’ AUM increased only 5% last year, despite a solid gain in domestic equity prices as it suffered from net outflows of 0.3%. The total value of AUM in North America grew 6% to US$33 trillion last year from 2015.

In the UK, currency devaluation following the Brexit vote and the buoyant financial markets compensated for weak net outflows as its AUM grew 11% last year. Europe, as a whole, saw solid gains from net flows, particularly in Spain, Germany and Italy. The region experienced 7% growth to US$18.4 trillion in 2016 from the previous year.

Net flows continued to decline in the Middle East and Africa last year with no growth in value of AUM at US$1.3 trillion. This was due to persistently low oil prices, which caused outflows from sovereign wealth funds.

Developed markets Japan and Australia experienced 4% growth to US$6 trillion last year from 2015.

Strategic imperatives

In the current asset management environment, costs are likely to increase faster and product life cycles shortened, requiring asset managers to spend more on innovation and product launches to maintain growth. This dismal outlook requires a strategic response from the asset managers, and significant gains will come from five sources — growth in China, product portfolio management and innovation, business models and mergers and acquisitions (M&A), technology and cost management.

Although China experienced robust growth last year, many asset managers there have yet to see positive returns. However, the report says this prospect may have improved as Chinese investors are becoming more sophisticated. Additionally, the ageing population and the growth of wealth are raising demand for dedicated products, including target-dated funds and ETFs. Meanwhile, foreign players are now able to get onshore licences, and new regulations allow insurers and pension funds to enter the market.

Boosting revenue and retaining existing businesses are becoming increasingly elusive for asset managers. The traditional wholesaling models and relationships have been undermined by the accelerating changes in the advisory business, including the arrival of a new generation of advisers, the transition from commission-based to fee-based models and the slowing growth of the larger firms.

However, there are ways to run successful next-generation wholesaling models by leveraging technologies such as big data analytics, machine learning and virtual assistants. According to the report, there are four elements that could transform wholesaling into a growth engine for the future — microsegmentation, demand-response systems and capabilities, timely coordinated messages and digitised services. Instead of being isolated solutions, the four elements must be integrated and operationalised together.

Microsegmenting is the use of big data to profile each individual adviser to create a set of specific messages and actions to influence an adviser’s future investment choices. The profile may include the adviser’s business model, past transaction activities and demographic characteristics. Once the data has been mapped against the individual profiles, it is continuously updated and optimised by machine learning algorithms that use performance data and qualitative feedback from the field to ensure the right actions are taken at the right time for each adviser.

The demand-response systems and capabilities identify high-priority sales targets based on digital data. This may include inbound communications, product queries, response to digital marketing initiatives and web search engine data. This model allows asset managers to identify and prioritise the most promising opportunities and allocate their resources accordingly.

To improve decision-making process, asset managers are able to provide timely, relevant and coordinated messages to advisers. These messages may contain access to digital information and tools to guide investment decisions, resources provided by their own organisations or rival asset managers and other sources.

The final element of a next-generation model is the deployment of effective digitised service capabilities such as chatbots and virtual assistants. It can address generic product questions and service needs better and quicker than manual processes, leading to an improved experience and allowing the wholesaler to focus on interactions with higher priority.

Cost savings and M&A

Continued margin pressure means that asset managers must seek any cost savings consistent with the company’s growth strategies. By adopting new digital tools, the report says, there are four ways for companies to seek cost savings — organisation delayering (increasing the manager’s span of control and cutting middle management head count), centralisation and automation (using robotics and automation tools), efficiency review and business transformation (such as rationalising products, pruning unprofitable clients and exiting poor locations).

During such trying times for asset managers, M&A will often be the attractive option. Bold firms can rapidly acquire the scale, products, expertise or distribution channels they need for sustained success. M&A activity has slowly picked up in recent years — the number of asset management deals globally rose to 65 in 2016, compared with 49 in 2011. While most deals in the past were small acquisition driven by private equity or multi-affiliate firms, deals today are expected to be larger and more cross-border.

However, M&A is not a silver bullet as less than half of the deals in asset management create shareholder value. This is the reason why firms undertaking a deal must understand the strategic imperative it serves, on top of having the right team to get the job done. Post-merger integration must be executed swiftly with strict discipline.

According to the report, there are four winning asset management business models of the future — alpha shop (with deep investment expertise in specific asset classes and investment strategies), beta factory (with scale and operation efficiency), solution providers (with skills in multi-asset class portfolio construction and manager selection) and distribution powerhouses (with superior access to investors and distributors).

While many asset managers have adopted some aspects of one of the models or more, they do not fully embrace any one in particular. The report says M&A can help close the gap by giving access to products and investment capabilities, opening new distribution channels or end-clients and reducing unit costs by adding volume to an existing platform. However, growth through acquisition is a winning formula only if it achieves or consolidates a winning business model. If done for the wrong reasons, a merger can dilute the brand, erode margins and drive away the firm’s top talent.

For a successful M&A, companies should recognise that while cost synergies matter, revenue synergies matter more. Asset management remains a high-margin business, hence the top priority should not be generating short-term values, but growing the AUM. Examples include cross-selling current products in new regions or through new channels, and providing stronger products in the current market.

M&A provides valuable opportunities to review and redesign the operating model. This should be done quickly as slow and indecisive action in the target organisation can lead to extended paralysis and loss of top talent.

The time between announcing a merger and closing the deal typically involves considerable uncertainty among leadership teams, investment professionals, staff, regulators and even clients. This is where communication across every layer is vital. Failure to communicate can have profound consequences as people will assume the worst without information.

Lastly, it is important for companies in an M&A to embrace cultural differences. Integration can lead to cultural clashes and they can be further aggravated when the new leadership team acts inconsistently. For a seamless integration process, the target culture must be defined quickly with a clear and honest acknowledgement of differences.

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