McKinsey Report: Thriving in the New Abnormal, NA Asset Management

By | November 6, 2016

The global asset management business is huge. There are lots of billionaires and lots of people like you and me who have our wealth with pensions, 401K, and in stock/bond mutual funds. With the incredibly loose monetary policy (read: printing money), it is no surprise that global assets under management (AUM) have done well. In fact, they had their best year ever. McKinsey notes that global AUM is $68.6 Trillion in 2015 up 40%+ from the end of 2007.  To put that large number in perspective, the US economy is $18 Trillion. (Hat tip: Reddit)

 

For a copy of the McKinsey report – request it here. Note, they require a work email or a student email address.  Your “gmail” or “yahoo” email address will not suffice.

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Troubling signs in 2H of 2015. While it might look like things are going well, McKinsey notes a lot of unsettling things happened in 2015:

  • Major volatility in the crude oil prices, S&P index, and the price of Treasuries
  • Average corporate operating profit fell for the first time in 7 years
  • First net OUTFLOWS (taking money out) of mutual funds and ETFs since 2011

Passive equity is growing. No surprise but John Bogle’s (founder of Vanguard fund) vision for a low-cost way to invest in equities – continues to become more of a reality. Although passively managed AUM are only 1/3 of the total, they are gaining steam quickly. The graph below is from the McKinsey report, and clearly passive equity on the retail side is half of the total net flows of money. (Hat tip: Reddit)

consultantsmind-passive-equity-is-growing

Tons of competition. Oddly, the supply of investment products is not slowing down. More than 800 new products are launched annually, with only 500 getting retired (McKinsey report, page 12). This has led to a universe of 11,000 mutual funds and exchange-traded products, up 17% since 2009.

Note – all this great research was done by McKinsey. Ask McKinsey for a pdf copy here. Note, they will require a work email or a student email address.  

Feast or famine. While there are many choices – only a few get the lion’s share of investor funds and attention. Of the 3,000 newly launched mutual funds since 2009, only 8% (239) of them got 70% of the net inflows. Major pareto principle. The industry needs to cut costs but that is easier said than done.

consultantsmind-orphan-funds

Cost structure. McKinsey did a breakdown which estimates the cost drivers of traditional asset managers and shows that costs are rising fastest in sales and marketing, operations/IT, and legal/compliance. As the industry gets crowded and more complex, so does the costs it must incur.

consultantsmind-cost-structure-of-asset-management-business McKinsey forecasts 5 megatrends which will affect the asset management business:

1. The end of 30 years of exceptional investment returns: They expect that equities will have 150-400 basis points lower return, fixed income will be 300-500 basis points lower. In the graph below, McKinsey shows the returns across stocks and bonds in the US and Europe: last 30 years, last 100 years, next 20 years (growth recovery vs. slow growth). You don’t have to be a savant to see that the next 20 years of returns are forecast to be lower. A lot lower. Ruchir Sharma, from Morgan Stanley, says the same thing: expect lower returns. This is bad news for investors and retirees.

consultantsmind-historical-and-future-returns

2. Shake up of actively managed funds: Tony Robbins points out in his recent book on Money, Master the Game (affiliate link) that 96% of actively managed funds do not beat the stock market average over any 15 year period. That means investors are paying a premium to under-perform the index. McKinsey naturally sees a lot of this market at risk – to be taken over by passively managed funds or alternative investments.

consultantsmind-market-share-at-risk

3. Lower returns will drive money to more alternative investments: They expect a big move to more illiquid investments as investors seek above-average returns “alpha”. McKisney also notes that hedge funds have been a disappointment – which will drive even more money to alternative investments.

consultantsmind-growth-in-alternative-investments

Another view into private equity and hedge funds. Investor confidence survey.

consultantsmind-investor-confidence-in-pe-and-hedge-funds

4. Digital revolution to improve efficiency, and customer engagement: This is happening in all industries – no reason why it would not happen here. Sidebar – my first job was a stockbroker and my clients would actually call into my office to get stock quotes. . .yes, we have come a long way since 1993.

5. Increased regulation: Yes, this is a trend you see in most industries, and financial services is no exception. Apparently, the US Department of Labor (DOL) issued a fiduciary rule going into effect April 2017 which will force investment advisers to act as fiduciaries when advising on retirement accounts. I am not an expert on this (Note: this is a 1,023 page document), but in summary . . . regulation is increasing.

The DOL Fiduciary rule constitutes one of the largest shocks to the wealth management industry in over 40 years. – McKinsey

Trouble Ahead. For me, this means we all need to re-set expectations. The good ole’ days of 10% average US stock market returns are gone. Need to save more, have a portfolio of investments (personally, I am a fan of residential real estate), be smart about your money. Look at the graph below. This means that A LOT of social security, government worker pensions, and other sketchy public financing are at risk.

consultantsmind-gap-in-public-funding-from-investments

McKinsey argues persuasively that the industry will have to change to meet the increased volatility, lower expected returns, increasing customer expectations, and continued competition. They end the report with multiple potential strategies and paths forward for asset managers. They argue for new capabilities, new products and new operating models. Personally, I think this portends a lot of M&A. None of them are “easy”, or “quick fixes”, but Wall Street has a strong track-record of surviving and making a good profit from the volatility.

Note – all this great research was done by McKinsey. Ask McKinsey for a pdf copy here. Note, they will require a work email or a student email address.  

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