McKinsey: After crisis, asset managers now need to “pick their spots for growth”

A year ago, as the dust was just beginning to settle after the financial crisis, McKinsey & Co. reported that some asset managers were “depressed and in denial” about their prospects (see related post).  These firms’ propensity to not cut costs delivered an average drop in profits of 60-75% in 2009.

The consultancy’s newest report on the industry shows that hope does indeed spring eternal.  According to the report, “The Asset Management Industry: Now it’s about picking your spots” (produced in partnership with Institutional Investor’s U.S. Institute), nearly half (42%) of managers previously categorized as “depressed and in denial” expected profits to increase 10% in 2010 (although, we guess that after having their heads handed to them in 2009, a bounce back of 10% is perhaps to be expected.)  By contrast, the other categories of firms identified by McKinsey expected roughly a 20% increase in profits this year.

After a decade of declines, firms surveyed by McKinsey finally reported a modest increase in net revenues from retail assets last year.  The 2 basis point increase was the highest year-of-year increase seen since the survey was first conducted.  Meanwhile, net revenue from institutional assets fell precipitously.

The three-year drop in institutional fee revenue is a result, says McKinsey, of a move away from higher-fee alternative investments to low-fee products…

“Institutional net revenue yields, which increased 9 bps between 2001 and 2006, as investors flocked to higher-yielding alternatives products, such as hedge funds and private equity, fell a remarkable 6 bps (17 percent) over the past two years as investors quickly retreated to the safety of lower-yielding fixed-income investments.”

But the bad news may be about to end for pure-play managers of alternative products.  McKinsey “expects institutional appetite for higher-fee alternatives to recover.”  And when they do, the firm says investors will turn to “specialist alternatives managers, rather than traditional asset managers.”

In fact, the report lists alternative investments as one of five key growth areas for the asset management business. The others are retirement, international investing, sovereign wealth funds and ETFs/passive investments.

McKinsey reports that institutional investors anticipate a “steep” recovery in their alternative investment allocations over the next two to three years.  The firm also expects alternatives to grow in the retail market, albeit in a more focused manner:

“Investment managers are reportedly dusting off plans to offer new alternatives fund products to retail investors, but this will likely remain a niche segment over the next few years, dominated by firms with the strongest alternatives brands.”

Notwithstanding its belief in the power of brand differentiation, McKinsey laments that “there appears to be limited conviction (or ability) in many firms to invest in these opportunities and carve out differentiated leadership positions.”

This problem is familiar to institutional asset management salespeople, some of whom have dedicated their careers to explaining why one large cap US equity fund is any better than the next large cap US equity fund.  McKinsey reveals this frustration several times in the report (our emphasis added below):

“…the investments in growth that asset management firms are making do not match the strength of their convictions, and few appear to have a clear sense of how they will differentiate themselves from their peers. Nonetheless, firms remain confident, with more than 80 percent believing they will gain or maintain industry share.”

Only one-fifth of the firms who say they are targeting sovereign funds are creating a differentiated sales and service strategy that combines greater coverage by senior executives, a local presence, increasingly dedicated sales resources and a strong team-based approach emphasizing service and support, as well as best-in-class investment expertise.”

But regardless of their interest in true competitive differentiation, it seems from this survey that institutional asset managers are looking to grow once again.  With the overall size of the pie expected to remain unchanging for some time, a shifting product mix, competitive differentiation, and industry analysis will be the keys to success.  In other words, it’s a good time to be a McKinsey consultant.

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