SAFT ON WEALTH: The asset management shakeout

03/14/2013

By James Saft

March 14 (Reuters) - The gusher of new money that has fed the growth of the global asset management industry for a generation has slowed to a trickle, making the next few years make-or-break for many firms.

Growth in new money flows will slow to less than 1 percent annually for each of the next five years, according to a study by industry consultants Casey Quirk, as against 6 or 7 percent in the good old days before the crisis.

That is sure to put pressure on many existing firms, many of which owe their institutional framework to a time when a simple focus on traditional products aimed at baby boomer savers was enough to ensure success.

"In as soon as ve years, league tables of industry leaders already will look different," Kevin Quirk and Benjamin Phillips of Casey Quirk wrote in a February industry study ().

"Most large rms today, saddled with the costs of serving slower-growing legacy client segments and unable to redirect resources toward newer, better opportunities, will struggle to maintain their historical growth trajectories."

Asset management, to be sure, is a good business: worldwide revenues in 2012 were about $350 billion, generating about $100 billion of earnings. The ratio of earnings to revenues for the entire industry is not too far off of what Google Inc is able to generate and about three times as high as Wal-Mart Stores Inc, so there is plenty of gravy even if growth rates are going to reduce.

Let's look at asset management with an investor's eye. If the industry sees revenue growth - even at a low level - the value of those best-performing franchises will rise.

We will be living in a low-growth world for at least several more years, and businesses with steady and rising cash flows and a reasonable defensive moat will be very attractive indeed.

As such, of course, asset management attracts a constant stream of new capital and entrants. This makes it tough to maintain a sustained competitive advantage. Banks will be plowing capital into asset management, technology firms will be seeking ways to make end runs around financial services firms to get directly at consumers and, as always, thousands of new small hedge fund and other firms will start, grow and sometimes wither.

FOLLOW THE MONEY

Most of the growth, however, is going to be outside of the traditional business of serving domestic developed market clients with standard equity and bond products.

Instead, look to alternative models for the fastest growth.

Between now and 2017, Casey Quirk estimates that upward of 20 percent of the revenue opportunity will come from private equity and hedge funds, and so-called "solutions," an industry buzz word used to cover thing like target date funds.

Another 15 percent will come from passive investment, a low cost, scale-driven business that, as it grows, pressures margins throughout the industry.

There will also be a huge global play; both in serving newly affluent investors from emerging markets and an ongoing diversification of big-market money into global stocks and bonds.

Of particular importance is the fact that 80 percent of the growth is going to be from individuals, with the highest growth rates among high-net worth and above investors, according to Casey Quirk. Mamas, tell your babies to grow up to be private bankers.

So, the winners in the industry will be able to position themselves for that growth; either by projecting an image that they can actually create high alpha - or outperformance - especially in unusual asset classes, or by being cheap and efficient sellers of a market return.

Being able to knit it all together into a coherent portfolio, what we commonly call asset allocation, will also be increasingly valuable, and is a skill in surprisingly short supply.

So who are the losers? In a lot of ways it is the same group that has been losing for years: those who hug investment benchmarks, never strongly outperforming or underperforming; firms that do a little of everything but can't credibly package it for clients; anyone who isn't the cheapest at offering a low-cost market return product like an index fund. When returns are only 6 percent a year, as they may well be, benchmark performance at an active management price isn't going to cut it.

The big difference going forward is that in 2017 we will have suffered a decade of low inflows, and, in developed markets, will be looking at another 20 years in which baby boomers will be eating their investments rather than adding to them.

That is going to amplify pain for those who are already on a long, slow slide.

It is kind of like in freshman-year Calculus. Asset managers: look to your left and look to your right, one of you may well not be here in four years.



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