There is little doubt that the mega-trends of the last several years have thrust the investment management industry into a period of transformative change. While still buttressed by a strong tailwind of asset-price inflation, investment management firms are facing increasing risks as the relentless downward fee pressure and passive flow migration threatens revenues and profits and, for some firms, their very existence.
Faced with the same profit pressures, the major fund platforms have been winnowing their fund offerings, leaving an increasing number of smaller or underperforming funds on the outside looking in. At the crux of the problem are clients who act on the belief, justifiable or not, that active managers provide no net value. These trends are now calcified in the structural framework of the industry, presenting a serious existential threat to a five-decade old business model.
We’ve chronicled these trends in past articles over the last couple of years as have all the top industry observers. However, as the industry begins to grapple with the key issues, we wanted to take a deeper dive to better understand the forces at work. For that, we turned to Avi Nachmany, former Director of Research and co-founder of Strategic Insight, a leading business intelligence firm for the asset management industry.
We asked Avi what he sees as the key drivers of the trends that are having the biggest impact on investment management firms.
Shift Towards Asset Allocation Diminishing Active Funds’ Role
“There are several that are having the impact of driving down investment management firms’ profitability and amplifying competitive trends. However, the one development that appears to be accelerating the most is the increasing use of asset-allocation solutions among wealth managers and mutual fund distributors.”
Avi points out that asset allocation solutions, such as wrapped funds and ETFs, standalone funds with balanced strategies, and target-date funds now comprise 80% to 90% of mutual fund sales made by financial advisors.
Increasing Standards of Performance Excellence
Among the many ways the broader use of asset allocation protocols impacts mutual fund firms is the pressure by financial advisors to increase the standards of performance excellence for actively managed funds. For example, when considering an asset allocation solution, financial advisors are increasingly looking to top decile/quintile actively managed funds to match with index funds, ETFs or smart beta funds. That is, if they consider actively managed funds at all.
Because financial advisors and fund selectors are becoming increasingly product agnostic, once a fund falls out of the top tier, they are quicker to remove it from an asset allocation-based portfolio or drop it from the recommended select list.
Asset Allocation Driving Low Cost Solutions and Fund Liquidations
In addition, the increasing pressure to deliver low cost investment solutions is driving advisors and fund selectors to focus on low-fee share classes. More than 80% of new fund sales are in this category. And, with the growing emphasis on fee-for-service compensation there is a greater likelihood of the emergence of a “clean share” class that will put even greater pressure on profit margins.
According to Avi, the fallout of these new trends has already begun, with an acceleration of fund line rationalizations through a slowing of new actively managed fund introductions and faster liquidations of aging or subscale younger funds. With a greater focus by fund companies on expenses and fund performance, he foresees continued closures of small and underperforming funds.
Turning Threats into Opportunities
Although the current trends seem to be strengthening, Avi notes that, through greater awareness and thoughtful planning, firms can confront the challenges and turn threats into opportunities. Planning for their future, firms need to address several key issues that will test their business models as well as their investment strategies.
The critical question is what is the investment manager’s strategy for AUM growth? Drilling down, firms need to consider several key issues, including:
- What distribution and investment opportunities exist beyond the U.S.?
- Do we need to expand our investment vehicle range or distribution footprints, or both?
- How can we use profits from surging stock prices to re-invest strategically?
- How do we protect our talent’s depth and range?
Whatever form their business models and investment strategies take in the future, achieving growth will require firms to differentiate themselves with a good story to tell and full-scale strategy for communicating it. They must be able to demonstrate their value through effective sales, marketing and public relations campaigns and gain competitive advantages through advanced capabilities in data-driven decision-making.
Without exception, every firm, small and large, should continue to think strategically by identifying the vital issues and mapping out a plan for its stability and growth.
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