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Key Trends in the U.S. Asset-Management Industry: Secular and Cyclical Headwinds

A closer look at the U.S.-based asset management industry’s profitability

Gregg Warren

 

Many of the traditional U.S.-based asset managers have benefited from a bull market in equities for much of the past decade. Concerns about that bull-market run ending sooner rather than later, though, have left the shares of most firms in our coverage trading at historic lows. In addition, ongoing pressures from poor active-equity investment performance and the growth and acceptance of lower-cost, index-based products have impacted organic growth and raised longer-term questions about fee and margin compression.  

Historically, we've found that it can often pay to stick with quality over price during periods of increased market volatility. This is because firms capable of generating consistent levels of organic growth and profitability, over a variety of market cycles, tend to maintain premium valuations to the group. Conversely, those failing in either regard end up trading at steep discounts.   

Below, we explore the anticipated landscape of the asset-management industry over the next three to five years. 

Secular trends: 5 potential headwinds to asset-management profitability  

Moving forward, we expect a handful of secular trends to impact asset managers’ flows, fees, revenue, and profitability. These trends could potentially limit the asset-management industry’s ability to generate the kind of outsized returns we’ve seen previously: 

  • An evolving regulatory environment for asset and wealth managers. Though asset and wealth managers saw little in the way of additional regulation in the aftermath of the 2008-09 financial crisis, issues of transparency, liquidity, distribution renumeration, and fiduciary standards have come into focus. 
  • Retirement phase of U.S. baby boomer generation. Baby boomers—individuals born between 1946 and 1965—began reaching the U.S. retirement age of 65 in 2011. The subsequent rise in annual withdrawals and rollovers has put pressure on flows for defined contribution plans, which had been a strong source of organic growth for U.S.-based asset managers during the 1990s and early 2000s. 
  • An increased focus on relative and absolute investment performance and fees. Many investors have become less willing to pay up when it comes to fees for investment products, especially when they believe they may not be justified by performance and investment outcomes. 
  • The ongoing secular shift from active to passive products. With $3.4 trillion in exchange-traded fund assets under management at the end of 2018, and another $3.3 trillion in index-fund AUM, the passive market has become a force with which to be reckoned. It continues to grow as more investors seek out lower-cost alternatives to active funds. 
  • Rising costs associated with investment performance and distribution. Regulatory, structural, and behavioral changes in the industry have increased the cost of asset management. Firms are now spending more to help improve performance and enhance distribution, ultimately squeezing profit margins.

Cyclical trends: 3 potential headwinds to asset-management profitability 

Similarly, we expect several cyclical trends to play a significant role in asset-management activity: 

  • Curbed U.S. and global economic activity. The current economic expansion has already gone on longer than most, so growth can be expected to slow eventually. The U.S. economic expansion, for its part, is already largely expected to peak in the next six to 12 months as the effects of the late 2017 tax cuts start to wane. 
  • End of the post-financial-crisis bull market. The fourth-quarter 2018 downturn moved U.S. markets closer to ending the bull market that started after the 2008-09 financial crisis. A sustained bear market would put further pressure on revenue and margins, as most asset managers have relied heavily on market gains to generate AUM growth over the past decade.
  • Industry consolidation. We expect to see consolidation, both internally and externally, as asset-management firms look to increase scale (as a means of minimizing the impact of fee and margin compression), enhance product offerings, and eliminate underperforming funds. 

With investors focusing on organic growth and profitability when assessing the U.S.-based asset managers over the past year, we’ve seen an even wider bifurcation within the group of 12 companies we cover. This division includes the perceived “haves,” which are capable of generating organic growth and maintaining margins, and the “have-nots,” which are expected to struggle to do both or have fallen into a pattern of poorer performance and positioning. 

While the group as a whole is now trading at price/earnings multiples not seen since the financial crisis, long-term investors may consider continuing to focus on quality over price. 

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The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission.

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