Greater use of relatively high-priced alternative investments may help U.S. asset managers stay profitable despite increasing costs and the booming popularity of low-cost index funds, according to an analysis released Wednesday by McKinsey & Co.
In its report, “The New Imperatives: Gaining an Edge in North American Asset Management,” the consulting firm said flows to passive products accounted for nearly a quarter of the industry's asset-gathering but just a minuscule 5% of its revenue in 2013, the most recent year for which data are available.
By 2020, the firm estimated that the percentage of assets in passive strategies will drop to around 20% and its share of revenue will slip as well. Alternatives, on the other hand, will account for 15% of assets, up three percentage points from 2013, and a sizable 40% of revenues. Last year, alternative products accounted for about 33% of revenue across the global asset management industry.
Working against the industry is a steep jump in costs which, in the U.S., have gone up by 29% since 2007, driven by a higher cost of selling products through a consolidated retail brokerage industry, competition to improve technology and a greater spending on regulatory compliance.
That means growth in the asset management industry is “fueled in large part by the performance of financial markets” and by higher-profit alternative profits.
Alternatives, which include hedge funds and
private equity, accounted for three times the flows as passive products last year and the majority of the industry's new revenues, $4.4 billion, compared with $225 million brought in by index funds and exchange-traded funds.
In addition to index funds, ETFs and alternatives, specialty, active stock and bond managers and multiasset class products such as target date funds also grew in 2013, according to McKinsey.
But traditional asset categories, which McKinsey defines as including domestic equity, core and core-plus fixed income and money market funds, lost money to investor withdrawals in 2013.
“Moreover, the increasing competition for shelf space and fragmentation of adviser channels is challenging asset managers to meet sales and service needs in a scalable and cost-effective way,” according to the report.
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The report did not delve into a debate that McKinsey reignited earlier this year following
a recommendation that asset managers adjust their sales strategies in light of the fact that wirehouses — the top four U.S. retail broker-dealers — “increasingly struggle to acquire new customers” and “the growing number of advisers who are moving to independent broker-dealers or striking out on their own.”
Some say the so-called “breakaway broker movement” is overstated by press coverage and pundits favorable to independent-affiliation models for financial advisers.
“I think some of the reaction misconstrued what the report was saying, and that could be on us,” said McKinsey spokeswoman Allison Cooke Kellogg.
“Those firms are going to continue to be dominant,” she added, referring to wirehouses.
All in all, though, the new report is well within the mainstream of analysis of the fund sales business, which suggest the cost of distributing funds through advisers is simply getting higher.
For instance, a report earlier this year by the Boston Consulting Group Inc., a McKinsey competitor,
cited the industry's increasing cost burdens.
kasina, a specialty consultant for asset managers, earlier this year
asked firms to reconsider the high cost of compensating wholesalers.
And Cerulli Associates Inc., another specialty financial-services consultant, wrote recently that the largest broker-dealers have increased their “negotiating power” with asset management firms, pressuring those firms to “increase revenue sharing and strategic marketing partnerships.”
