The asset management industry has been hit by shocks over the past 18 months. Surging inflation and interest rates were the defining disruptions, compounded by a market downturn, banking turmoil, and geopolitical upheaval.
Our 2023 review of the sector explores five themes in this challenging environment:
- The industry is down but not quite out, with aggregate industry economics holding up relatively well, particularly when compared with prior crises.
- Market stresses have accelerated long-term shifts in industry structure (such as active versus passive, the rise of platform business models, and the adoption of new investment vehicles), widening the gap in performance between leading and laggard firms and narrowing the path to success.
- The industry faces a period of structural adjustment to the new reality of a higher-for-longer interest rate environment, which is upending business models that feature high leverage, complex liabilities, or significant liquidity and duration mismatches.
- This structural adjustment creates an unprecedented money-in-motion opportunity for asset managers to expand their roles as financial intermediaries: assets and liabilities are gravitating beyond the balance sheet into the world of capital markets and professionally managed assets.
- Asset managers need a trifocal agenda of growth, operating effectiveness, and productivity, simultaneously repositioning their firms to capture the tailwinds of new growth while retooling their operating models to deliver capabilities with customization and scale.
Down . . . but not quite out
In an industry that had enjoyed a decade of nearly unbroken growth, 2022 marked an unusual year of significant contraction. Global assets under management declined by 10 percent as markets surrendered a substantial portion of their pandemic-era gains. Net flows slowed and clocked in at near zero in every region apart from Asia–Pacific. Total global net flows registered 1.1 percent, in contrast to the norm of 3 to 4 percent during the past decade (Exhibit 1).
The economic impact was significant, with industry revenues for asset managers based in North America experiencing an 11 percent decline. Profitability also suffered, though margins were closer to pre-pandemic levels rather than those experienced during the 2008 global financial crisis.
Profit-margin declines reflected an inflexible cost structure in the face of falling revenue. In the pandemic era of 2019–21, the asset management industry’s cost base grew by $24 billion, or 19 percent. Yet in the face of a significant revenue shock in 2022, that cost base contracted by just $4 billion, or 3 percent, attributable mainly to the automatic stabilizers of lower variable compensation for investment management and distribution professionals (Exhibit 2).
While the first half of 2023 showed some signs of optimism, with positive net flows across many asset classes, what has emerged so far is a lower-margin recovery. Clients have been reentering the market in lower-fee passive and fixed-income strategies, while higher-fee active equity strategies are again in outflows, and private markets fundraising has pulled back.
An increasing wedge between the industry’s haves and have-nots
Market volatility has affected industry structure. This is reflected in a growing gap between the industry’s best and the rest, in terms of organic growth and profitability.
The gap between the profit margins of top- and bottom-quartile performers in our Global Asset Management Survey has grown from 37 percentage points in 2021 to 43 percentage points in 2022. Top performers were able to hold their ground in a stressed environment, while those at the bottom faced significant revenue contractions and had difficulty reducing costs (Exhibit 3).
Drivers of the widening performance gap
Market stresses have contributed to widening the performance gap between leaders and laggards over the past 18 months. Our research suggests four major drivers of this trend: a difficult environment for active management, customer adoption of new investment vehicles, growth of platform-based business models, and differences in the effectiveness of firms’ operating models.
Structural outflows in active management offerings, particularly in equities, have exerted a drag on growth for many firms focused on these strategies. In our latest review of active strategies by investment performance and pricing deciles from January 2021 to June 2023, we found that only a small share of active equity funds were able to achieve positive net flows. These tended to be funds with top-decile performance, and even in that category, not all experienced positive net flows, suggesting an increasingly narrow path to success.
The industry’s accelerating adoption of new vehicles that deliver strategies in more efficient and flexible ways has been another source of the performance differences among asset managers in North America. Between 2018 and the first half of 2023, actively managed US exchange-traded funds (ETFs), collective investment trusts (CITs), and separately managed accounts (SMAs) together garnered positive net flows of $500 billion. These inflows made up for about a third of the $1.6 trillion in mutual fund outflows over that period.
Business model changes made by asset managers have also affected performance. Platform-based business models, long established in the technology sector, have started to take root in the world of asset management and now account for a disproportionate share of growth in the industry. Platform business models allow asset managers to create deeper (and in many cases direct) relationships with clients, often by extending reach into different parts of the investment management value chain, moving beyond the delivery of relatively narrow investment products. Collectively, firms using these platform business models have captured a disproportionate share of growth.
Finally, asset managers’ operating models also played an important role in driving differences in operating performance, particularly in profitability. Firms that created highly scalable operating platforms with built-in operating leverage generally proved to be more resilient in their ability to remain profitable in a highly volatile year. Similarly, firms with greater organizational agility were able to pivot and reallocate resources toward areas of growth.
Structural adjustments and once-in-a-generation opportunities
As with any disruptive event, new stresses can lead to new ways of doing business. Asset owners of all stripes are open to alternative intermediation channels as midsize US banks cope with bond market losses, deposit flight, a decrease in lending activity, the preemptive restructuring of potentially impaired assets, and the potential of increased regulation. Where some banks pull back from parts of the market, opportunities arise for asset managers to play the role of alternative lenders or havens for investors looking for yield.
We highlight four opportunities for asset managers arising in this new environment.
Dash for cash
The radical shift in interest rates has made the old quip of “cash is trash” appear outdated. Cash isn’t just a safe haven anymore; it is an asset class with a respectable return, and investors are literally being paid to wait. These factors have triggered record inflows of more than $600 billion into money market funds in the first half of 2023.
Beyond inflows, the business of liquidity has become far more commercially attractive as asset managers have been removing fee waivers on money market funds, which were commonplace during periods of low interest rates to keep investors’ yields from dropping below zero. As a result, we estimate that the revenue pool for money market funds in the United States has more than doubled over the first eight months of 2023 to about $13 billion, not far behind the revenue represented by other large asset classes such as multi-asset funds, estimated at $15 billion.
Amid the growth in cash as an asset class, the key challenge for asset managers is retaining shorter-term assets that have migrated into the industry from the depository system. To broaden their structural role in the liquidity ecosystem, asset managers should consider these steps:
- Provide cash segmentation services that optimize balances by investment horizon and liquidity needs, as well as laddering across different investment instruments (e.g., short-duration fixed income) to deliver customized liquidity with superior yields.
- Offer liquidity solutions tailored to the needs of larger corporate clients (e.g., dynamic portfolio management in SMAs) and smaller clients (e.g., liquidity-driven bond ladders).
- Deepen their investments in technology (and integrations with client-facing cash management technology platforms) to increase the stickiness of their liquidity services.
A new future for fixed income
Higher interest rates have led to a recalibration of the role of fixed income in asset allocation. What was once viewed primarily as a low-risk diversifier has become an increasingly attractive source of income, now that risk-free yields sit at roughly 5 percent. When combined with long-term trends (e.g., the retirement needs of an aging population, default asset allocation shifts in target date funds), demand for fixed income is expected to be robust in the coming years. However, fixed income has been changing in three important ways: more use of ETFs, more illiquid credit, and a bigger role for insurance balance sheets and reinsurance-oriented entities.
An evolution in private markets
The relentless growth of private markets alternatives has undoubtedly been one of the most important trends reshaping the asset management industry over the past decade. However, macro and market conditions have created a fundraising slowdown. Annualizing first-half fundraising for the remainder of 2023 would result in fundraising figures closer to the roughly $1.1 trillion raised in 2020 than to the fundraising peak of $1.5 trillion reached in 2021.
Still, the longer-term outlook for private markets demand remains robust. A recent McKinsey survey of about 300 institutional investors showed that half aim to allocate more to private markets asset classes over a three-year horizon, as opposed to the 35 percent who plan to do so over the next 12 months.
A reset in real estate
Commercial real estate has quickly emerged as one of the most talked about sub-asset classes in the industry, given the intersection of massive shifts in usage patterns post-COVID-19 and financial tightening on highly leveraged assets. Nowhere is this more evident than in the office segment, where valuations have fallen 24 percent in the year ended in July 2023. The situation is further exacerbated by the looming refinancing cliff of more than $1.2 trillion in commercial mortgages scheduled for renewal over the next few years, necessitating refinancing at markedly elevated interest rates.
We estimate that collectively, these four disruptions represent a potential $5 trillion money-in-motion opportunity over the next five years, with the prospect of shifting significant pools of assets into the world of third-party investment management. If asset managers are able to capture these opportunities, they stand to assume a far more expansive role within the capital markets ecosystem.
An agenda for navigating this new environment
The past 18 months have ushered in a new normal for asset managers—a sharp departure from the decade that came before. Adjusting to this new structural reality will require a trifocal agenda: coming up with new strategic positioning for investment and product platforms, reengineering operating models to create greater flexibility and agility, and upgrading firms’ execution engines, focusing in particular on distribution and strategic partnerships.
Beneath the challenges that asset managers experienced this year lies significant opportunity. As the financial markets ecosystem undergoes a once-in-a-generation transformation, asset managers have the potential to play a bigger role in the world of finance while helping meet clients’ needs in an increasingly uncertain environment.
