The year ahead will be tough for fund managers globally a new Deloitte report argues as margin squeeze, ongoing technological disruption, regulatory pressure and consumer revolt come to a head.
According to the Deloitte ‘2018 Investment Management Outlook’, the average funds management business “will likely be less profitable and have roughly the same assets under management (AUM) at the end of 2018 as in the beginning, even in a continuing bull market”.
“While some firms will likely thrive, overall the operating environment for the industry is likely to be difficult in 2018,” the report says. “Firms are expected to face margin compression as investors favor low-cost investment solutions, while at the same time the case for alpha may be difficult to make for many IM [investment management] firms.
“Further, operating models at many IM firms could continue to face challenges while keeping pace with environmental changes driven by regulators, changing customer preferences, and advancing technologies.”
Managers will have to consider multiple strategies to avoid the fate of the average with Deloitte tipping mergers, outsourcing and new client service models to jump in 2018.
The study says mergers have been increasing as fund management firms seek margin protection in scale and business diversification.
In 2016 the global funds management industry witnessed 217 merger deals, the report says, almost double the number compared to three years previously.
“The strategic importance of these deals is clear. The average transaction size has jumped as well, with 2017 witnessing a few big-ticket transactions,” the paper says citing the £11 billion Standard Life/Aberdeen Asset Management hook-up as a prime example of the trend.
Size has proven particularly effective for the three main beneficiaries of the passive juggernaut – BlackRock, Vanguard, and State Street – which collectively scooped up 70 per cent of net cash flows in 2016, Deloitte says.
“In the past year, the top three IM firms reported steady margins of about 34 percent while other public IM firms reported an 8 percent margin decline to 23 percent,” the report says.
However, active managers can still carve out a place in an increasingly passive environment by offering proof of their alpha-generating credentials.
“One of the keys to success for active mutual fund managers is to credibly ‘make the case’ for alpha, which likely starts with having a product lineup with high ‘active share,’ meaning the percentage of holdings in a portfolio that differs from the benchmark index,” the Deloitte study says. “Beyond that, managers demonstrating a well-capitalized and differentiated process to uncover investment opportunities will likely see more success.”
Managers will also look to streamline operations by outsourcing more functions, the report says, bolstered by the growing confidence in external service providers.
“Over the past few years, many IM firms have started to rely on full-service providers for various front- and middle-office functions, such as dedicated trading desks and settlement functions,” the report says.
During 2018 Deloitte says fund managers should also turn their attention to servicing the emerging ‘millennial’ generation with digital strategies coming to the fore.
While millennials currently may hold the minority of assets over the next 15-20 years the generation in Europe and US could control almost US$30 trillion, the report says, indicating early-adopter investment firms could earn long-term loyalty.
“There is typically value in identifying the leading indicators that significant change is coming,” the paper says. “In this case the test seems to be whether low-cost, low-touch digital investment products and services can gain enough traction to transform investment management.”
Generally, fintechs and fund managers will “continue to complement each other”, Deloitte says, in developing innovative products for niche markets.
“Robo-advice is expected to see continued, but slowing, growth as the base expands,” the report says.
Overall, the Deloitte paper says 2018 is shaping up as the “year of exceptions” for funds management.
“Some exceptional firms could get the elements of growth, agility, and service right for their unique strategies,” the report says. “Executing these plans may also set them up to deliver on their brand promises to current and future investors, whether that be risk-adjusted return, alpha, or another important customer experience metric.”