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Industry Gearing Up For 'Two Speeds'

Although worldwide assets under management rose 8% in 2010 from the previous year to $56.4 trillion and profit margins gained two percentage points to 33%, the industry faces a number of challenges for continued growth.

Most notably, assets managers are heading into a "two-speed world" with low-cost beta products on the one hand and exotic alternatives and outcome-oriented products on the other.

That was the key finding in Boston Consulting Group's report released last week, "Global Asset Management 2011: Building on Success."

The biggest challenges include a weak economic recovery, more demanding retail and institutional investors emerging from the financial crisis; continued demand for safe-haven, passive, low-margin products; weak inflows to equities and other funds with higher fees; tighter regulations; and widely diverse markets that makes creating a cohesive sales and marketing strategy extremely difficult.

In the U.S., additional risks include rising commodity prices, high unemployment, continued weakness in housing and budget deficits among the private and public sectors that will take years to unwind, according to BCG.

"It will be an exciting and unpredictable industry going forward," said Monish Kumar, senior partner and leader of BCG's U.S. East Coast Financial Institutions practice.

"Economic uncertainty lingers, and the full potential of money in motion will be difficult to capture," Kumar added. "The question of how to achieve further growth in both mature and emerging markets is a daunting one. Asset managers will need to forge thoughtful strategies in order to build on the successes we have seen."

Boston Consulting Group emphasized that while global assets grew in 2010, that growth was primarily driven by the continued recovery of the equity markets, much as in 2009. Net new inflows were only marginally positive, rising slightly less than 0.5%.

Inflows varied greatly by region, as well, with the Americas posting net outflows of 0.4%. Asia-Pacific saw inflows rise 5.6%, and in Europe, asset managers posted net outflows of 0.4%.

Total AUM also varied by region. The strongest growth was in Latin America, where assets soared 18%. North America's AUM rose 8%, led by the United States at 8.5%. Assets in Europe rose by 7%, and in Japan and Australia, assets rose 2%, whereas in the rest of Asia, assets increased by 11%.

This rise in assets boosted profitability for managers, with average revenue margins increasing to 29.8 basis points, up from 29.0 basis points in 2009. Costs remained steady at 20 basis points.

While profit margin as a share of net revenues reached 33% in 2010, it is still considerably lower than the 39% it reached in 2007 just before the Great Recession began.

"Profits are still 23% below 2007 levels because assets have not returned in a meaningful way to equities," Kumar noted. "There is a more conservative bent to the money being invested and much faster growth in low-cost beta products. There is a secular dimension to this. Nonetheless, in 2010, 42% of asset managers' profits increased by 30% or more."

These healthy profit margins have dissuaded parent companies to divest their asset management units, with the pace of mergers and acquisitions slowing in 2010, BCG said. However, M&As are likely to pick up as firms look to offer alternative products or move into emerging markets, BCG predicted. By 2014, assets under management in emerging markets should deliver 10% to 12% of asset managers' revenue, BCG predicts.

"You can see that there is widespread good news across the asset management industry. However, there are a number of headwinds," Kumar said.

As to why investors have become more demanding, Brent Beardsley, partner and topic expert for asset management in the U.S., said the financial crisis and the Bernard Madoff ponzi scheme have made institutional and retail investors far more cautious.

"Investors are more demanding on the institutional side," Beardsley said, "with a long due diligence cycle that includes thorough, sophisticated risk management analysis and greater requirements for transparency. On the retail side, distribution platforms are becoming more institutionalized, and brokers are using more wrap programs, which means they accept fewer products on their shelves."

As to what types of funds investors are now looking for coming out of the recession, Beardsley said that in the early 1990s, there was a "massive equity bull run" and in the 1970s, investors poured into gold and commodities.

Boston Consulting Group does not expect investors to once again embrace equity funds but to instead gravitate to a bar-bell mix of passively managed index and exchange-traded funds on the one hand, and alternative and outcome-oriented funds such as target-date and absolute-return funds on the other hand, Beardsley said.

While actively managed assets still account for 80% of global AUM and are expected to remain above 70% for some time, their share is slowly declining, BCG said.


A 'Two-Speed World'


"This two-speed world will put a massive squeeze on traditional, long-only equity fund managers," Beardsley said.