Watching the asset management bottom line in a normal growth environment

It's widely accepted that the tremendous financial asset growth of the 1990's was an anomaly. As the market returns to more normal growth, asset managers will need to focus on cost reductions rather than top-line expansion to fuel earnings. This is not a matter of simple cost cutting; merely reducing capacity will be insufficient. Instead, it requires radical reformation of the ownership of core business components and their underlying cost structures. This reshaping must start with a change of mindset -- from managing assets to managing a complete portfolio of operations.

Growth in household assets is one of the primary drivers of assets under management (AUM) in the U.S. From 1960 to 1990, growth in U.S. household assets closely matched overall growth in the U.S. gross domestic product (GDP).¹ However, throughout the 1990's, household assets grew at an average of 8.6 percent annually, while GDP grew at an average of 5.6 percent -- an annual difference of 3.2 percent. ² This tremendous ramp up in household assets was a primary driver of asset management industry revenue growth during the decade.

Since 2000, that trend has reversed. Household assets dropped 14 percent between 2000 and 2002 while GDP grew 7 percent.³ Problematically for the industry, growth rates for household assets will likely continue to lag behind GDP as they return to the standard growth path. In short, top-line growth rates of the 1990's are unlikely to recur.

Compounding the challenge presented by the slowdown in AUM growth are a number of other threats to revenue growth and industry profitability, including industry overcapacity, process redundancies, a shift in power to distributors, commoditization and new, lower-margin products.

Despite this adversity, industry analysts predict 14 percent annual earnings growth over the next five years for public U.S. asset managers.^4,5,6 With revenues projected to grow at about half that rate, reaching that target is daunting. In fact, the only path to achieving that growth is a dramatic reduction in cost structure. Specifically, the IBM Institute for Business Value estimates that with revenue growth of 7 percent, a typical asset management firm would have to reduce costs by 16 percent in order to attain 14 percent earnings growth.⁷

How best to achieve such ambitious cost reductions? The key lies in embracing and accelerating the industry trend toward specialization. As firms specialize, they not only shed inefficient and non-differentiating pieces of their business, but they also regain the opportunity to focus on optimizing those pieces of the business they consider core and have elected to retain -- those that add differentiated and sustainable value to clients.

To better understand the marketplace trends impacting future asset management strategies, IBM Institute for Business Value interviewed 51 executives from a variety of players in the asset management industry, including mutual fund complexes, institutional managers, hedge funds, pension funds, endowments, industry associations, investment banks and investment consultants. ⁸ These firms are based in Hong Kong, Japan, Singapore, England, Germany, Scotland and the U.S. Analysis of their industry perspectives suggests several key trends affecting asset managers.

To read the complete study, download the PDF file at the top of this page.