Providing outsourced asset management services may soon become a less lucrative proposition, according to a report from Boston Consulting Group (BCG). Sweeping losses to client portfolios are already resulting in equally expansive profit declines for asset managers.

Average operating margins fell to 34% of net revenues at the end of 2008 — the lowest level in five years from 38% a year earlier — and are likely to fall to 30% or lower in 2009.

And in wake of such global decimation of equity markets, institutional investors are also expected to reduce their equity allocations from 55% in 2007 to 35% to 45% by 2015. The report reveals that professionally managed assets fell globally by 18% to $48.6 trillion in 2008, compared to an average growth of 12% per year from 2002 through 2007.

The overall damage has been worse than the dotcom bubble early in the decade because more investors have been hurt in asset classes presumed to be reliable.

As a result, institutional investors have already started to require more product transparency and are unwilling to pay higher fees for actively managed products that deliver returns similar to those of passively managed products. Retail investors are also demanding greater product transparency, while regulators have intensified their scrutiny of the investment industry.

Ultimately, BCG says, asset managers must face the fact that investor trust has taken a severe hit that may take years to repair.

From an asset allocation standpoint, money market funds (which benefited from more than $1.5 trillion in net inflows from the beginning of 2007 through 2008), exchange-traded funds and savings deposits have emerged clear winners of this crisis.

The report describes three possible scenarios for the future: Armageddon (the most pessimistic), Recovery (more optimistic), and Happier Days (the most optimistic).

Whatever scenario plays out, one thing’s for sure: Going forward, markets will see a decline of long-only equity products as investors review their risk versus return profiles and growth in fixed-income products as pension funds move assets into less volatile securities with the retirement of baby boomers. Also expect an increasing shift into passively managed products; a shakeout in alternative products (which will nonetheless remain an important asset class as investors seek diversification); and interest in tailored investment solutions.

The report also suggests a higher degree of industry consolidation as more large financial groups exit the asset management business to focus on other activities. The report says in a hypercompetitive market, subscale players or those with weaker value propositions will have no option but to leave the business. This situation will allow some asset managers to consider mergers and acquisitions to reinforce core businesses or move into markets that were previously seen as too expensive or closed. Some M&A activity will be driven by industrialization logic, as more asset managers create “factories” for their traditional range of funds to gain scale advantages.

(07/07/09)