McKinsey report: ‘Solutions-oriented’ assets to hit $2 trillion in 5 years

Outcome-oriented solutions have become one of the few significant growth opportunities in North American asset management and could upend the nature of the industry, according to a McKinsey & Co. report released Thursday.

McKinsey expects solutions-oriented assets to double to $2 trillion within the next five years.

“Institutional investors, particularly sponsors of defined benefit pensions, are … actively seeking outcome-oriented solutions as they attempt to cope with worsening plan deficits and liability management,” according to the report, “The Asset Management Industry: Outcomes Are the New Alpha”

Growth opportunities are shifting rapidly away from seeking alpha or “the relative performance game that has dominated the industry for decades to three key categories: passive products, outcome-oriented solutions and alternatives,” the report said.

Since 2007, a few “focused asset managers have been capturing a highly disproportionate share” of inflows within each of the three fast-growing categories — from 59% to 100% for the top 10 firms alone — “but with few winning across more than one category” and none across all three, the report said.

More than $1.3 trillion combined flowed into the three categories from Jan. 1, 2008, to June 30, 2012, while some $400 billion flowed out of relative return equity strategies over the same period.

Among the three growth categories, passive investments includes index and exchange-traded funds; solutions includes target-date funds, Treasury inflation-protected securities and 529 college savings funds; and alternatives includes strategies in 130/30, long-short, options arbitrage, absolute return, volatility and currency trading.

“Traditional means to achieve growth — namely beating a benchmark — are no longer proving sufficient and account for just over one-third of the average asset manager's growth,” the report said. “More critical now is meeting a changing set of client needs, which increasingly means shifting from alpha to outcomes.”

“Focused business models – for example, global specialists or retirement specialists – have gained share at the expense of generalist firms that have spread their bets, often in an unfocused way, and failed to win in any of the big three growth categories,” the report said.

Profitability of the North American asset management industry was off 19% as of Dec. 31 from the pre-financial crisis level of 2007, because of increased costs, reduced productivity and lower pricing, the report said. It is off 16% in 2012, based on asset managers' projections for this year from 2007.

Overall growth has stagnated, with aggregate assets under management recovering from their pre-crisis level, up a predicted 2% in 2012 from 2007.

“Market performance is accounting for virtually all asset growth in the U.S.,” the report said.

It “is now the lifeblood of the industry — clearly, an unstable foundation on which to move forward.”

The full report can be found on McKinsey's website.