NEW YORK - The investment management industry has excess capacity, which will cause big changes during the next five years, according to a new report by Goldman, Sachs & Co., New York.
Some companies could grow to as much as five times their current assets under management during the next five years; 20 to 25 investment management companies will dominate the market by 2000, according to the report, "The Coming Evolution of the Investment Management Industry, Opportunities and Strategies".
Managing assets will become more costly and competition more intense as money management splits into two tiers, leaving the middle-market companies in a bind, according to Goldman's research.
Some companies with $30 billion in assets today will be able to find partners and grow to $150 billion or more in five years, said Mark P. Hurley, a Goldman Sachs vice president and one of the study's authors.
In the traditional institutional investment segment - defined benefit plans, foundations and endowments - 10 to 12 companies will have about 50% of the market in five years, said Mr. Hurley. Based on the current size of that segment, a 5% to 6% market share will equal $195 billion to $225 billion, he said.
The shakeout already has started, according to the report. Several managers told Goldman their pension clients plan to double the size of their average mandate, even though their defined benefit assets are not growing more than 5% per year, which means they plan to drop managers and concentrate their assets in fewer portfolios.
"When the shakeout occurs, some people gather immense amounts of market share at the expense of others," said Mr. Hurley.
But asset generation is becoming more difficult and costly, according to the report. Besides investing in technology and client service functions, money managers will have to add certified public accountants and lawyers to portfolio management teams to ensure the products meet clients' legal and tax needs.
To stay competitive, companies will have to develop separate sales forces that can make the kinds of presentations portfolio managers now make at clients meetings, the report said. The report mentions Brinson Partners Inc., Capital Group and J.P. Morgan Investment Management as companies that already have that ability.
Pricing will come under increasing pressure during the consolidation stage, according to Goldman's report. Fees will drop as sponsors concentrate more money on fewer large managers. One disturbing tendency, according to the report, is the increasing trend toward managers offering fixed-price contracts, where they manage several asset classes under one fee schedule. This practice will tend to undercut specialist boutiques.
The boutiques also will be under pressure from their own bottom lines. As large firms raid boutiques for specialist talent to offer clients, small firms will have to pay more to keep their investment professionals.
As the industry concentrates more, the disparity between core management and specialist fees will become more apparent, according to the report. Boutiques will have to show very good returns to compete.
The resulting firms in the consolidation will be global players that can manage money anywhere in the world; many of them will be under foreign ownership or in joint ventures with Asian and European financial institutions.
The report also predicted:
Mutual fund companies will lose assets as investors factor tax considerations into their investment decisions. Goldman's analysis notes several major mutual funds mix taxable and tax-deferred assets, and many investors will pull out of those mixed funds when they realize the effects of taxation on their net returns.
High-net-worth individuals will become increasingly important, but they are a difficult market to reach without referrals from accountants, lawyers and insurance agents. The managers will need to create a separate marketing and client service structure dedicated to the high-net-worth market.
Wrap account managers will have to compete more heavily with fee-based financial planners for the individual customer. Individual customers are becoming more sensitive to the high fees charged for wrap accounts, as well as the potential for excessive trading by brokers who get paid for transactions.
In order to get through the coming shakeup, managers have to decide which tier they belong in and how to anchor their position, according to the report. They need to gauge their capital, culture and skills and decide whether to buy or build.
The report also mentioned growth areas for investible assets, such as the small-plan segment of the 401(k) market.
Nearly 1.8 million U.S. companies have fewer than 100 employees, the report notes. While it is tougher to access, the competition in the small 401(k) market is less intense, the report said. Because companies that compete in the large plan market can't manage a small plan effectively, the lack of competition would allow providers to charge higher fees.
Additionally, continental Europe and Japan are facing a potential pension crisis, which offers U.S. money managers a great opportunity as private pension systems develop. U.S. firms have the advantage of greater experience in equity investing and mutual fund management.
Foreign firms have realized that, and are seeking U.S. and U.K. partners to compete, said the report. It notes both the acquisition of Brinson Partners by Swiss Bank Corp. and Jupiter Tyndall Group PLC by Germany's Commerzbank AG "presage many transactions that are likely to occur over the next 18 months."