NEW YORK — The asset management industry's profitability reached a five-year high in 2005, but that rising tide has masked a growing divide between winners and "also rans," according to a report by McKinsey & Co., New York.
The report, McKinsey's fifth annual look at the state of the industry, concludes that less focused firms, as well as those with lackluster innovation, face an urgent need to revamp their business models to avoid falling further behind.
McKinsey said the average pre-tax margin in 2005 for its sample of more than 80 money management firms with a total of $8 trillion in assets under management came to an "impressive" 31%. For the previous four years, the average ranged between 25% and 28%.
For the latest year, however, the average margin for the top one-third of those firms was a full 41 percentage points higher than the average for the bottom third, up from a 38 percentage-point gap in 2004 and 32 percentage points in 2003.
While the gap was actually larger during the bear market years of 2001 and 2002, when it held steady at 43 percentage points, the latest trend covering a prolonged bull market reflects a new dynamic, McKinsey said.
The report traced that widening gap, in part, to the speed with which investors are separating alpha from beta.
Growing demand for "higher alpha" strategies, including "alternative" and international products, and "cheap beta" strategies, including index and active quantitative approaches, has left firms that are focused on traditional long-only strategies struggling to cope with soft demand and deteriorating pricing power, the report said.
On the higher alpha side, alternative strategies, including hedge funds, more than doubled in 2005 to 13% of overall assets under management, while on the cheap beta side, quantitative active strategies doubled to 16%. By contrast, traditional equity strategies saw their share sag to 29% from 32%, fixed income tumbled to 16% from 25%, and balanced slipped to 2% from 5%, McKinsey said.
Against that backdrop, the average long-only retail-focused strategy saw its fee revenue slip to 48 basis points, from 51 basis points in 2004 and 54 basis points in 2003, the report said. Balanced funds and large-cap equity funds suffered the sharpest declines. Fees for retail balanced funds dropped 11% during 2005, while fees for retail large-cap equity funds dropped 4%.
By contrast, the average traditional institutional product's fee revenue improved to 37 basis points from 35 basis points in 2004 and 36 basis points in 2003.
But "given the increasing polarization of flows to higher-alpha and cheap beta products, we believe that recent price declines in traditional core products are likely to continue," the report concluded.