Money management firms' pretax operating profits likely will be flat or fall in 2011 because of market declines and increased expenses, spoiling expectations earlier in the year of a full pre-crisis recovery, according to a survey by McKinsey & Co.
“Market volatility and the renewed risk of financial earthquakes in the second half of 2011 not only put a damper on these rosy expectations, but also called into question some of the industry's assumptions concerning the inevitability of profitable growth,” according to a report on the survey of 300 money managers.
In 2010 the money management industry's pretax operating margins had rebounded by five percentage points to 27%, just shy of the 10-year average of 28%. “It seemed possible the good old days were making a comeback,” the report said.
McKinsey's key finding from the survey was the increasing variability among individual firm's profits. The report said the top quartile of money managers earned an average operating profit margin of 46% in 2010, approximately 40 percentage points higher than the bottom-quartile of the industry.
The top performing asset managers reduced costs by one-third between 2007 and 2009 by leaving, or reducing their exposure to, low-margin businesses. Those money managers saw their costs relative to assets increase by 0.3 basis points, but saw growth of 33% in pre tax operating margins, McKinsey found.
In contrast, the report said, “depressed and in denial” asset managers that failed to act through the crisis belatedly cut costs in 2010 by around 3%.
The market gains in 2010 helped money managers in this group improve their profit margins in 2010, but they continued to lag the industry and they lacked the resources to invest in their growth, the survey found.
Another issue, McKinsey found, is that costs in the money management industry for the past two years have outpaced revenue growth, reaching record-high levels by the middle of this year. The report said that most money managers' costs grew an average of 11% in 2010 and the first half of 2011.
The root causes of higher costs, according to the report, were increases in staff, average compensation, technology and outsourcing.
While almost all money managers can have good and bad years in terms of net new flows, only about 20% of the more than 300 surveyed have sustained above-average net new flows and growth for a decade, the survey found. For example, from 2002 to 2007, less than 50% of money managers were able to sustain growth that was above the five-year weighted compound annual growth rate of 14%.
The survey found investment performance clearly matters to overall growth, but that it only explains just more than a third of net new flows over the past decade.
While none of the growth leaders had poor investment performance, none had the best, either, the report said. Rather, money managers that had superior net flows combined solid, sustained investment performance, business model advantages (often aided by M&A or strategic shifts) and explicit resourcing decisions about where and how to compete, the survey said.
The McKinsey report said independent money managers have outperformed bank- and insurance-owned firms on growth over the past decade because of M&A and a greater ability to recruit and compensate talent through the crisis.
Independent asset managers held 54% of assets under management of the firms surveyed in 2011 compared with 28% in 2002, according to the report. The survey was based on research conducted by McKinsey in 2010 and 2011.