The money management industry has experienced pretty much nothing but blue skies during the past 35 years. Bull markets propelled equities, while a steady decline in interest rates generated strong fixed-income returns.
Even the rise of alternatives managers still left plenty of assets to flow to traditional investment management firms for them to continue to enjoy growth. At the end of 2015, the worldwide institutional assets under management of the 500 largest money managers in P&I's annual survey totaled $36.12 trillion. Forty years ago, in the 1976 survey, the 331 investment managers then listed accounted for $250 billion in assets under management.
But the era of extraordinary returns that appeared ordinary now appears over. Economic and market forces threaten to transform the industry, even as the global investment managers reached an all-time high of $68.8 trillion in assets under management at the end of 2015, according to a McKinsey & Co. report released Nov. 2.
As the report said: “The North American asset management industry is on the brink of a once-in-a-generation shift in competitive dynamics, triggered by five converging trends that may be unprecedented in their combined impact.”
Asset owners should welcome change in the industry because it drives outcomes, especially innovation. The industry has continually transformed, mostly generating improved performance, lower cost and better outcomes. But those asset owners will have to adapt once again to such changes.
Transformations are nothing new to money management.
In the 1980s, the industry shifted away from the dominance of bank trust departments and insurance companies to independent, innovative investment management firms, attracting assets with their creative strategies and entrepreneurial business models.
But as passive management became more attractive, based on academic research and empirical evidence of active management underperformance and its higher fees, index fund managers increasingly gained prominence. For example, State Street Global Advisors, which ranked 19th in P&I's survey in 1986 with $12.2 billion in tax-exempt institutional assets under management, rose to rank first in 1996 with $198.1 billion.
The business has continued to shift as managers correctly rode investment trends. BlackRock Inc., which was founded in 1988, now ranks as the largest, in part because of its strengths in passive management and exchange-traded funds. The Vanguard Group rose to rank second, driven by its embrace of low-fees and passive management, defined contribution plans and innovation in target-date funds.
A low-return environment and weak economy are driving the potential for the newest transformation. No longer can asset owners ride investment management betas to meet expected returns. After the financial market crisis of 2008, asset owners strengthened risk management and turned toward derisking strategies to reduce volatility. But now a weak market could make passive management less attractive if returns fail to rise above the middle single digits. Yet reaching for returns could become more costly and riskier.
Among trends in both traditional and alternatives assets classes, managers increasingly are embracing sustainability investment management, incorporating environmental, social and governance risk factors in their analyses, to gain advantage. But ESG has yet to demonstrate a sustainable return and risk benefit.
Asset owners will have to strengthen their governance structures and investment policies to be able to adapt to new investment strategies as money management evolves. They will have to toughen their due diligence. They will have to be cautious in sorting out breakthroughs, such as indexing, from fads, such as portfolio insurance in the 1980s.