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Curatia Analysis for Mon, Aug 12

Go Big, Go Small Or Go Home — the Future of Asset Management?

Recent prognostications suggest a bipolar future for asset managers in which behemoths capitalize on economies of scale, while boutique firms differentiate themselves using active investing strategies and superior research.

But with that trend slated to unfold over a long time horizon, factors from economic cyclicality to accelerating tech innovation and regional regulatory differences could intervene.

Polarity

A recent report from BCG predicts a reckoning for asset managers over the next decade as relentless fee compression cleaves the industry into behemoths and boutiques.

With investments in technology platforms, expansion into new markets like Asia and Latin America, and diversification into private capital likely to be primary drivers of industry growth, large firms will seek to leverage economies of scale to claw their way to profitability.

Boutiques will meanwhile compete on the basis of exceptional returns from active investing strategies founded on superior research, data and analytics. Squeezed middle-market firms will resort to consolidation to compete, leaving an increasingly bipolar industry.

Those trends already appear to be unfolding. Among ETF strategists the market share of the Big Three asset managers (BlackRock, Vanguard, State Street) grew from 0.6% in 2014 to 23.6% in 2018.

Despite such gains, small asset managers are disproportionately represented among 2019’s best-performing funds. Through June, eight of the 10 best-returning ETPs in 2019 had less than $100M in assets, and none was run by a mega-manager.

An October AMG study found that, from 1998 to 2018, boutique asset managers beat their larger peers by 62bp annually and outdistanced relevant indices by 135bp.

Market Implications

Mega-managers meanwhile continue to hold ever-greater sway over public equity markets in the US. BlackRock, Vanguard, and State Street already control one in five S&P 500 shares — a figure projected to jump to one in three over the next two decades.

The trend raises questions like whether asset managers are prepared to embrace corporate stewardship and how the concentration of assets with the largest firms will impact trading.

So far, the Big Three have taken a “cautious approach” to stewardship, per an academic report, opposing corporate managers in votes on executive compensation “‘very rarely’” and seldom opposing managers in proxy fights against activists — characterizations with which all three mega-managers disagree.

With younger investors becoming increasingly ESG-conscious, though, the question of how large asset managers vote their shares only figures to grow in importance.

Separately, asset management’s burgeoning top-heaviness has prompted speculation that a sea of sameness in public equity holdings could prompt herd behavior in trading or, worse, trigger a liquidity crisis during market turbulence as fund investors flee en masse.

Potential Disruptors

Still, studies tracing tectonic shifts in asset management have adopted long time horizons, leaving them open to a high degree of uncertainty.

Whether a steep market downturn could reverse the investor stampede into low-fee index funds that has defined asset management trends for the last decade, for example, is anyone’s guess.

In addition, the advantage of the largest asset managers in tech R&D competition may be overstated. Asset managers as a whole have conspicuously lagged sell-side firms in budgeting for R&D, suggesting the emergence of tech platform vendors servicing all asset managers (including middle-market firms) is as likely as an epoch of big-firm dominance.

Finally, mega-managers hope to flex on smaller rivals by undertaking capital-intensive expansions into promising areas like emerging markets and alternative investments. But those initiatives carry considerable execution risks themselves such as regional regulatory differences and competition from entrenched and equally well-capitalized incumbents.

For those reasons — and others beyond our ken — predicting the structure of asset management ten years hence may ultimately prove as elusive as predicting today’s asset management landscape would have been a decade ago.