Accelerating Into the Curve

Achieving Success in a Challenging Market

Findings of the 2003 McKinsey/U.S. Institute Asset Management Benchmarking Survey

Introduction A Difficult Environment Keys to Future Growth and Profitability Growing and Retaining Assets Achieving Market-Leading Profitability Appendix – Survey Participants 2 3 6 6 9 17



This report contains the findings of the 2003 Asset Management Benchmarking Survey by McKinsey & Company and Institutional Investor magazine’s U.S. Institute. This industry-leading benchmarking effort involved more than 55 firms with $5 trillion in assets, nearly one-third of the industry total. As such, it provides a comprehensive view of the true economics of the U.S. asset management business. It also offers senior managers a diagnostic tool to assess their competitive positioning and identify high-priority opportunities for the future, using a set of clear, integrated metrics. Our survey covered the participants’ full-year 2002 economics. Overall, we found that, in spite of a tough stock market and challenging competitive conditions, a small set of leading firms demonstrated the continued potential for high growth and profitability in asset management. However, success is no longer a given, as it was for many firms during the bull markets of the last decade. As the results highlighted in this report show, the gap between strong and lagging firms is substantial and is likely to widen. Today, the most successful firms employ distinctive approaches to managing the entire firm, not just investment performance. Our survey revealed a number of key revenue and cost levers that consistently differentiated these top performers. This report combines the survey results, along with our conversations with senior managers across the industry, to highlight how managers can guide their firms to produce extraordinary performance, and accelerate ahead of the pack.

A Difficult Environment
It is not news to any active participant that the asset management industry has faced a difficult operating environment for several years, coupled with doubledigit equity market declines. What is news is that, in the face of these challenges, a minority of leading firms achieved strong profits and/or maintained significant asset growth while, industrywide, margins and assets fell. As a whole in 2002, the U.S. asset management industry delivered average profit margins of 25 percent, down 2 percent from the previous year. This reduced profitability for the industry was caused by average asset declines of 9 percent, offset in part by average cost reductions of 8 percent (Exhibit 1). However, the industry’s increasing challenges are separating the winners from the rest of the pack, creating a dramatic gap with bottom performers. Indeed, while the top third of all firms had average profit margins of 46 percent, the bottom third averaged only 3 percent. However, it was not only large fixed-income or money market firms that excelled. There are firms of all sizes, client segments and assetclass focuses that delivered outstanding profitability (Exhibit 2).



Just as with profits, the gap in asset growth between winners and losers was also stark. While the top 10 percent grew assets by greater than 10 percent, fully 20 percent had asset declines in excess of 20 percent. Broken down by segment, fixed-income firms, on average, clearly grew more than others in 2002. However, there were a number of firms in each segment that delivered market-leading growth (Exhibit 3). Looking forward, the challenges of the industry will likely continue to increase the performance gap, with a minority of firms achieving distinctive growth and profitability, while the majority work hard just to maintain assets and their current profit margins. Most firms believe that achieving the profitability levels of the late 1990s will be challenging. Therefore, many have lowered their forward-looking profitability targets (Exhibit 4). However, we believe the future should not be about lowered expectations. Rather, we feel firms should place an increased focus on developing the skills and capabilities required to achieve market-leading profitability and growth levels.


Keys to Future Growth and Profitability

The 1990s provided an environment in which simply being in the race was good enough to obtain exceptional performance. In sharp contrast, the current decade is placing a premium on senior management strategic decision making, and operational execution. Well-managed firms will continue to distance themselves from competitors that rely on market appreciation for revenue growth, and pay little attention to strategic choices or excellence in execution. We are already seeing this pattern emerge, after just 2 years of our benchmarking survey. For instance, many of the firms that were most aggressive in adjusting their cost structures to declining asset levels not only achieved greater profitability, but also had smaller declines in assets (Exhibit 5). The most profitable firms continue to manage core growth and profitability levers more effectively.

Given the maturing U.S. investment management market, and the equity market declines of the past 3 years, senior managers have now put finding ways to achieve growth at the top of their agenda. The survey revealed that the average firm’s assets under management declined 9 percent in 2002, following a decline of 1 percent in the prior year. The range of growth for the surveyed firms spanned from a high of 39 percent growth to a decline of 51 percent. The most


successful firms understand that, in the future, organic growth in most U.S. markets will continue to be modest. As a result, they are focusing on growing through three alternative levers: Leverage core strengths. The most successful firms continuously leverage their core strengths and aggressively extend into new markets and products that will augment growth and profitability. For example, over the past few years, many successful institutional firms have focused on the sub-advisory market, achieving double-digit growth rates. Many of these winners have also launched products that satisfied investors’ current needs, such as high-yield bond funds. However, careful assessment of new growth opportunities is critical, not only to drive growth, but also to maintain and enhance profitability, as the evidence shows that dabbling is a major drag on profits (Exhibit 6).

Improve sales skills to steal share. There is little doubt that institutional and retail clients are continuing to become more sophisticated, and are demanding new and improved sales and service capabilities from their asset managers. On the institutional side, leading firms are discovering ways to provide better service across DB and DC plans, by segmenting their servicing and client relation-


ship management approaches, improving reporting, broadening their participant servicing and education, and other steps. In retail, the bar for distinctive wholesaling is rising, as is the cost, due to a number of factors. These include the proliferation of new products, such as 529s and separate account wraps, and the addition of new channels for many of these products, such as independent broker dealers, coupled with rising advisor expectations for service. Advisory firms and their advisors want investment solutions linked to holistic advice, not “the product of the day.” The most successful asset management firms view these changing client preferences as a real opportunity to distinguish their sales forces, and steal share from competitors. They are actively transforming their sales forces and practices for distinctiveness. An important prerequisite to this transformation is first identifying the underlying drivers of strong or weak sales performance. And, a critical first step in that process is gaining an understanding of current sales performance by product, within each client segment (Exhibit 7).


Focus on existing asset base to boost retention. Many in the industry have long believed that investment performance is the only thing that influences retention. While it is clearly a major driver, our survey reveals that there are other important levers that can have real impact on reducing outflows. For example, firms that invest in client servicing also realized substantially lower outflow levels (Exhibit 8). In addition to investing wisely in client servicing, firms with strong retention also pay their sales people (at least in part) on net sales rather than purely gross sales, and have a deliberate retention management approach tailored to each client segment.

As we have discussed, many firms appear to have given up hope, for the foreseeable future, of achieving profit margins that were common in the last decade (i.e., in the mid-40 percent range). While our belief is that such profit levels will no longer be the industry average, we believe that this level of prof-


itability, and even higher, is achievable for the best-run firms. The most profitable firms will be those that excel at seven major revenue and cost levers: Revenue yield and pricing. Average revenue yield for a firm is driven by two primary factors – product mix and relative pricing levels within those products. In terms of product mix, those firms with a focus on the higher-yielding asset classes will naturally achieve higher average revenue yield. However, despite common perceptions that pricing is dictated by the market, we found there is substantial variability in realized pricing levels in the same asset class, client segment, and average mandate size (Exhibit 9).

The reward for pricing excellence is significant. The top one-third of the firms in our survey, as measured by profitability, had the highest realized pricing yields in four out of five major asset classes. Small differences in realized pricing have substantial impact – a pricing advantage of just one to three basis points translates into a 2 to 7 percent improvement in profit margin. The best firms will continue to maintain a pricing edge through pricing and discounting discipline,


such as requiring CIO or CEO approval for any discounts from the agreed list price. They will also take creative approaches to unprofitable legacy businesses, such as moving lower-priced business to commingled vehicles. Product management. While many well-run investment management firms know that product fragmentation and sub-scale products can drag down overall profitability, we found that managing the product portfolio is far more important that many envisioned. Across all firm sizes, those that had fewer products and higher AUM per product and asset class were up to twice as profitable as those that achieved similar overall asset levels through more products (Exhibit 10).

Each additional product typically brings increased costs for investment management, sales & marketing, IT, and operations. The challenge for firms is to ensure that they have sufficient scale in each product to sustain profitability, while at the same time building a diversified product line. Those that achieve diversification and scale at the product level experience more consistent growth and attractive profit margins. The most successful firms have clear product management processes, ranging from product development, to processes that


can result in closing or merging products when necessary. These processes involve both manufacturing and distribution professionals, who are increasingly adopting best practices from other industries, where many of these capabilities are well-advanced. Capturing benefits of scale. Scale is clearly a driver of profitability. Large firms (those with greater than $250 billion in assets) had an average cost base of 15 basis points, versus 40 basis points for small firms (less than $25 billion) – an average scale advantage of 25 basis points. Moreover, this advantage is present in every function, with the most benefit coming from investment management, sales and marketing, and management/overhead (Exhibit 11). However, the benefits of scale are not enjoyed by all large firms. Costs bases for the largest firms ranged from 10 basis points to 23 basis points. Capturing the benefits of scale requires concerted efforts on many dimensions, particularly when a firm has achieved scale through acquisitions. Each part of the business system needs to be addressed to capture the full benefits, e.g., rationalizing investment management offerings across multiple managers, combining retail sales forces and operations, and integrating operations and IT.


Investment management productivity. The most successful firms are beginning to focus on managing themselves as professional services firms, and paying particular attention to their talent management approach. We believe that investment professionals can be managed for productivity, as well as invest ment performance. However, currently the productivity of investment professionals varies considerably across firms – even when controlling for the asset classes managed (Exhibit 12). Those firms that have the most productive investment management professionals have total investment management costs of five to seven basis points, considerably below the average of 10. Firms that manage investment management costs most successfully did it through a combination of actions, including appropriate use of junior portfolio managers, routine product rationalization, and use of commingled vehicles for smaller accounts.

Sales and marketing productivity. With sales levels down for most asset managers in both retail and institutional markets, many asset managers still need


to determine what is the sustainable size and composition of their sales and marketing forces. Just as in investment management, the productivity gaps between average and distinctive performers are high (Exhibit 13). Sales forces need to be managed for the long term, not dramatically restructured simply because of short-term product performance or market-related issues. Still, many firms have substantial room for improvement in sales productivity, with the cost of sales and marketing for institutional firms varying from 1 to 10 basis points, and for retail firms varying from 3 to 20 basis points. In the institutional market, leading players are optimizing their sales force roles across asset classes as well as major functions (e.g. specialized roles for client servicing). Success in retail wholesaling is primarily contingent on skilled external and internal wholesalers who concentrate on three things: maintaining a few distribution partners, as opposed to covering the waterfront; developing true partnerships with the distribution gatekeepers; and smartly targeting the most productive advisors.


Technology and operations. Aggressive management of technology and operations spending has traditionally taken a distant back seat to meeting the needs of investment and sales professionals for the latest applications. However, this has come at a cost, with technology and operations spending currently accounting for an average of five basis points of assets under management, and up to 20 basis points for some players (Exhibit 14). Leading firms are taking a hard look at all of their operations, determining which functions are strategic, and using multiple approaches to reducing costs, including process redesign, outsourcing, and early forays into offshoring.

Management and overhead. Despite significant belt-tightening over the past 2 years, management and overhead currently accounts for almost 10 percent of a typical firm’s cost base. The best firms have eliminated all non-essential corporate services and consistently deliver high-quality, low-cost support to the


organization. The right approach for capturing potential savings in these areas varies by type of firm. For firms that have grown organically (versus by acquisition) substantial cost reduction in the overhead functions typically requires a clean sheet approach, in which the specific activities of each overhead function are assessed to determine if their value exceeds their costs, and whether they should be in-sourced or outsourced. For firms that have been built up via merger, there are often substantial savings to be realized by combining duplicative support activities across managers and business areas.

The U.S. asset management industry is maturing, and the competitive intensity is continuing to rise, leaving no doubt that strong growth and profitability will be increasingly difficult to capture. However, the best firms are using this as an opportunity to pull away from the pack, and are accelerating their investments in managerial talent and capabilities. Now more than ever, we believe there are real opportunities for senior managers to greatly influence the future of their firms. Those who combine strategic and operational excellence will be best positioned to achieve the outstanding returns this industry has to offer.

American Century Bear Stearns Asset Management Brown Advisory CDC/AEW Capital Management CDC/Harris Associates CDC/Reich & Tang Capital Management Group and Reich & Tang Funds CDC/Vaughan, Nelson, Scarborough & McCullough CDC/Westpeak Global Advisors CDC/Loomis, Sayles and Company Citigroup Asset Management Columbia Management Group Credit Suisse Asset Management David L. Babson & Company Deutsche Asset Management Dresdner RCM Global Investors LLC Evergreen Investment Management Co., LLC Federated Investors, Inc. FTI Institutional Gartmore Group GE Asset Management ING Investment Management Americas (Aeltus) Invesco JP Morgan Fleming Asset Management Lazard Asset Management Legg Mason – Brandywine Asset Management Legg Mason Capital Management Legg Mason Funds Management Legg Mason – Private Capital Management MacKay Shields Mellon – Franklin Portfolio Associates Mellon – Mellon Capital Management Mellon – Standish Mellon Asset Management Mellon – The Boston Company Merrill Lynch Investment Managers Morgan Stanley Asset Management Nicholas-Applegate Capital Management Northern Trust Global Investments Old Mutual Asset Management Old Mutual – Analytic Investors Old Mutual – Pilgrim Baxter & Associates Phoenix Investment Partners Phoenix – Duff and Phelps Phoenix – Kayne, Anderson, Rudnick Phoenix – Roger Engemann & Associates Phoenix – Phoenix Investment Counsel Phoenix – Seneca PIMCO Pioneer Investment Management USA Inc. Principal Global Investors Prudential Investment Management State Street Global Advisors State Street Research & Management Co. Thrivent Investment Management Trust Company of the West Turner Investment Partners, Inc.


North American Asset Management Practice September 2003 Designed by the New York Design Center Copyright © McKinsey & Company