Asset managers and wholesale banks are under increasing investor pressure to accelerate growth while managing down costs. Yet both are facing falling margins and a market environment that is disappointing relative to expectations.
Asset managers need to respond to the commoditization of market /benchmark returns caused by passive, and the knock-on impact of this shift in market structure on sell-side revenues demands that wholesale banks, in turn, find cheaper ways to serve their investor client base and seek growth elsewhere.
The race is on to launch new propositions for clients and gain share by addressing emerging client needs and combat disruption from new entrants. But this must be accompanied by an aggressive focus on the bottom line. While costs can be high, more possibilities now exist to restructure consistently challenged businesses.
Management in both industries need to decide their strategy in China as markets open up. The growing pool of externally managed AUM is an opportunity for foreign asset managers, and over the long term this will drive an expansion of the investor wallet for the sell-side.
In the battle to adapt and leverage new technologies, established firms with the capital to reinvest as well as new entrants are seeking opportunities to quickly outcompete slow-moving incumbents. Winners will leverage their data advantage in providing new client solutions. Investment is ramping up in both industries. Both incremental and 'greenfield' builds should be considered.
Fundamental shifts in market structure and client behaviour mean that firms with the weakest starting point are increasingly disadvantaged. They will have to balance competing demands to defend core markets with the need to follow the money and find long-term growth. The cost of catching up is increasing.
Implications For Asset Managers
Asset managers need to respond to the commoditization of benchmark returns caused by passive. As with other industries that have undergone dramatic pricing pressure, asset managers need to decide whether to stay and fight in traditional active or to move away. Delaying has been an option so far, but decisions are coming to a head.
Devise a strategy for China as markets open up. Supporting capital market development in emerging markets represents a USD 30BN revenue growth opportunity – with China driving half of this. Today, the bulk of foreign asset managers’ emerging market client AUM is sourced from large public funds investing into Western markets. However, the future growth opportunity will be more “local” in nature. To benefit from this, foreign asset managers will need more localized operating models. In China, recent industry liberalization and the government-led push to strengthen domestic capital markets is adding to optimism among foreign asset managers.
Look to Private Markets for higher growth in developed markets. The growth in private capital markets has outstripped public markets. But the investment into private markets continues to come from a subset of institutional client segments: defined benefit pensions, sovereign wealth funds and endowments. Growth opportunities for asset managers will come from helping other segments, namely high net worth individuals, defined contribution pensions and insurers, to increase participation in private markets. Asset managers that can efficiently deliver product whilst working closely with policy makers and distributor platforms, will find this opportunity more accessible.
Reinvest cost savings into growth opportunities to outcompete slow-moving incumbents. The most aggressive asset managers will be investing up to 5-10% of revenues to pursue growth. With industry operating margins already meaningfully lower than at this point in the previous cycle, and uncertain economic conditions ahead, the industry needs to find radical reductions in the existing cost base to allow investment for growth. Investment is ramping up, and both incremental and “greenfield” builds should be considered. Winners will leverage their data advantage in providing new client solutions.
Claire Negiar and Toby Pittaway discuss the implications for asset managers.
Implications For Wholesale Banks
Wholesale banks need to restructure and find break-out growth solutions to combat weak underlying revenue growth. The optimism from mid-2018 that investment banks had weathered the worst has passed: we expect industry wide revenues to grow at just 1.2% CAGR out to 2021, which will deliver only modest improvements in RoE. The goal should be to starve uneconomic businesses and restructure operating models, whilst shifting resources to growth pockets.
Target legacy to get efficient, leverage tech and data. To restructure and release cost from the core business, we see three broad levers that different banks will need to pull to a lesser or greater degree: tackle service provider costs, exit business lines or creatively capitulate (particularly in flow trading businesses).
The race is on to capture growth pockets. It is decision time for foreign banks in China, as regulatory changes across both the buy-side and sell-side are leading to faster and more accessible revenue growth (4% CAGR out to 2021). Sustained commitment will require significant investments and it will take time to earn a return on these. Corporates clients, and transaction banking particularly, will remain engines for growth, outpacing institutional clients growth rate by 4x out to 2021. Capturing growth will require improved customer propositions and competitive price point as the competitive landscape shift.
The embedded advantages that scale banks – particularly US leaders – enjoy today, will cement their longer-term outperformance. Revenue pressures and the need to invest are mandating cost control, but their strong starting point, both in terms of scale and profitability, gives them the option of both expanding their footprint and defending existing leadership positions. Within this group, the biggest winners will be those that can expand their addressable market through low-marginal cost business models employing new technology. This will require deep pockets and a management team willing to maintain investment levels through the cycle.
Mid-sized global wholesale banks, particularly European banks, need to look at more radical options. Returns on Equity are, on average, half that of their US rivals, and home markets are less profitable and shrinking. These banks will need to free up the investments required to defend their strongest businesses, in many cases the corporate franchise, and to position in growth markets. To do this, they will need to cut deeper in their weaker businesses. And with smaller technology budgets, they will need to make bolder moves on innovation, including considering partnerships, more radical forms of creative capitulation, and options to build greenfield platforms.
Regionally-focused banks rooted in a corporate client base need to innovate to defend. Their profitability remains bound to the (highly varied) economics of their home markets, but their revenues are under threat by the investments being made by others. They need to improve service models to their core group of clients where they have a competitive advantage and reduce their delivery costs. Away from their home markets and client base, many will find it advantageous to look for partnerships and ways to creatively capitulate to scale back commitments.
For more detail on our analysis of the wholesale banking and asset management industry, please download the full version of the report.