Outlook for the Buy-Side and Its Impact on the Research Biz

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Portfolio managers and analysts working at asset management firms are the key consumers of the investment research services produced by sell side investment banks and independent research providers.  Thus to understand where the research business should head in the next few years, it is important to grasp the various factors impacting the asset management business and the likely growth of this industry.

Forecast for the Asset Management Industry

According to PwC, global AuM in the asset management industry is projected to grow from current levels to $101.7 trillion by the end of 2020, representing a compound annual growth rate of nearly 6%.  The fastest growing regions of the world are estimated to be Latin America (12.5% CAGR), Middle East & Africa (11.9% CAGR), and Asia Pacific (9.8% CAGR).  North America (5.1% CAGR) and Europe (4.4% CAGR) are expected to grow at a more modest pace.

In a recent survey conducted by PwC, more than 40% of asset managers in developed countries looking to grow their businesses outside their home countries believe the most important geographical area of focus in the future will be the South America, Asia, Africa, Middle East region (SAAAME).  This view is consistent with World Bank forecasts that GDP growth in East and South Asian countries will outperform developed nations over the coming decade.  PwC forecasts that the growth in AuM in Asia Pacific will result from a significant increase in mass affluent and high net worth individuals throughout the region.

Asset Management Industry Forecast – By Region ($ trillions)

Source: PwC analysis.  Past data based on Hedge Fund Research, ICI, Preqin, Towers Watson and The City UK data.

One of the recent trends in the asset management industry that is expected to pick up steam in the coming years is the growing popularity of passive investments as many investors adopt strategies to generate beta separately from alpha. Another factor which is expected to prompt growth in passive investment is regulatory pressure to increase cost transparency with active investments – a factor that will lead many investors to look for lower cost ways to generate market returns.

Based on PwC’s forecasts, passive investments are expected to grow from $7.3 trillion (or 11.4% of AuM) in 2012 to $22.7 trillion (or 22.3% of AuM) by the end of 2020.  As you can see from the chart below, by 2020 institutional investors will hold the largest share of passive investments via pension funds ($12.2 trillion), while retail investors will hold a slightly smaller share of passive investments through mutual fund vehicles ($10.5 trillion).

It is important to note that active investments at both mutual funds and pension funds are expected to shrink as a total share of AuM from 2012 to 2020.  Mutual fund assets invested in active funds are projected to fall from 36.9% of AuM in 2012 to 30.3% in 2020, while active pension fund assets are estimated to shrink from 41.6% in 2012 to 34.7% in 2020.

Despite the growth in beta strategies via passive investments, demand for alpha generating active management is expected to continue to grow.  According to PwC, alternative investments (hedge funds, private equity, real estate funds) should expand from $6.4 trillion (10% of AuM) in 2012 to $13.0 trillion (12.8% of AuM) in 2020.  The growth in alternative investments should be supported by shrinking fees and relative outperformance when compared to other investment options.

Asset Management Industry Forecast – By Investment Type ($ trillions)

Source: PwC analysis.  Past data based on Hedge Fund Research, ICI, Preqin, Towers Watson and The City UK data.

Pension fund mandates are also projected to drive some of the AuM growth through 2020 as the switch from pay-as-you-go systems to defined contribution plans in fast growing countries produces a surge in retirement assets.  PwC estimates that pension fund mandates will grow 5.7% per year from $33.9 trillion in 2012 to $56.5 trillion in 2020.

Key Trends Impacting the Asset Management Industry

Despite experiencing moderate growth in assets over the coming few years, the global asset management industry is expected to face a number of pressures which will significantly impact the competitive position of individual players as well as the profitability of the industry as a whole.  These include:

  1. Regulatory Pressures: AIFMD, UCITS V, VI, and VII, EMIR, PRIPS, MiFID II and III, Shadow Banking I and II, and Dodd-Frank have all placed greater regulatory demands on asset managers – forcing changes in fund product features, service provider arrangements, regulatory and investor disclosure, distribution channels, compliance and risk management functions, and in some cases business models.  It is highly unlikely that this regulatory focus will decrease in the coming few years, forcing asset management firms to increase the number of compliance staff they employ in order to address these regulatory requirements.  This trend will increase the costs of doing business for asset management firms.
  2. Changing Competitive Landscape: Customer demand for new products will change the competitive landscape as traditional asset managers won’t retain the competitive advantage they have had for years.  It is likely that providers of nontraditional assets like hedge funds, private equity funds, etc. will compete with traditional managers by offering some of their staple products like long-only funds, multi-asset, or other specialty products.   In addition, the asset management industry could well see new competitors enter from outside the business like social media or other technology companies who decide to leverage their customer base or core capabilities to offer innovative new asset management services.
  3. Digital & Data Revolution: Over the next decade, digital technologies and expertise in big data management and analysis will impact the asset management industry, much as it is currently impacting other industries.  This will enable many asset management firms to move to enterprise wide risk management, data sharing, and market-driven product development throughout the firm.  While this trend will inevitably lead to increased technology investments over the near term, it is likely to result in increased productivity and business efficiencies over the intermediate to long-term.
  4. Globalization: Customer demand for greater investment diversification and management’s search for new sources of growth will lead many domestic asset management firms to become global in scope.  This has been evident among US and UK asset managers over the past decade, and should start to take place with Asian managers in the coming decade.  This presence in multiple geographic markets, while a source of new clients and growing revenue, also brings with it operational complexity and higher costs.

What This Means for the Research Business

Clearly, the overall asset management industry faces a period of moderate AuM growth and significant cost pressures which should have a meaningful impact on participants in the research business.  We suspect that increased regulatory pressure and investors’ shift from active to passive investments will have a large impact at mutual funds, making this market extremely cost conscious.  This should lead mutual funds to be cautious in increasing their budgets for external research provided by sell-side or independent research firms.

As we mentioned earlier, hedge fund firms should experience robust AuM growth in the coming years as many investors continue to look for concentrated strategies to generate alpha.   Even with the cost pressures expected in the industry and the shrinking of management fees, we expect that hedge funds will increasingly become the most important customer base for sell-side and independent research providers.

While we expect that buy-side investors in North America will continue to be the largest revenue source for third-party research firms, we also expect that over the next 5 – 10 years, asset managers in Asia, Latin America, and the Middle East / Africa will increasingly become a larger percentage of sell-side and independent research firms’ business as buy-side firms in these regions grow in both number and size.

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About Author

Mike Mayhew is one of the leading experts on the investment research industry. In addition to founding Integrity Research, Mike is on the board of directors of Investorside Research Association, the non-profit trade association for the independent research industry, and a frequent speaker on research industry trends and developments. Mike has over thirty years of research industry experience. Email: Michael.Mayhew@integrity-research.com

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