Big warning for small players

A clutch of leading European asset management companies will treble their profits in the next few years, but up to half of today's participants could be "knocked out of the game" by 2015, according to analysis by McKinsey & Company*.

The management consultancy foresees an accelerated polarisation of the industry; while a handful of large players will reap economies of scale and nimbler boutiques will proliferate, mid-sized companies risk being squeezed out.

"Trying to be a jack-of-all- trades ends up being a dead end," the report concludes.

These changes already appear to be under way, with small players - with less than €50 billion under management - seeing their assets rise by an average of 19.7 per cent a year between 2001 and 2005, large players (above €150 billion) witnessing asset growth of 10.7 per cent, but mid-sized outfits seeing tepid 5.5 per cent growth.

McKinsey argues that the European asset management industry has performed strongly in recent years, with aggregate profits having trebled since 2002 to €16 billion in 2006, aided by a cost-income ratio of little more than 50 per cent.

However, it sees dramatic changes ahead, with the industry assailed by the rise of guided architecture, threatening cosy captive sales arrangements; a switch from asset accumulation to decumulation; an unbundling of alpha and beta generation and a blurring of boundaries between traditional and alternative managers, life insurers, private equity firms and investment banks.

"Today's environment looks fabulous," says Robert Stark, a partner at McKinsey and co-author of the report.

"The starting position for the European asset manager could not be better. However, the traditional playing field is changing."

Stark sees both a challenge and an opportunity from the blurring of boundaries. Even as other organisations invade asset managers' traditional territory, more innovative fund management groups can embark on a land grab of their own.

Stark points to the spread of 130/30 funds, mimicking some of the techniques of hedge funds, and the development of risk- management tools pioneered by investment banks as early examples.

He sees scope for asset managers to enter the pension buyout market in Britain, currently dominated by insurance companies, and to offer comprehensive "wrapped" investment solutions to the mass retail market.

The impact of the switch to guided architecture is already stark in France and Italy, McKinsey argues, with foreign asset managers capturing €34.2 billion of assets in the latter in 2005 and 2006 even as domestic players faced "significant" outflows.

Assets gathered through third- party channels across Europe have surged by 36 per cent since 2003, McKinsey reports, compared with growth of just 7 per cent from proprietary channels.

Even as these changes are being digested, within 15 years McKinsey expects more people to be decumulating capital (generating an income stream from amassed assets) than accumulating it. However, it estimates that the asset management industry's market share for decumulation products is just a third of its share for accumulation, with banks and insurers in the box seat.

The separation of alpha and beta generation will also become more marked in Europe, McKinsey argues. In the US, where this trend is more advanced, it says "higher alpha" and "cheaper beta" strategies saw asset growth of 73 per cent and 66 per cent respectively between 2002 and 2005, while money held in "traditional active/core" strategies rose by just 30 per cent.

These changes will lead to the formation of five to 10 European mega players, each with more than €1,000 billion of assets, by 2015, McKinsey believes, alongside a small number of more specialised heavyweights and a swarm of boutiques.

* 2015: The Radical Redesign of the Asset Management Chessboard