Margin Compression a Sign of Maturity

Using the earnings results of publicly-traded asset managers, kasina examined industry operating margins (operating income/revenues) and net margins (net income/revenue) since 2000.  It found that industry operating margins have decreased from 39% to 29% and net margins have declined from about 27% to 20% over the same period.   

“This compression is exactly what we would expect to see in a maturing industry,” said Eric Daugherty, Director of Research and Principal, according to a press release.  

The consulting firm says several overarching factors will contribute to the continuation of this squeeze: slower U.S. economic growth over the intermediate term; aging demographics that will slow asset accumulation and inch toward decumulation; increasing and centralization of distributor power; and  consumer demand for lower fees.   

To prop up margins, kasina recommends:  

• Focusing on higher revenue products, geographies, or segments; 
• Differentiated products with believable alpha stories that sustain higher fees; 
• Go international, into less mature markets with less price competition; 
• Focus on market segments where the firm has a competitive advantage (e.g. retirement, where no one is an acknowledged leader); 
• Cutting costs at a given level of revenue, like using the Web to drive efficiencies. 

Or, kasina says, asset management firms can live with decreasing margins, and make money on volume: 

• Compete on price on commodity-like beta products, 
• Get scale via acquisitions and organic growth of core funds. 

According to the press release, kasina asserts that in the long-term, there will be a shakeout as stronger firms survive and thrive while others wither. This may not happen for ten years, as making 30% operating and 20% net margins is still fairly attractive.   

Short-term, kasina expects firms to fight to maintain margins by ramping up marketing, striving for organic growth via differentiation, and considering strategic mergers. In the long-term, firms should be taking steps to rationalize product lineups, drive efficiencies, optimize distribution, and gain scale in order to protect themselves from the margin squeeze that has already begun, kasina said.