Passives, Smart Beta and Alternatives Reshape Investment Landscape

The Boston Consulting Group has published an expansive new report, “Global Asset Management 2018: The Digital Metamorphosis,” which includes numerous findings of interest for the retirement planning audience.

A team of 10 Boston Consulting staffers penned the report, finding that the global asset management industry has ballooned in recent decades to oversee $79.2 trillion in client wealth. During 2017, assets under management (AUM) grew at their strongest rate in a decade, a fact the report describes as “especially remarkable,” given the previous year’s “plodding performance.”  

Important to note, however, is that “most of the bounce-back growth of 2017 was market driven, not structural.”

“Below the surface, pressure on margins due to continue fee erosion and cost pressures will persist,” the report warns, “especially when the strong equity market run eases or turns, as it eventually will.”

According to the report, when the equity market’s growth slows, net asset flows will likely return to lower levels. Signs of slowing in fact appeared in the first quarter of 2018 but have since abated somewhat.

“Institutional long-only asset managers recorded global net outflows in that quarter, after four positive quarters in 2017,” the report states. “Flows into mutual funds remained strong in most markets through the end of April 2018, representing 1.3% of AUM at the end of 2017. But in the U.S., a highly sophisticated global market, year-to-date net flows slowed to just 0.3% of AUM.”

Passive investing popularity continues

According to BCG, among asset management products, passives were far and away the fastest growing category in 2017, with a record 25% increase in AUM over an already very sizable base. As a result, the report shows, traditional active management products “continued to lose share against solutions and specialists.”

“Active now represents just one-third of total AUM, compared with 57% in 2003, even though strong flows in active fixed income more than compensated for outflows in active equity,” the report states. “Solutions, specialties and alternatives now own 50% of the market, versus one-third in 2003. … The results confirmed investors continuing shift to passive strategies, both in the retail segment and in the institutional segment.”

According to the BCG report, asset managers are feeling pressured by the popularity of passive investments, given that they can collect a lot more in fees from actively managed products. Notably, despite the major uptick in the relative use of passive products versus actives, passives accounted for just 6% of the asset management industry’s total revenues in 2017.

Smart Beta, alternatives and real assets

The report suggests the smart beta investing market remains small but is poised for strong and lasting growth.

“Although smart beta is still a small category with just $430 billion in AUM, or 0.5% of the global total, it has grown by 30% a year since 2012,” the report states. “In the future, smart beta will pose a substantial threat to traditional active players—potentially even greater than that of the overall shift to passives. That is because smart beta seeks to replicate active management results at lower costs to investors.”

According to BCG, fee levels for smart beta equity funds average about 35 basis points, or “well below the average of about 50 basis points for active equity products.”  

“We believe that smart beta growth will become a driver of organic consolidation in the industry going forward,” the report concludes. “The winners in smart beta should be able to leverage their scale, along with any early investment they make in relevant data infrastructure, to maintain lower fees than those that follow.”

Turning to alternative investments, the report finds this category grew by “just 8% in 2017,” or half the category’s pre-financial crisis growth rate.

“Nevertheless, their share of AUM and of revenues is increasing, and the category seems likely to remain relatively stable,” the report states. “Real-asset categories continue to benefit from fast growth, led by infrastructure’s 17% gain and followed by strong numbers for real estate and private debt. Private equity and hedge funds, on the other hand, were in low-growth territory, rising just 5% to 6% each.”

Also important to note, although costs decreased by 0.5 basis points for asset managers, the report concludes “this statistic reflects cost containment, not cost management.”

“Costs effectively increased by 69% of average AUM growth during 2017,” the report states. “This is a considerable rise, given the quantity of fixed costs involved. On the positive side, firms have a significant opportunity to boost efficiency. Many asset managers have not yet duly noted the importance of cost management.”

The full report is available for download here.