Blog What Happens when the Bull Market Ends? Eight Predictions for 2018 and Beyond

Posted January 9, 2018 by Steven Miyao

The market continues to deliver. Assets under management are breaking records, lifting revenues. Operating margins reached an average 34.2% during the third quarter – the highest in the last eight quarters – among the 15 publicly-traded asset management firms that make up the DST Research, Analytics, and Consulting Asset Manager Composite.

Research, Analytics, and Consulting Eight Predictions for 2018 and Beyond illustrationBut just under the surface of these encouraging results, a much more complicated and daunting picture emerges. In the third quarter of 2017 alone, the top 10 asset managers accounted for 50% of all net flows, while more than half of the 719 asset managers in the industry experienced net outflows. For the last two and half years, active funds and active ETFs suffered negative flows of roughly $500 billion. Meanwhile, more than $1.3 trillion poured into passive funds and ETFs, according to data from Morningstar Direct.

When markets are strong, it is often easy to overlook the tough choices confronting our industry. But there are tectonic shifts in the market that managers urgently need to address: changing demographics, lower fees, and technological innovations.

My annual long-term industry outlook involves eight predictions:

  1. Financial advisors will have to provide holistic wealth management – Even before the likes of an Amazon or Google entered the market, technology had changed the game. Investors will start questioning the need to pay a human 125 bps for asset allocation when robos charge between zero and 75 bps for the same service. To compete, advisors must support clients’ life decisions, from retirement planning to their kids’ college applications. In fact, our research conducted in association with Horsesmouth found that the majority of wirehouse (73%) and independent broker-dealer (67%) advisors already believe that their continued transition to advisory platforms enables them to take a more holistic approach to managing client assets. The long-term winners are going to be RIAs, already the fastest-growing advice segment, and other fee-only advisors who cater to the high-net-worth investors. The remaining investors, who have less wealth to manage, will be serviced through mostly or fully automated advice. I foresee substantial advisor consolidation as the role of technology increases.
  2. Highly concentrated portfolios will thrive amid shrinking shelf space – Major broker-dealers will further scrutinize the products on their platforms, placing even greater pressure on asset managers to prove their investment strength and overall value proposition. Asset managers will attempt to differentiate their strategies by building highly concentrated portfolios to deliver higher alpha. Alternative managers will incorporate more illiquid securities in their product structures, such as interval funds and non-traded business-development corporations. These kinds of products will become more shareholder-friendly, offering more competitive fees and a wider range of share class structures. Firms that can’t generate differentiated alpha will not survive the next market downturn.
  3. The largest asset managers will lower their fees aggressively – Investors will continue to gravitate toward the lowest-cost products. A few of the largest active managers will decrease their fees significantly, while the rest of the industry will continue to lower fees gradually. I expect to see the first ETF priced at zero, likely in conjunction with a major distributor that will use the ETF as part of its managed account or No Transaction Fee (NTF) platform offering. Fees will also continue to decline for smart beta and other specialty ETFs. Firms should think about how they can use their pricing strategy to their competitive advantage. Ultimately asset managers and broker-dealers alike will have to get used to lower profit margins.
  4. National accounts and product development will align – The emphasis by broker-dealers and RIAs on model-based investing (home-office, third-party, and proprietary) will continue to grow. Asset managers will react by shifting their resources and attention from the individual advisor to the home office. Distribution will increase the number of people within their national accounts teams who are capable of covering the home office and “research analysts.” Product development will focus on building specific investment sleeves, and marketing will start to build programs targeting the broker-dealers’ home offices. Firms have to concentrate their resources on the forces that actually drive the investment decision.
  5. National Sales will right-size their external and internal wholesalers – Digital and/or hybrid wholesaling roles will increase as more sales organizations move to team-based, adaptive sales models that use data analytics to sharpen their focus. Increasingly, sales organization will align compensation with consultative behaviors and objectives; the transactional nature of commissions will struggle to keep its place in a fiduciary environment.
  6. The SEC will approve additional options for active non-transparent ETFs – The SEC will approve active non-transparent ETFs and the market will finally get to determine whether Eaton Vance’s NextShares or Precidian’s ActiveShares will meet its needs. ETFs will continue to win market share, fueled primarily by RIAs, other fee-based advisors and online financial advice firms, such as Vanguard and Charles Schwab. Asset managers recognize that they can’t get to scale through organic ETF growth, so the largest ones will continue to look to acquire the few remaining independent ETF sponsors.
  7. Marketing will align with national accounts to support key distribution partners – Marketing will shift resources away from national sales to support national accounts with account-based marketing strategies and customized digital experiences for distinct distribution partners. At the same time, marketing will start playing a larger role in bringing in new sales directly with data-driven campaigns.
  8. The largest firms will improve their investment performance and distribution strategies through data-driven insights – Leading firms will continue to invest heavily in their data infrastructure and analytics. These organizations will create the role of a chief data officer (CDO) to oversee their business intelligence efforts and expand their data science staff. If they haven’t already done so, they will build data innovation centers and will outsource any functions that don’t provide a true competitive advantage. On the flip side, most other firms’ BI teams will continue to be underfunded, and continue focusing on reporting and tactical campaign support. Executives have to make sure they are fully aware of what their firm’s data strategy is and that the organization is positioned to be able to compete on data.

We will see firms that are already successful taking some significant steps forward, evolving their business models to address the most important industry shifts. Fee-based advisors, specifically RIAs, and automated advice solutions will be the big winners in the wealth management space. The wirehouse firms will have the scale to incorporate both of these successful models. Small and midsize broker-dealers will struggle to compete.

The value of asset allocation will continue to decline and become more automated, even for the advisors who provide personal advice. Investors will continue to gravitate toward lower fee products, only paying for truly differentiated alpha. The asset managers that will thrive in this environment will advance their low-cost product solutions, evolve their marketing and distribution strategies, and invest heavily in data.

Steven Miyao
DST Research, Analytics, and Consulting

categories: advisor engagement/client engagement, industry trends, investment strategy, etf/etfs, internal & hybrid wholesaling

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