More than 75% of 2018 U.S. open-ended mutual fund and ETF assets are managed by 20 firms, according to ZS analysis of Morningstar Direct data, but apart from a handful of trillionaires, the rest are in the $100 million to $1 trillion assets under management (AUM) range. The next 30 firms account for only another 15% of assets. We have no doubt that the trillionaire firms are a strong influencer, but it’s fair to say that the largest 20 firms play a significant role in setting the industry landscape by:
- Setting prices
- Shaping product trends
- Nurturing strong relationships with broker dealers and consultants
- Wielding influence on industry organizations, regulators and suppliers
Sure, M&A will change the names on the top 20 list, but that’s how any industry evolves and creates more value for all stakeholders. In and of itself, it does not portend doom and gloom for mid-sized firms. That said, firms that have troubling economic prospects should address them for two reasons:
- Increasing industry competition: Roughly two-thirds of U.S. open-ended mutual fund and ETF assets are managed by five or six asset managers. On top of that, the largest 20 firms accounted for 73% of positive net flows in 2018, and only 29% of negative net flows. But, most of these firms’ AUM decreased, some by over 10% of their prior year assets, signaling decreasing revenues. Firms could continue their current point of view and interpret this concentration as an industry trend, that is, as a phenomenon that cannot be influenced. But it raises questions about why assets and flows are getting concentrated and, more importantly, whether concentration is good for industry stakeholders.
- Improving economics of the business: Asset managers roughly incur about 35 basis points (bps) in operating costs (20 bps of distribution costs and 15 bps of other costs), meaning that to maintain a 30% operating profit, they would have to earn 50 bps on every dollar of AUM. But as Figure 1 illustrates, the expectation is that fees will continue to decline, therefore placing enormous pressure on firms to manage their expenses.
Source: Morningstar Direct. Data as of 12/31/2018
Even within this context, there is a large spread in average expense ratios of the largest 20 asset managers (see Figure 2 below), ranging from 15 to 105 bps. Many of the firms with higher expense ratios also reported negative outflows, meaning there’s obviously some relationship between pricing and asset gathering.
Figure 2: Simple average fees for the 20 largest asset managers (2018)
Source: Morningstar Direct, ZS. The green dots denote firms with negative outflows in 2018.
But the asset weighted expense ratios provide a better sense for the price generating revenues (see Figure 3 below). The range is still large but goes from nine to 82 bps. It would be tough for a firm at the higher end of spread, where most are bleeding assets, to compete at the lower end, but they could strengthen their competitiveness by working their way into Fee Cluster B. Firms between Cluster A and B could make strategic decisions to move towards Cluster A or B. It’s neither straightforward nor easy but essential to increase their prospects for growth and profitability.
Source: Morningstar Direct, ZS
There is unquestionably room to reduce costs, but there is even more opportunity to increase distribution productivity. That, together with a strategic approach to reducing the asset weighted expense ratio, puts the entire firm in a better position to grow assets (and therefore revenues)—a balanced path to profitability.