Global Asset Management 2023—21st Edition

The Tide Has Turned

May 2023

By Chris McIntyre, Sultan Alsubaihin, Simon Bartletta, Philip Bianchi, Joe Carrubba, Peter Czerepak, Dean Frankle, Lubasha Heredia, Bingbing Liu, Gleb Margolin, Michele Millosevich, Miftah Mizan, Edoardo Palmisani, Ian Pancham, Neil Pardasani, Kedra Newsom Reeves, George Rudolph, Blaine Slack, Brian Teixeira, and Andrea Walbaum

Introduction

The asset management industry has reached a turning point that will require rethinking the way it operates. For much of the past two decades, accommodative central bank policies drove up equity markets. That rise, in turn, gave asset managers a major boost; in fact, market performance has been responsible for 90% of the revenue growth since 2006. However, we are now facing an era of higher interest rates and market uncertainties. The tide has turned, with major implications for the business model that has served the global asset management industry so well in the past.

In 2022, interest rates rose faster than expected, causing both stock and bond values to plummet. The result was the second-largest single-year decrease in global assets under management (AuM) since 2005. Global AuM fell by $10 trillion, or 10%, to $98 trillion—near 2020 levels. The net flow rate also fell below 3% for the first time since 2018, reaching 1.6% of total AuM at the beginning of 2022, or $1.7 trillion.

With the collapse of a built-in bull market to support revenue growth, preexisting pressures on the asset management business have been exacerbated and will continue to put a dent in profitability.

But there are new ways to approach profitability. In addition, new technologies are making it possible to expand into high-growth private markets and highly personalized products and services. As we see it, by embracing these three Ps, asset managers can meet investors' demands and have excellent prospects for growth in the chaotic economic climate that lies ahead.

The most forward-thinking industry leaders now recognize that they will have to change course in order to thrive. Make no mistake, the changes will need to be nothing short of transformational if asset managers are to continue enjoying the growth and profitability of years past.

Exhibit 1 - In 2022, Global AuM Fell to 2020's Level, and the Net Flow Rate Was the Lowest Since 2018

Global AuM ($trillions): 36.4 (2005), 46.6 (2010), 65.2 (2015), 69.9 (2016), 77.5 (2017), 76.3 (2018), 87.5 (2019), 96.3 (2020), 108.6 (2021), 98.3 (2022)

Net flow as a share of beginning-of-year AuM (%): 1.5 (2005-2009), 2.9 (2010-2014), 0.9, 1.5, 3.1, 1.2, 3.4, 3.1, 4.4, 1.6 (2022)

The Case for Transformation

In looking at the external and internal forces shaping the industry, we find that asset managers face five fundamental pressures that, when taken together, present a clear case for transformation. Nearly every part of the value chain is under stress.

Pressure One—Growth Is No Longer Guaranteed Since Market Performance Has Been the Main Driver of Revenues

Global equity returns from 2012 through 2021 were in the top decile of most rolling ten-year periods since 1987, according to MSCI World Index data. The net result was a built-in floor for asset managers' revenue growth. In fact, 90% of revenue growth came from market performance since 2006—more than enough to offset higher costs, pressure on fees, and strong capital inflows into low-fee products.

While 2022 was among the worst years for investor returns since 2008, markets are expected to recover. However, central banks are no longer engineering sustained market appreciation. In fact, their goals for the short term are the exact opposite; they are trying to slow growth to combat inflation. Even if central banks succeed in their mandate and interest rates stabilize, it is unlikely that we'll continue to see massive, coordinated stimulation efforts, barring an unforeseen shock. As a result, revenue growth from market appreciation is likely to be significantly less, perhaps as little as half that of the past decade.

Exhibit 2 - Five Pressures Show the Need for Transformation

Growth is no longer guaranteed since market performance has been the main driver of revenues

• 90% of total revenue growth came from market performance (2006–2022)
• Revenue from net flows: $9B; Revenue pressure: -$42B; Revenues from market performance: $193B

Passive funds are increasingly popular

• Share of net flow into US passive mutual funds and ETFs: 9% (1990–1999), 27% (2000–2009), 90% (2010–2022)
• Net flow into US passive funds: $5.5T (2010–2022)
• Net flow into US active funds: -$1.0T (2022)

Fee compression is accelerating

• Average fee (net distribution costs): 28 bps (2010), 27 bps (2015), 23 bps (2022)

Costs are rising

• Costs index (2010=100): 100 (2010), 129 (2015), 184 (2022)
• Costs as share of revenue: 71% (2010), 69% (2015), 72% (2022)

Fewer new products are surviving despite attempts at innovation

• New funds that reach the ten-year mark: 60% (2010), 42% (2015), 35% (2022)

Pressure Two—Passive Funds Are Increasingly Popular

In the US, passively managed investment products were the primary beneficiaries of market appreciation from 2010 through 2022. The share of net flows into passive exchange-traded funds (ETFs) and other passive products reached 90%, which was roughly triple the net flows from 2000 through 2009. In 2022, the same dynamic played out. Passive funds continued to be winners, with a net inflow of $0.5 trillion, while actively managed funds experienced a net outflow of $1.0 trillion.

We can expect increased market volatility to create more investor demand for expertise in outperforming the benchmarks, yet we do not anticipate a sea change in which significant capital flows back into active funds in the US. The passive value proposition has proven to be compelling, and it is now deeply ingrained in the ecosystem.

Globally, the status of passive versus active investments is very different. In Asia and Europe, passive funds hold only 21% and 20%, respectively, of mutual fund and ETF assets, indicating that active management seems to have a safe haven, at least for the moment. The scenario is driven by multiple factors. In China and other Asian markets, for example, active managers have been able to deliver better-than-average market returns, thereby outpacing any cost advantages to be found in index products.

In Europe, however, there are reasons to believe that the amount of money in passive assets may grow more quickly than it will in Asia. Along with increasing customer demand, regulatory changes could provide a more favorable climate for passive management. The UK already requires fair value assessments of investments. Meanwhile, proposed amendments to the Markets in Financial Instruments Directive (MiFID) II legislative framework could lead to bans in the European Union on inducements for investment products—a move that could give advisors more incentives to steer their clients to lower-priced passive funds.

Pressure Three—Fee Compression Is Accelerating

As a general rule, asset management fees are headed down, not up. Pricing is increasingly used as a differentiator not only for passive products but also within the overcrowded space of active products that are otherwise similar to one another. The result is persistent downward pressure that is only accelerating.

Since 2010, average fees have declined by more than 15%, a drop that would have generated $55 billion in revenues given 2022's AuM. In last year's report, we found that some clients of asset managers were still willing to pay for strong performance. That continues to be the case, but only 50% of industry AuM meets that standard.

Over the past 10 to 15 years, extraordinary market performance more than offset the fee pressure on revenue growth and margins, but those days are over.

Pressure Four—Costs Are Rising

The cost base for asset management was built for better times. Since 2010, costs have generally risen in line with AuM growth, which created the impression that margins were stable despite the pressure on fees. However, from 2015 onward, costs as a share of revenue have increased, alluding to cost structures that are unfit for the new environment. We estimate that about 60% of asset management costs are fixed; certainly, the vast majority of costs are related to personnel.

Looking ahead, we expect that asset managers will need to reduce their cost base by at least 20% to maintain historical levels of profitability. Nothing short of an organization-wide transformation will be required to meet that goal.

Pressure Five—Fewer New Products Are Surviving Despite Attempts at Innovation

The asset management industry has perfected the art of slicing and dicing products into niche offerings in an effort to stand out in a competitive playing field. Such offerings have led to an abundance of products, but proliferation has not meant meaningful innovation. In fact, investors are increasingly sticking with established products with reliable track records. A whopping 75% of global AuM in mutual funds and ETFs sits in products that are at least ten years old. Meanwhile, less than 40% of all products launched ten years ago are still offered, compared with 60% of all ten-year-old funds in 2010.

Simply put, the current approach to product innovation is not working. To succeed in the next decade, asset managers will need to reframe their innovation agendas to include new product categories and value-added services.

The Only Choice Is Change

The pressures facing asset managers now will continue into the future but without the benefit of rapid market appreciation. According to our estimates, the existing pressures and market expectations are such that if asset managers simply stay the course, their profit's compound annual growth rate (CAGR) will be approximately half the industry average of recent years (5% versus 10%). This is a massive gap that would send shockwaves throughout the industry.

Exhibit 3 - Asset Managers Must Set a Transformative Path to Return to Profitable Growth

Projected profits (index = 100, 2022)

• Industry's prior trajectory: 10% CAGR
• Industry's current trajectory: 5% CAGR

Achieving profitable growth of 10% requires:

• Cutting costs by 20%
• Diversifying so that 30% of revenues comes from higher-margin products

To get back to historical levels of profitable growth, asset managers will need to address their costs and revenues equally and thoroughly. We estimate that asset managers will need to cut costs by 20% overall. In addition, they will need to shift their revenue mix to generate at least 30% of their revenue from higher-margin products, such as alternative investments.

As we scan the industry, few firms have recognized this reality and taken action. Meanwhile, insurance asset managers are finding that transformation measures are needed to meet increasingly complex regulatory standards.

Asset managers need to change. They need to embark on a transformative journey and assess all aspects of their existing business model. Those that make the journey stand to emerge strong and resilient for years to come.

The New Pressure Gauge for Insurance Portfolios

Managing assets for insurance clients has just become more complex. On January 1, 2023, amendments to International Financial Reporting Standards (IFRS) 9 and 17 came into effect for the industry, bringing on a new set of accounting practices designed to standardize the way market participants measure an insurer's financial performance. That includes the key factors of investment return and risk exposure.

Not all insurers will be affected by the change: only European and Asian insurers will adopt the new principles in total. However, the amendments require adopting new standards that will be transformational for any global asset manager with insurance clients in Europe or Asia.

Under the new measurement logic, assets and liabilities are marked at fair market value instead of at book value or historic value. This provides greater transparency around the insurer's financial positions at any given time. However, it is also expected to introduce greater volatility into key performance metrics.

The new rulings will also require that the fair market value of an insurer's portfolio appears on all quarterly income statements and balance sheets. Insurers will need the support of asset managers in assuring that the new granular units of account are not showing losses.

Life insurers will have the additional responsibility of reporting their contractual service margin.

We see four main initiatives that insurance asset managers should put in play to support their clients:

1. Design portfolios that will stand up to scrutiny and provide hedges against volatility, consistently monitoring earnings at risk and defining acceptable volatility bands.
2. Enhance key investment decision-making processes and tools to make sure that the new measurement logic is ingrained, clarifying all tradeoffs that come with an investment decision.
3. Define more-granular portfolio construction rules to steer the allocation toward optimal tradeoffs among return, volatility, and risk capital absorption.
4. Launch change management actions so that portfolio teams have the capabilities to look at the business in a new way, potentially requiring monthly or even weekly meetings with insurance clients.

Moreover, a transformation strategy should include developing forecasting capabilities to guide an insurer's portfolio decisions. Asset managers may consider partnering with fintechs for these capabilities or investing in transformative technologies such as simulation engines.

What Now?

There is a path forward, but it requires a transformative mindset and a leadership agenda focused on three major themes: profitability (achieved by addressing the cost structure and by funding the transformation journey), private markets (a focus for developing high-growth products that will help significantly diversify revenue), and personalization (a cutting-edge way to own the customer relationship).

Profitability

Over the past few years, asset managers' costs have outgrown revenues by about 2%, on average. In a supportive market, this dynamic has been tolerable and didn't call any special attention to cost rationalization. But times have clearly changed.

In 2022, asset managers' net revenues declined by approximately 11%, compared with their 2021 net revenues. At the same time, total costs were stagnant, and total profits declined by 27%. The decline in profits was more pronounced for North American firms—32%—while their European counterparts saw profits slump 13% because of a lower decline in net revenues.

The typical value chain for asset managers includes a wide variety of costs that firms will need to assess in order to drive savings.

Organizations Should Evaluate and Optimize Costs Along the Value Chain

Asset Manager Value Chain and Typical Cost Structure

Value Chain Area	Share of Total Costs	Functions	Two-year CAGR
Sales and marketing	5%–20%	Sales professionals, Marketing, Product specialists, Client services, Other	Mixed
Investment management and trade execution	20%–35%	Portfolio managers and traders, Research and analytics, Other	>6%
Operations	15%–25%	Fund services, Asset services, Client operations, Post-trade services, Utilities, Transfer agency, Other	Mixed
Information technology	10%–25%	App development, App maintenance, App hosting, End-user technology, Other	Mixed
Business management and support	15%–20%	Management and strategy, Finance, Procurement and facilities, Legal and audit, HR, Compliance, Risk management, Other	>6%

Two-year CAGR Legend: >6% (rising), 2%–6% (moderate), 2% (stable)

In order to take action, asset managers need to understand the drivers of key costs, which may come from upstream demand (such as from recent product proliferation and increasing client needs) or from greater organizational requirements.

It is important to scrutinize expenses and what drives them in each function. In addition, asset managers should examine the costs of organization-wide functions. We have identified ten key initiatives that asset managers should consider when designing a plan for controlling costs across the organization.

Operational and support-function costs can be addressed through many initiatives. For example, asset managers can simplify broadly, across the organization, by optimizing managerial capacity, flattening the organization structure, and increasing their managers' spans of control. Cost efficiency is not the only benefit of this exercise; it also leads to better decision making, enhanced accountability, and faster and more reliable communication throughout the firm. By gaining a deeper understanding of how resources are being allocated across activities and functions, as well as how the allocations compare with those made by industry peers, a firm will also be better equipped to rightsize support functions.

Exhibit 4 - Asset Managers Should Identify Key Drivers of Cost Growth

Value Chain	Key Drivers
Sales and marketing	The increasing number of sales personnel, because clients are requiring a more personalized or specialized sales experience and higher service levels
Investment management and trade execution	The increasing product suite and the associated expanded staff, related support, and data and technology in order to expand the implementation of next-generation ways of investing (such as those that use artificial intelligence and machine learning)
Operations	The increasing number of client-driven customizations, the firm's expanded footprint, and the higher average cost of investing in private markets all put pressure on operations teams if they have not scaled effectively
Information technology	The investment to build more capabilities, especially in data and analytics; the rising costs of maintaining legacy systems due to slow decommissioning; and the ongoing migration to the cloud
Business management and support	The expansion of the HR, legal, and finance functions to support business growth without adopting leaner and agile ways of working

Private Markets

Alternative investments and the private market opportunities therein continue to be a bright spot for the asset management industry. Alternatives represented more than $20 trillion of global AuM as of year-end 2022. These products accounted for half of the industry's global revenues in 2022—a milestone that was achieved sooner than industry observers had predicted—and generated more than $190 billion in revenues for the firms that offer alternative investments.

To address investment management costs, it is critical to conduct a thorough examination of the business model with an eye toward product optimization. The long bull market from 2012 through 2022 gave asset managers the opportunity to expand their fund portfolios and explore uncharted territories. Trimming away subscale and unprofitable products compels a firm to refocus the business in ways that can yield strong value creation.

There is nothing new about managing costs to ensure a sustainable and profitable business. However, this time around, the focus should be on optimizing costs in transformative ways instead of simply slashing expenses.

Exhibit 6 - In 2022, Alternative Assets Represented 21% of Global AuM and 50% of Global Revenue

Global AuM by product

• 2005: $36T | 2010: $47T | 2015: $65T | 2021: $109T | 2022: $98T | 2027E: $128T

Global revenue by product

• 2005: $133B | 2010: $180B | 2015: $260B | 2021: $376B | 2022: $386B | 2027E: $470B

Alternative assets | Active specialties | Solutions, LDI, and balanced | Active core | Passive | CAGR (%)

Private Markets (continued)

This strong momentum is expected to prevail, with 7% CAGR in alternative assets over the next five years. This is a growth rate that we expect to see surpassed only by passive investments, which are projected to grow in AuM at approximately 9% annually through 2027. A substantial amount of growth in the alternatives space will be driven by investments in private debt and private equity, both of which are slated to see their global revenues rise by 9% to 10% annually over the next five years.

The Retail Opportunity

The continued opportunity to reach retail investors is a key contributor to the optimistic future for alternative investments. The asset growth in the retail segment has outpaced that of the institutional segment globally from 2012 through 2022. At the same time, technology, product innovation, and, in select markets, regulatory reforms, have created tailwinds to democratize access to alternative investments.

Globally, retail investors have allocated trillions of dollars to alternative products, with current assets projected to grow by more than 15% annually in the next three to five years. Using private equity funds as a proxy for alternative investments, most of the retail distribution opportunity exists in the North America and Asia-Pacific regions. These two regions account for nearly 60% and 30%, respectively, of global household investment in private equity funds.

Beyond growth, one of the most attractive aspects of retail investment in alternatives is profitability. The fees tend to be higher because retail investors lack the scale that allows institutional investors to pay steeply discounted fees.

The retail market is a diverse demographic, however, and asset managers need a strategic plan to address product packaging and investor access points. The wealthiest retail segment, ultra-high-net worth investors, have a broader suite of products that they can access. Their choices include more institutional-like offerings, such as closed-end and direct funds, tender offers, and interval funds. At the other end of the wealth spectrum, mass-market retail investors are limited to more liquid products that have lower minimum investment requirements, primarily alternative mutual funds and ETFs, real estate investment trusts, and business development companies.

Entering the Alternatives Market

Numerous conventional asset managers have entered the alternatives market. These firms have gathered significant assets, unlocked new offerings to bring to their clients, and catalyzed a high-growth opportunity for their business. Among some 30 leading global asset managers that launched an alternatives unit, the AuM for alternative investments and private markets have grown by an estimated 15% to 20% annually over the past five years, amounting to more than $3 trillion. The firms have made more than 50 acquisitions for an instant step up in alternatives capabilities. Roughly 90% of the firms have focused on offering private equity, private debt, and real estate products, while 30% have established strategic partnerships, often with fintechs, or distribution agreements with third parties.

Exhibit 7 - Private Debt and Private Equity Investments Are Expected to Generate More Than 60% of Total Revenue from Alternatives by 2027

Global AuM for alternatives by product

• 2005: $4T | 2010: $7T | 2015: $9T | 2021: $19T | 2022: $20T | 2027E: $29T

Global revenue from alternatives by product

• 2005: $42B | 2010: $73B | 2015: $103B | 2021: $172B | 2022: $193B | 2027E: $258B

2022–2027E CAGR (%) by product: Liquid alternatives: 4.0 | Commodities: 5.7 | Infrastructure: 9.6 | Private debt: 10.1 | Hedge funds: 3.2 | Real estate: 4.7 | Private equity: 9.0

Four Primary Pathways to Enter the Alternatives Market

For firms aiming to enter the alternatives market, there are four primary pathways, all of which contain tradeoffs and operating model design choices.

• Build in-house. Using this approach, a firm builds out its alternatives business in-house, a process that may include acquiring some external teams for instant upskilling but is otherwise an internal effort. This approach yields the highest potential for integration and synergy with the broader asset management unit, and it affords the parent company more control and oversight. Building in-house often requires a longer timeline to prepare a market-ready offering, however. Firms with brand strength and extensive distribution have a higher chance of success.

• Buy and use an affiliate or boutique structure. This pathway involves multiple acquisitions and the use of an affiliate or a multiboutique structure, enabling the eventual full-suite build-out of alternatives or private market asset class offerings. The structure includes the possibility of some integration and synergy across the value chain, primarily in noncore functions. Alternatives investment teams remain independent of one another, each maintaining its own distinct brand. The parent company's primary role consists of managerial oversight, select distribution opportunities and introductions, and best-practice sharing.

Exhibit 8 - Asset Managers Need a Strategy for Packaging Retail Alternatives and Identifying Investor Access Points

Investment vehicle	Liquid alternatives	Traded REITs and BDCs	Nontraded REITs and BDCs	Interval funds	Tender offers	Closed-end and direct funds
Common access points and methods	Traditional or alternative managers with a mutual fund or ETF lineup; accessed in brokerage or exchange, direct or via a wealth manager	Traditional or specialized managers with REIT and BDC products; accessed in brokerage or exchange, direct or via a wealth manager	Direct vehicles, typically accessed via an advisor or intermediary; some availability via institutional platforms	General partners, funds of funds, and secondaries, accessed directly; may utilize institutional pooling platforms	General partners, funds of funds, and secondaries, accessed via an advisor; may utilize institutional pooling platforms	General partners, funds of funds, and secondaries, accessed via an advisor; some availability via institutional pooling platforms

• Mass-market retail: Lower minimum and more liquid products
• Lower-high-net-worth and affluent individuals: Mid-range access
• High-net-worth individuals: Broader access
• Ultra-high-net-worth individuals: Higher minimum and less liquid products

Exhibit 9 - Alternatives Create Significant Growth Opportunities for Traditional Asset Managers

• $3T+ Alternative and private market AuM
• 15%–20% Estimated five-year CAGR of alternative and private market AuM, on average
• ~90% Share of firms bringing private equity, real estate, and private debt products to market
• ~60% Share of firms bringing hedge fund strategies to market
• ~50% Share of firms bringing liquid alternatives to market
• ~30% Share of firms with fintech or other distribution partnerships
• 8%–12% Share of a firm's total AuM in alternative and private market products
• 50+ Number of acquisitions made to expand alternatives capabilities

Asset Managers Should Consider Four Paths for Launching an Alternatives Business

Build in-house

• Build out alternatives capabilities in-house
• May need to acquire external teams
• Allows for high integration and more control by parent company
• High cost; requires an established brand and strong distribution capabilities

Buy and use an affiliate or boutique structure

• Acquire alternatives firm and use a multiple affiliate or boutique model
• Partial integration is possible across noncore functions
• Can build a broad suite of alternatives through acquisitions
• Parent company supports brands while providing distribution

Buy and operate independently

• Acquire alternatives firm that will remain independent
• Full autonomy is a key to success
• Seek products that fill gaps and clients' needs
• Nearly all functions remain independent

Establish partnerships

• Develop partnerships or distribution agreements
• Provide third-party products, rather than proprietary ones
• Alternatives partners benefit from unique distribution access
• Scalable, but must optimize shared economics

Level of integration between alternatives functions and traditional functions for each activity in the value chain (Investment management, Sales and distribution, Middle and back offices, Corporate and shared services) varies from Low to High across each pathway.

Buy and Operate Independently

Buy and operate independently. A firm following this model must make at least one acquisition to gain an alternatives investment capability. Full autonomy is a key success factor for the operating model, and nearly all functions across the value chain are kept detached from the parent company. Independence and the alignment of incentives are critical to the performance of the investment team and to keeping the sales and distribution staff from the acquired firm in place. Products are highly targeted, determined by the parent company's capability gaps and an analysis of which offerings are most likely to boost the overall financial performance.

Establish Partnerships

Establish partnerships. In this case, an asset management firm develops distribution agreements, joint ventures, or other strategic partnerships to ensure that client demands for alternatives are met. The partnerships are designed to marry the distribution capabilities of the established traditional asset manager with the best-in-class alternatives investment capabilities of a third-party manager. Exclusivity agreements are common. Some co-investment may be required for shared middle- and back-office capabilities, such as onboarding and reporting, since scalability is a key driver for the shared operating model. While such partnerships are cost effective in nature, it is essential that all participants optimize the shared economics in order to have a successful arrangement over the long term.

Five Core Principles of Success in Establishing an Alternatives Business

When we look at these four market-entry pathways, it becomes clear that no one archetype is more successful than another—all methods are viable.

Perfect the value proposition. The strongest alternatives units are built around a harmonized value proposition. A traditional asset manager bringing an alternatives team onto its platform must convey the benefits of doing so and deliver on that promise.

Tailor incentives to drive growth. Distinct incentive structures are essential to driving the growth, recruitment, and retention of management teams for alternative investments. This may come in the form of compensation schemes, such as increasing carried interest or providing stock options of the parent company.

Preserve the autonomy of the alternatives team. Irrespective of how a traditional asset manager enters the alternatives market, a consistent determinant of success revolves around autonomy. The highest-performing alternatives teams are kept independent of the traditional asset management business.

Optimize distribution and fundraising. Assuring the continuity of sales and fundraising while forging new distribution opportunities gives an alternatives business a secure foundation with the prospect of strong growth into the future. Traditional asset managers can provide anchor capital to aid fundraising efforts and form a specialized alternatives sales team.

Align Strategic Interests

Align strategic interests. The most successful alternatives units have been formed around the alignment of strategic interests. When building, buying, or partnering with an alternatives team, a traditional asset manager must have full conviction in the underlying alternatives business and, therefore, possess a fundamental belief in value creation. Furthermore, the bold decision to expand into alternatives must be a strategic priority among the firm's top leaders, who must then communicate their plans and rationale to all of the organization's stakeholders.

The alternatives arena is one of the most prosperous avenues across the asset management industry. This much-in-demand asset class meets investor goals of increased diversification and return potential while, at the same time, creating an unprecedented profit opportunity for the firms that manage it well.

Personalization

Owning the customer experience will be as important as having good products in the years ahead. Advances in data availability, data science, and computing power now make it possible to create true personalization in the asset management industry, much like consumers experience when they use entertainment platforms and service apps. Personalization will span both the client experience and products.

The Client Experience

Personalized engagement already exists in asset management. In the US, where asset managers are often independent businesses, employees of the wholesaling function of an asset manager typically call on a financial advisor to discuss the advisor's needs, which is a version of personalization. The problem is that this method doesn't scale efficiently to serving thousands of advisors, so it's an expensive proposition.

New technologies, however, can provide a huge boost to personalization efficiency and effectiveness. For example, systems that have automated features can help marketers engage prospects in a dialogue. A marketer sends purpose-built multichannel communications (such as targeted educational and product emails and content interactions on web properties) to a prospect, and the system captures and processes every interaction and recommends the next step on the basis of the prospect's responses. By deploying such technologies, we have seen asset managers increase their sales conversion rates by about 20% relative to traditional approaches.

Once a prospect becomes a client, a client data system can guide an asset manager using a new set of data and analytic capabilities. It will be possible to create fully automated lists that synthesize all known opportunities, risks, and relationship metrics in one place, delivered in natural-language sentences that clearly explain why an advisor is on the list.

Personalization Can Be Applied Throughout the Client Journey in Marketing, Sales, and Products

Client Journey Stages

Lead

• Engagement examples: Brand marketing, Website and app interactions
• Data evolution: Name, contact information, demographics, and location (Limited view)
• Marketed products: ETFs and mutual funds

Prospect

• Engagement examples: General educational emails, Website and app interactions, Personalized emails, Sales calls
• Data evolution: Asset allocation, fund holdings, web interactions, and interest in content
• Marketed products: ETFs, mutual funds, and SMAs

Client

• Engagement examples: Personal calls, Platform and app interactions, Reminder emails and text messages
• Data evolution: Trade behavior (purchases and redemptions), performance, and call interactions (Customer 360° view)
• Marketed products: ETFs, mutual funds, SMAs, and direct indexing

Asset managers can provide more-personalized products the more they know their clients

Data inputs: Third-party data, Current customer data → Lookalike modeling → Informed outreach → Creative personalization → Personalized products

Personalized Products Using Direct Indexing

The vast majority of products sold to retail customers are one size fits all. Customization (through products such as separately managed accounts) is reserved for ultra-high-net-worth individuals or institutional segments. Direct (or custom) indexing (the ability to create highly customized portfolios at scale) has the potential to change the game by unlocking the potential for truly personalized products at scale for affluent individuals.

So far, the US has been the main adopter of direct indexing. The past several years have seen AuM from portfolios built with direct indexing more than quadruple, rising from roughly $100 billion to more than $450 billion since 2015. Direct indexing really caught on in the US after fractional shares and zero-fee trades went mainstream in 2019.

Direct indexing works in much the same way that some streaming services make it possible for customers to download and mix individual songs, instead of buying albums. Direct indexing enables advisors and their clients to buy securities one at a time and mix them into an individualized portfolio. With that, the power to create value shifts from the asset manager to the end customer.

Three Strategies for Direct Indexing

The successful implementation of direct indexing will require a number of considerations, and a game plan is essential.

• Product Play. The lightest-touch direct indexing offering is a tax-focused product with limited customization. The product makes it possible for asset managers to limit the risk of direct indexing disintermediation without having to make significant resource commitments. Current investors can achieve tax alpha benefits, while new investors may have an incentive to leave competitors that lack comparable offerings.

• Platform Play. For asset managers that do not have a significant wealth-management client base, direct indexing is an opportunity to provide investors with a quasi-wealth-management experience at scale, without requiring a large staff of advisors. A likely starting point would be to combine this with an existing or new robo-advice offering to provide wealth services.

• Service Play. Another strategy that can lead to success in the direct indexing space is to develop a white-label service for wealth managers who lack the scale and sophistication to build or buy direct indexing themselves. Taking this approach positions the asset manager as a value-added service provider whose expertise can be monetized through either a fee for service or through increased customer share of wallet and loyalty.

Personalized Products Using Direct Indexing (continued)

Such systems can be implemented now, but many asset managers face challenges with data integrity, technology capabilities, data science talent, and buy-in from the sales team. Overcoming such barriers should be a top priority. The power of personalization will lead to a winner-take-most dynamic, in which the firms that truly know their customers stand to earn more than a fair share of capital inflows and lock in longer-term trusted relationships.

Personalized Products Using Direct Indexing

The vast majority of products sold to retail customers are one size fits all. Customization (through products such as separately managed accounts) is reserved for ultra-high-net-worth individuals or institutional segments. Direct (or custom) indexing (the ability to create highly customized portfolios at scale) has the potential to change the game by unlocking the potential for truly personalized products at scale for affluent individuals. Gaining access to these retail investors requires asset managers to determine how they are going to build this disruptive technology into their transformation plan; if they don't, it could present an existential risk to their business.

So far, the US has been the main adopter of direct indexing. The past several years have seen AuM from portfolios built with direct indexing more than quadruple, rising from roughly $100 billion to more than $450 billion since 2015.

Three Strategies

• Product Play. The lightest-touch direct indexing offering is a tax-focused product with limited customization. The product makes it possible for asset managers, particularly those that already have existing tax-focused products, to limit the risk of direct indexing disintermediation without having to make significant resource commitments.

• Platform Play. For asset managers that do not have a significant wealth-management client base, direct indexing is an opportunity to provide investors with a quasi-wealth-management experience at scale, without requiring a large staff of advisors. A likely starting point would be to combine this with an existing or new robo-advice offering to provide wealth services, further differentiating the value proposition.

• Service Play. Another strategy that can lead to success in the direct indexing space is to develop a white-label service for wealth managers who lack the scale and sophistication to build or buy direct indexing themselves. Taking this approach positions the asset manager as a value-added service provider whose expertise can be monetized through either a fee for service (such as a subscription-based business) or through increased customer share of wallet and loyalty.

Firms that build a direct indexing service can leverage their scale, selling their technology to smaller shops and regional players. While white-label service players risk having to compete with fintechs, a strong service-based offering can increase the stability of earnings that are not reliant on market outperformance.

Key Considerations for Asset Managers Entering Direct Indexing

Internally, asset managers that want to get into direct indexing products need to evaluate a number of core factors to ensure success. In particular, they should consider such details as product pricing, resource commitments, existing capabilities, and distribution positioning.

Product and Price Landscape

When it comes to the product and price landscape, asset managers must be careful not to treat direct indexing as a silver bullet against margin pressures. Direct indexing has not been immune to the fee compression that has plagued many areas of the industry. As it has received more attention, competition has increased, and average fees have already fallen by roughly a third, with more room to decline given that performance costs are relatively low. Firms must also consider how freely they will allow customization, as straying into too many permissible positions invites operational complexities that could be more akin to an active strategy than a passive one. A viable compromise is to institute customization within a core-satellite model. In this model, large portions of the portfolio are standardized with limited customization, while a smaller part of the portfolio has increased flexibility.

Resource Commitment

While talent and resourcing have been top concerns for the past couple of years, these factors will be particularly important to succeeding with direct indexing. Building a transformative framework will take an outsized level of effort at the beginning. The firm's leadership should plan to make it their main focus for approximately 6 to 12 months. In addition, given that the pool of people with experience in this area is small, asset managers may want to consider cross-training in-house talent with strong experience in tax-focused or index-based products before looking to hire or acquire talent.

In-House Capabilities

Having the internal capabilities to scale automation across the value chain is also critical to success. Fractional shares and zero-fee trades are key to enabling direct indexing, so the firm must have these capabilities in systems across the value chain. In addition, the tech stack must be configured to have strong connectivity throughout, enabling automation in the rebalancing engine, trade execution, and client reporting. Even with best-in-class automation, asset managers may experience difficulties quickly processing complex transactions, so they should be prepared to handle constrained positions and large redemptions, both of which will require specialized knowledge to resolve.

Distribution Positioning

Existing distribution channels will play a significant role in an asset manager's ability to roll out direct indexing. In the US, wire houses have been the quickest to educate themselves—and their clients—on direct indexing. As a result, the partnerships they've forged, especially when combined with their large volumes, have made them the preeminent channel for direct indexing. For asset managers with a larger concentration of registered investment advisors, a well-designed product with streamlined integration will be key to convincing the advisors to grow their direct indexing offerings. Asset managers connected with family offices, which often follow investment strategies that are aligned with a set of principles, will find that strong customization capabilities are key to winning clients over to direct indexing.

After years of organic growth and record profits, asset managers must now test their mettle. The markets are full of uncertainties, and the march of technology is bringing inevitable changes to the way financial services firms serve their clients. It is, therefore, more important than ever for asset managers to transform and build more innovative organizations.

On the bright side, however, the path to transformation is clear and imminently achievable for most. The leaders who take action now are the ones most likely to survive and thrive in the decade ahead.

Appendix

Appendix 1 - Asset Managers' Profits Fell Significantly in 2022, While Costs Remained Constant

Metric	2010	2015	2021	2022	Change 2021-2022
Average AuM (index)	100	142	238	227	–5%
Net revenues (index)	100	134	200	179	–11%
Costs (index)	100	129	184	184	0%
Profits (index)	100	144	233	169	–27%
Net revenues as share of AUM (bps)	28.3	26.5	24.2	22.7
Costs as share of AUM (bps)	20.1	18.2	15.6	16.4
Profits as share of net revenues (%)	29	32	36	28

Source: BCG's Global Asset Management Benchmarking Database, 2023.

Note: Analysis is based on a benchmarking study of 74 leading asset managers that represent $62 trillion in AuM, or about 63% of global AuM.

Appendix 2 - Global AuM Fell 10% in 2022, with North America and Europe Being the Main Drivers of the Decline

Region	2005	2010	2015	2021	2022	2021-2022 Change
Global	36.4	46.6	65.2	108.6	98.3	–10%
North America	19.1	24.1	31.6	54.0	46.5	–14%
Europe	11.0	13.0	17.5	24.9	22.2	–11%
Japan and Australia	3.1	3.4	4.9	7.3	7.1	–3%
Latin America	0.3	0.6	1.0	1.8	1.9	+5%
Middle East and Africa	0.6	0.9	1.2	1.5	1.6	+5%
Asia-Pacific (excl. Australia and Japan)	1.0	3.0	7.2	16.0	16.3	+2%

Sources: BCG's Global Asset Management Market Sizing, 2023; The Economist Intelligence Unit; Institutional Shareholder Services Market Intelligence's Simfund; WTW; government agencies, including regulators; BCG analysis.

Note: Market sizing was performed on assets sourced from each region and professionally managed in exchange for management fees. Globally, 44 markets were assessed.

Appendix 3 - ETFs and Select Alternative Products Are Expected to Lead Growth Through 2027

AuM growth, 2022–2027E (%)

The chart plots product categories by AuM growth (2022–2027E, %) on the Y-axis and net revenue margin (basis points) on the X-axis, with bubble size representing estimated 2022 AuM of $1 trillion.

High growth products (>9% AuM growth):

• Passive fixed income (~13%)
• Fixed-income ETFs (~13%)
• Equity ETFs (~12%)
• Infrastructure (~10%)
• Private debt (~10%)

Moderate growth products (3–9%):

• Passive equity (~9%)
• Fixed-income specialties (~8%)
• Solutions (~7%)
• Balanced (~6%)
• Commodities (~6%)
• Real estate (~5%)
• Liquid alternatives (~5%)
• Equity specialties (~4%)
• Private equity (~6%)
• Hedge funds (~4%)

Low/negative growth products (<3%):

• LDIs (~2%)
• Money market (~0%)
• Structured (~0%)
• Equity core (~0%)
• Fixed-income core (~0%)
• Funds of hedge funds (~–1%)
• Funds of private equity funds (~5%)

Sources: BCG's Global Asset Management Market Sizing Database, 2023; BCG's Global Asset Management Benchmarking Database, 2023; Institutional Shareholder Services Market Intelligence's Simfund; Pensions & Investments; Investment Company Institute; Preqin; HFR; INREV; BCG analysis.

About the Authors

Chris McIntyre is a managing director and partner in the New York office of Boston Consulting Group.

Simon Bartletta is a managing director and senior partner in BCG's Boston office.

Joe Carrubba is a managing director and partner in BCG's New York office.

Dean Frankle is a managing director and partner in BCG's London office.

Bingbing Liu is a managing director and partner in BCG's Shanghai office.

Michele Millosevich is a principal in BCG's Milan office.

Edoardo Palmisani is a managing director and partner in BCG's Rome office.

Neil Pardasani is a managing director and senior partner in BCG's Los Angeles office.

George Rudolph is a partner in BCG's New York office.

Brian Teixeira is a project leader in BCG's Boston office.

Sultan Alsubaihin is a consultant in the firm's New York office.

Philip Bianchi is a partner in the firm's New York office.

Peter Czerepak is a managing director and senior partner in the firm's Boston office.

Lubasha Heredia is a managing director and partner in the firm's New York office.

Gleb Margolin is a consultant in the firm's Seattle office.

Miftah Mizan is a project leader in the firm's Los Angeles office.

Ian Pancham is a managing director and partner in the firm's New York office.

Kedra Newsom Reeves is a managing director and partner in the firm's Chicago office.

Blaine Slack is a lead knowledge analyst in the firm's Chicago office.

Andrea Walbaum is a knowledge expert in the firm's New York office.

Acknowledgments

The authors are deeply grateful for the contributions of their colleagues. In particular, they thank Francesco Bigonzetti, PJ Fallon, Chad Jennings, Chetan Kashyap, Sonali Maheshwari, Anirudh Matam, Nisha Mittal, Silvio Palumbo, Barric Reed, Richard Rouse, Vipin Shrivastava, and Shubham Utsav.

For Further Contact

If you would like to discuss this report, please contact one of the authors.

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