Bright Spots Leaven a Somber Future for Mutual Funds

The pandemic is further slowing organic growth and pressuring fees but “upside surprises” are providing respite — and hope — for the beleaguered mutual fund market.

Peter Boer/Bloomberg

Peter Boer/Bloomberg

The mutual fund industry had been struggling to grow its assets under management, was forced to keep lowering fees, and faced increasing competition from other investment vehicles. Then the Covid-19 pandemic struck, accelerating industry trends in a stark wakeup call for asset managers, according to PwC.

“Organic growth in the U.S. mutual fund industry has continued to slow, despite upside surprises in the overall market. The long-term outlook is under stress, too, from downward pressure on fees, reduced profit margins and changing investor preferences. Adding a pandemic to the list deepens the challenge for asset managers trying to remain competitive,” PwC asserted in a report.

PwC had estimated U.S. AUM growth would average 5.6% annually between 2018 and 2025. In 2020, it changed its forecast to only 3.1% between 2019 and 2025. “There’s a much more difficult road ahead,” the report said.

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In addition to those headwinds, the long shift toward passive mutual funds and exchange-traded funds continues. In 2019, passive accounted for 39% of the total assets in the U.S. mutual fund and ETF industry. By 2025, they will account for 55% of the total.

“Clearly, asset managers can’t depend on AUM (assets under management) growth and the fees it generates to sustain their business as they once did,” the report said.

But there were some bright spots in the report. Asset managers need to adjust their forecasts for the near- and mid-term future “but this isn’t just about playing defense.” There are steps mutual fund companies can take to help themselves “prosper over the next five years.”

Scale can help companies withstand industry headwinds and there have already been more mergers and acquisitions in recent years. PwC predicts this will continue and that the industry will shrink, with up to 20% of existing firms being acquired or eliminated by 2025.

Like many companies across industries, some asset managers have done well adapting to help employees work remotely during the pandemic. But more should consider those changes or making them permanent. Increasing the number of employees working from home, even part of the time, could create opportunities to shrink office space. Those changes could prove important to some asset managers.

“The pandemic won’t last forever, but the pre-pandemic workplace is unlikely to return any time soon; the need to reduce costs won’t allow it,” according to PwC.

Another way to shrink an office footprint? Employ fewer people. “We now predict a 10% reduction in mutual fund employment over the period from 2019 to 2025, tied to cost trimming, fund consolidation, and increased automation and outsourcing.”

But cost-cutting is only one tool in the box. The PwC report suggested other solutions that would help asset managers in the long-term.

If complex strategies are what differentiate a firm, then they need to consider new vehicles. Examples of more products on the horizon include smart-beta funds, periodically disclosed active ETFs, ESG, and outcome-oriented funds, according to PwC.

The consultant also said companies need to modernize their technology and offer products and services beyond their funds. “Investors understand the need to pay for services, but as many valuable services are now available at low or no cost, the fund value proposition just isn’t as reasonable to them,” the PwC report said.

If they haven’t already implemented them, fund companies might need to offer performance-linked and/or fulcrum fee structures to better align manager ability with investor value. They should also think about offering “new ancillary services,” such as automated tax-benefit advisors, financial wellness tools and more complex analytical guidance.

“In addition to generating revenue, these services are sticky — embedding firms in the daily lives of their clients and increasing customer loyalty.”

Michael Thrasher (@Mike_Thrasher) is a reporter at RIA Intel based in New York City.

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