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  • 1. Financial Services Global Asset Management Industry Outlook Integrating Strategy with Experience in a Changing World
  • 2. Dear Colleague: For the past eight years, the Financial Services practice of the member firms of Deloitte Touche Tohmatsu (DTT member firms) has produced the annual Asset Management Industry Outlook to address the “top 10” issues affecting firms in the year ahead. This year, we took a new approach, working with the Economist Intelligence Unit to develop both a long-term industry view, entitled Global Financial Services Industry Outlook: Shaping Your Strategy in a Changing World, as well as companion reports that consider the same issues at a more focused level by sector. There are several distinct Our Global Asset Management Industry Outlook: Integrating Strategy with opportunities for growth – Experience in a Changing World report finds that while issues like risk particularly through globaliza- management and regulatory compliance remain a challenge, there are tion and expansion into new several distinct opportunities for growth – particularly through global- markets, a differentiated product ization and expansion into new markets, a differentiated product set set and new strategies for the and new strategies for the retirement market. retirement market. To identify critical market drivers for our Global Industry Outlook reports, we conducted an online survey of 175 board members and global executives across the financial services industry, of which 40 were from the asset management industry. Based on our findings and our client experiences, we believe that the issues identified within this report will have the greatest impact on asset managers as they approach 2010. Asset managers should embrace the imperatives outlined in this report to achieve long-term success. We plan on continuing our research into the future of the asset manage- ment industry and examining other ways in which asset management firms can sustain growth and integrate strategy with experience in a changing and dynamic world. In the meantime, we hope you find this report valuable. Garry Moody Global Asset Management Leader Deloitte Touche Tohmatsu
  • 3. Asset management firms are adapting to a future that requires the ability to “think different.” The challenges are clear. Major asset management firms have begun to reinvent themselves to succeed in an increasingly global, technology-enabled and heavily regulated sector of the financial services industry. Despite the challenges facing the industry, growth prospects • Product differentiation can increase margins, but also involves are high. Asset managers should consider catering to the aging investments in non-traditional fund management capabilities. baby-boomers, emphasizing product innovation and seeking The more eclectic the funds, the more costly it is to build or expansion in new markets around the world. In this paper, we buy them. focus on the most important issues over the next three to five • A more consistent and disciplined approach to compliance years as revealed through an industry survey, interviews with can reduce (or at least slow the growth of) compliance expen- senior industry executives and practice leaders from the DTT ditures over the long term, but can involve large upfront member firms. The five top issues on the asset management investments. watch list are: • Globalize and consolidate. Asset management firms will grow by consolidating and by exploiting fast-growing overseas The five issues to watch markets such as China and India. 1. Globalize and consolidate Over the next three to five years, asset managers will grow by • Promote compliance. The regulatory burden on asset man- consolidating as well as by exploiting overseas markets – China agement firms is increasing – as are the reputational conse- and India in particular. Throughout the Asia-Pacific region, gov- quences of infractions. ernments are encouraging savers to become investors, turning • Differentiate products. The appetite among institutional the region’s high savings rate into a source of risk capital to and individual investors for diversification and uncorrelated drive economic growth. returns will continue to propel growth in alternative invest- Nearly 63% of asset management survey respondents rank ments. Fast-growing product segments range from exchange- globalization as the top driver of profitability over the next three traded funds (ETFs) to portable alpha. to five years. Within the broad category of globalization, 45% • Better manage risk. Like executives in other sectors of the say global consolidation will have the greatest impact on profits, financial services industry, asset management executives cite while four out of 10 cite distribution opportunities in new better management of operational and reputational risk as a markets. key to profitability. The biggest bets are on China. As of December 2005, 20 for- • Adapt to demographic shifts. As baby-boomers become eign fund managers had moved in.1 China’s fast-growing mid- retirees, demand will grow for products that turn savings into dle class needs investment products and financial advice for retirement income. retirement. Despite the geopolitical and market risk, two-thirds of survey respondents (68%) say that China will be important A mixed outlook or very important to their organization in 2010. Nearly half say Survey respondents offer a mixed picture of the economics of the same about India, while Russia and Brazil rank a distant the asset management sector. More than 80% of asset man- third and fourth. agement industry respondents believe that revenues at their Profitability in China, however, can be elusive and requires a own organizations will grow over the coming three years. When long-term view. Some institutions that have made substantial it comes to profitability, 43% of respondents believe that prof- commitments stumbled out of the gate, including the UK’s itability will increase, 30% think that it will stay the same and Schroder and the Netherlands’ ING, which reported large losses 27% predict that margins will decline. One reason for this in their China joint-venture funds in the fourth quarter of mixed outlook is that the traditional asset management business 2005.2 Other asset managers, such as Fidelity and BlackRock, has entered an era of greater transparency and intense price are taking a cautious approach, avoiding major investment until competition. Another may be that the most promising avenues the path to profitability becomes more clear. “We currently do for growth also require significant investments. For instance: not believe that the conditions under which we would be able • Fast-growing markets with relatively young populations and to enter the markets would be of benefit to us,” contends high savings rates offer the promise of growth. But building a Jonathan O’Brien, chief financial officer and executive director presence in these markets – China, India and others – entails of oversight for Fidelity Investments, Asia-Pacific Region. “If we both expenditures and risk. were to go into China right now, we would be a minority A Bumpy Ride in China, James Walker, Wall Street Journal, March 1, 2006 1 Huge Losses for Chinese Joint Ventures, Financial Times, January 23, 2006 2
  • 4. partner in a joint venture, and that’s not something we will parts. These funds are most likely to be swallowed by larger usually consider. I’m not convinced that the first-mover advan- players, leading to lower overhead costs and greater operating tage in China is actually going to be an advantage.” efficiency. Examples of this trend include Northwestern Mutual’s sale of its Mason Street Funds to American Century Investments Some asset management firms are turning to joint ventures and Federated Investors, First Tennessee Bank’s merging of its with large Chinese banks to gain access to an established cus- funds into a group run by Goldman Sachs and AmSouth tomer base. With over 70% of retail deposits, the four big state Bancorp’s sale of its fund group to Pioneer Investments.5 banks have a captive client base of hundreds of millions of cus- tomers and formidable distribution power.3 The foreign firm – 2. Promote compliance which the government limits to a 49% stake – supplies the risk When asked to cite the top influences on profitability for their management, compliance and fund management expertise; the firms, asset management industry survey respondents rank com- Chinese partner supplies local market knowledge and a distribu- pliance as a close second to globalization. Sixty percent of tion network. respondents say regulation is a top issue, and 83% of these For instance, in 2005 Credit Suisse’s asset management business respondents cite the increasing cost of compliance as a signifi- formed a joint venture with the Industrial and Commercial Bank cant impediment to profitability in the next three to five years. of China (ICBC) to offer ICBC’s customers the first bank-spon- For example, as part of a number of rules promulgated in sored mutual fund in China, investing in stock and money mar- response to the market timing and late trading scandals, the US kets. In its launch, the fund raised over $500 million. ICBC Securities and Exchange Commission (SEC) adopted the Mutual owns 55% of the joint venture, Credit Suisse 25% and China Fund Redemption Fees rule (22c-2) which requires intermedi- Ocean Shipping Company 20%. aries to provide fund firms with information regarding individual India has also attracted considerable foreign attention, thanks shareholder trading activities so that the fund firms can detect to its rapid economic growth, strong equity market, declining any market timing activities. Fund firms are directed to enter interest rates, high savings rates and easing of protectionist reg- into written agreements with intermediaries that acknowledge ulations. Mutual fund assets under management almost dou- the intermediary’s obligation to provide sub-accounting data bled between 2003 and 2006 to $48 billion, while the Bombay and enforce frequent trading rules upon the funds’ request. A Stock Exchange’s Sensex index tripled during the same period. recent TowerGroup study estimates that the industry-wide cost About half of the money is managed by non-Indian firms. to comply with this rule could exceed $1 billion. Fidelity started its first domestic mutual fund in 2005, and Asset management executives interviewed for this paper cite JPMorgan Chase has announced plans for funds in the second compliance as critical to their firms’ reputations and thus ulti- half of 2006.4 mately to their ability to grow and prosper. Compliance can be Asset growth remains strong in Western Europe. However, as a especially difficult in Asia, where rules differ and sometimes result of further European integration, Central and Eastern conflict from one country to the next. European markets (for instance, Poland) will become attractive In Japan, for instance, regulators demand that each subsidiary from a distribution perspective. and affiliate of a foreign firm must have its own local compli- Twenty-five percent of asset management survey respondents ance department or compliance officer, with local control.6 This see industry consolidation in their home country as a major approach may make it difficult to develop global compliance business driver over the coming three to five years. And, processes and achieve economies of scale. indeed, domestic consolidation looks set to increase as mid-tier Although Japan is trying to harmonize its investment manage- asset management firms, pressured by a higher cost of doing ment rules, progress remains slow and the foreign investment business, find it increasingly difficult to compete. management industry is exploring the possibility of having input According to the trade group Investment Company Institute, a into the process. And two of the markets with the most prom- handful of large firms manage the lion’s share of money, with ise, China and India, are still developing and/or modifying their the rest divided among dozens of firms with between $5 billion regulations. and $20 billion in assets. Many are owned by banks, securities In the hedge fund sector, regulation is becoming a reality firms and other companies with core businesses outside asset throughout the world. Historically unregulated or lightly regulat- management. These owners (particularly banks) have increas- ed, hedge fund advisors or the funds themselves are now sub- ingly chosen to shed their fund management businesses as ject to regulation in the US, Canada, Japan, Australia and most these businesses are experiencing difficulty in achieving indus- European countries. In practice, this usually means that hedge try-beating performance, have a smaller asset base to spread funds are regulated or authorized like any investment adviser; in their fixed costs over and encounter the same conflicts between some jurisdictions, such as Luxembourg and Hong Kong, there fund ownership and fund distribution as their larger counter are specific proficiency requirements or recommendations.7 3 Quality Will Attract Big Funds’ Attention, Henry Smith, FT Mandate, December 2005 4 Mutual-Fund Hot Spot: India, Shefali Anand, Wall Street Journal, March 10, 2006 5 Merrill Deal Hastens Retreat From Funds, Tom Lauricella and Ian McDonald, Wall Street Journal, February 14, 2006 6 Compliance Function at Market Intermediaries Final Report, Technical Committee of the International Organization of Securities Commissions, March 2006 7 The Regulatory Environment for Hedge Funds: A Survey and Comparison, Technical Committee of the International Organization of Securities Commissions, March 2006
  • 5. 3. Differentiate products Asset management industry survey respondents cite product About the online survey innovation as a major contributor to revenue growth. The tools In November 2005, we used an online survey to poll 40 of financial engineering allow institutions to design products for senior asset management executives across the financial any audience; from lifecycle funds for future retirees to ETFs for services industry to identify the key transformative issues in active traders and alpha transport strategies for institutional the industry over the next three to five years. Respondents investors. Innovation is often associated solely with hedge funds were comprised of board members, senior executives and other alternative products. However there are a myriad of (“C-suite”), business unit heads and other senior profes- instances of innovation across markets, geographies and product sionals at asset management firms. The executives sur- lines. veyed were based in Asia-Pacific (30%), Europe (40%) and North America (30%). Institutions with assets of $1 billion The flip side of this is that investment managers who continue to $10 billion made up the largest single category (38%), to rely on traditional long equity and fixed-income products followed by those with more than $250 billion (25%). face increasing competition. Larger fund families may be able to increase fees, or at least maintain them while reducing expenses through economies of scale. For instance, TIAA-CREF sharehold- ers approved a fee hike in early 2006 after management In the European fund market, estimated net sales reached attempted – and failed – to get approval the previous year.8 In 373.7 billion euro in 2005 (outpacing the US), and the mix general, however, there is limited ability to increase fee income. among products is changing slowly.12 Although mainstream The dollar-weighted average expense ratio at a US retail fund products accounted for most of the sales, certain absolute was 0.89% in 2004, according to Morningstar.9 Compare that return products – for instance, Germany’s Allianz Total Return to a typical compensation structure at an alternative investment bond fund – were quite successful. fund: a 1-2% management fee and 20% share of profits. This In the alternative investment market, Europe continues to contrast may at least partly explain why survey participants witness a proliferation of products with complex investment point to new product development as essential to future success. structures and techniques, causing regulators to rethink their One of the fastest-growing new asset classes is ETFs. Already a approach toward alternative investments. The European liquid, low-cost alternative to index mutual funds, ETFs will con- Commission has set up an expert group on alternative invest- tinue to multiply and offer exposure to new types of assets. ment funds to analyze the current organization of alternative Global ETF assets grew more than 30% in 2005 and stood at investments. A white paper with recommendations on invest- $313 billion in January of 2006, according to the Investment ment funds is scheduled for release in October 2006. In the UK, Company Institute. In 2005, 51 new ETFs were introduced, and the Financial Services Authority plans to consult the industry in 2006 and beyond ETF growth is expected to focus on special- about creating authorized, onshore funds of hedge funds in ty products that track commodities, bonds and currencies.10 order to rectify the anomalous situation whereby exposure to According to Morningstar, the average ETF has an expense ratio hedge fund investment techniques could be achieved by retail of 0.42%, compared to 0.73% for the average index fund. investors through a growing number of structures, but not through an authorized fund structure. Other innovative products that have gained momentum in the past year include: The rush to develop alternative assets will continue. New hedge fund launches in Europe rose by nearly 33% to 330 in 2006, • Both private and public real estate investment vehicles with raising $27.8 billion, up 22% from 2005, according to the assets in Japan, China, Singapore, Korea, Thailand and other magazine EuroHedge. A handful of established hedge fund fast-growing Asia-Pacific markets. According to a 2005 poll of managers raised the bulk of the cash, underscoring the impor- fund managers by Singapore-based OCBC, Asia continues to tance of a track record when courting investors.13 It is increas- be a favored region for institutional real estate investment. ingly difficult to raise capital without an existing infrastructure, • In Canada, principal-protected notes sold to high-net-worth a strong business plan and established compliance processes. investors seeking both capital protection and exposure to risky markets or sectors. 4. Better manage risk • In the US and UK, lifecycle funds, which offer retail investors Risk management is another major area that survey respondents an easy way to reallocate their assets as they grow older. The cite as a key driver of profitability. Three major areas of risk funds are designed for growth early in the investor’s life and stand out: operational risk, reputational risk and market risk. principal preservation as the investor nears retirement. US Operational risk is top of mind for the asset management assets in lifecycle funds rose 50% between 2003 and 2005.11 executives who responded to our survey. Fifty-five percent 8 Fund Times: TIAA-CREF Gets What It Wants, Morningstar Advisor, January 27 2006 9 Fund Fees: The Silver Lining Has a Big Dark Cloud, Russel Kinnel, Morningstar, April 7 2005 10 ETFs Shift Focus, Tracking Items Like Oil, the Euro, Jen Ryan, The Wall Street Journal, January 19, 2006 11 Lifecycle funds let you do the retirement ‘one-step’, Christian Science Monitor, June 13, 2005 12 European Fund Market Data Digest, FERI Fund Market Information Ltd., 2006 13 Europe Had Record Growth in Hedge Funds in 2005, Margot Patrick, Dow-Jones, February 23, 2006
  • 6. identify operational risk as one of the key drivers of future prof- needs of an aging customer base. These include guaranteed its, of greater concern than market (credit and liquidity) risk, income products, asset protection products, reverse mortgages which they are generally able to manage more effectively. and improved variable annuity products. Closely tied to operational risk is reputational risk, since opera- The defined contribution market is also developing in many tional missteps can severely tarnish a firm’s reputation. In inter- regions – from Australia, where it is entrenched, to Japan, views with senior executives, reputational risk was most often where in 2000 pension reforms were passed introducing cited as the top concern in coming years. Most of the execu- defined contribution plans to the market, but the reforms are tives interviewed believe that reputation is critical to success viewed as too restrictive to realize the benefits, to Taiwan and and that it needs to be managed throughout the business Korea, where recent legislation has created opportunities. To rather than solely through the public relations department. sustain long-term growth, account managers who have focused “Managing our brand is operational; it’s public relations and it’s on the defined benefit market will need to extend their reach strategic,” says Jonathan Russell, managing partner and global to the defined contribution market and to retail investors. They head of buyouts at London-based 3i Group. will have to establish relationships with fund platforms, financial advisers and brokers. Ultimately, the defined contribution mar- Driving the focus on compliance, operations and internal audit ket will blur the distinctions between institutional and retail, as is a heightened awareness of the reputational risk stemming fund managers use the corporate customer to leverage a rela- from noncompliance. In the US, asset management firms tionship with the individual. untouched by the recent market timing and late trading scan- dals (such as Fidelity, Capital Group and Vanguard) have accu- The US fund group Fidelity has proposed measures to increase mulated large sums of new assets at the expense of other fund the use of defined contribution plans, since nearly one-third of groups that saw their reputation suffer. eligible US workers do not join, only one in 10 saves the legal maximum and few workers are saving enough to support them- 5. Adapt to demographic shifts selves in retirement. Among the suggested reforms are auto- The asset managers who responded to the survey cite demo- matic plan enrolment, increases in contributions to match pay graphic changes as a final driver of profitability over the next raises and the offering of lifecycle funds as the first savings three to five years. A greying population is moving from wealth option. Fidelity predicts that these reforms would double the accumulation to a lengthy retirement. Nearly three out of four retirement savings of low-income workers and, in combination asset management industry survey respondents (73%) see these with Social Security, bring these workers to 100% of pre-retire- customers driving a shift in demand among types of financial ment earnings.15 products. It has been estimated that by 2025, between a quarter and a Looking ahead third of the US population will be in retirement and the median Despite the challenges they face, most of the asset manage- age will stand at 39, up from 29 in 1975. The story is the same ment executives surveyed indicate that their revenues will throughout the developed world and even in parts of the devel- increase during the next three to five years. The asset manage- oping world. In Germany, Spain, Italy, Switzerland and Japan, ment firms that grow will share several characteristics. First, the median age will be between 49 and 52; in Korea, 43; and continued growth, whether through acquisition or merger, new in China, 39, the same as in the US (though China faces the product introductions or expanded global distribution is an risk that it may get old before it gets rich)14. important focus as it significantly impacts future profitability. For the asset management industry, the single biggest question Second, firms that lose the trust of customers also tend to is what new products and services these people will buy to impede future growth in revenue and profitability. A firm-wide assist with their financial security. A number of asset manage- commitment to controlling operational risk and running a com- ment firms are focusing on building a geographically broad- pliant organization can confirm that the firm’s reputation based advisory capability, protection products and a portfolio of remains intact. Finally, the need to anticipate the market’s lifecycle products that anticipate these changing customer changing demographics suggests that asset managers should needs. Some US firms are developing products to serve the focus continued attention on advice and products tailored to the needs of an aging global population. The World Is Getting Older, Progressive Policy Institute, February, 2004 14 The Next Generation, Robert L. Reynolds, The Wall Street Journal, November 28, 2005 15
  • 7. DTT Member Firm Asset Management Industry Leaders Americas France Spain Jean Pierre Vercamer Rodrigo Diaz Bermuda Partner Partner Bill Jack Deloitte & Associés Deloitte, S.L. Partner +33 1 40 88 22 03 +34 91 514 20 21 Deloitte & Touche jvercamer@deloitte.fr rodiaz@deloitte.es +1 441 299 1300 billjack@deloitte.com Gérard Vincent-Genod United Kingdom Partner David Barnes Canada Deloitte & Associés Partner Don Wilkinson +33 1 40 88 22 98 Deloitte & Touche LLP Partner gvincentgenod@deloitte.fr +44 20 7303 2888 Deloitte & Touche LLP djbarnes@deloitte.co.uk +1 416 601 6263 Germany dowilkinson@deloitte.ca Norbert Bruehl Partner Asia Pacific Cayman Islands Deloitte & Touche GmbH Glen Wigney Australia +49 69 75695 6037 Partner Sarah Woodhouse nbruehl@deloitte.de Deloitte & Touche Partner +1 345 814 2202 Deloitte Touche Tohmatsu Ireland gwigney@deloitte.com +61 2 9322 7510 Ronan Nolan sawoodhouse@deloitte.com.au Partner United States Deloitte & Touche Garry Moody China (People’s Republic of) +353 1 417 2250 Partner Wade Deffenbaugh rnolan@deloitte.ie Deloitte & Touche LLP Partner +1 617 437 2750 Deloitte Touche Tohmatsu Italy gmoody@deloitte.com +852 2852 6629 Riccardo Motta wadeffenbaugh@deloitte.com.hk Partner Deloitte & Touche S.p.A. Europe and Africa Japan +39 02 833 22 323 Dean Maines Austria rmotta@deloitte.it Partner Wolfgang Fritsch Deloitte Touche Tohmatsu Partner Luxembourg +81 3 6213 3068 Deloitte Wirtschaftsprüfungs Yves Francis dean.maines@tohmatsu.co.jp GmbH Partner +43 1 53700 3900 Deloitte SA Yoshihiko Suzuki wfritsch@deloitte.at +352 451 452 248 Partner yfrancis@deloitte.lu Deloitte Touche Tohmatsu Robert Pejhovsky +81 3 6213 3173 Partner Mauritius yoshihiko.suzuki@tohmatsu.co.jp Deloitte Wirtschaftsprüfungs Chandra Gujadhur GmbH Partner Korea +43 1 53700 4700 Kemp Chatteris Deloitte Nak Sup Ko rpejhovsky@deloitte.at +230 203 8000 Partner cgujadhur@deloitte.com Deloitte Anjin LLC Belgium +82 2 6676 1103 Frank De Jonghe Netherlands nko@deloitte.com Partner Frank Maertens Deloitte Business Advisory Partner Singapore CVBA/SCRL Deloitte Financial Advisory William Lim +32 3 800 88 89 Services B.V. Partner +32 497 51 53 74 +31 20 582 5444 Deloitte & Touche fdejonghe@deloitte.com fmaertens@deloitte.nl +65 6216 3173 wilim@deloitte.com Denmark South Africa Jens Hoeck George Cavaleros Taiwan Partner Partner Ray Chang Deloitte Statsautoriseret Deloitte & Touche Partner Revisionsaktieselskab A/S +27 21 670 1617 Deloitte & Touche +45 36 10 34 26 +27 82 558 5737 +886 2 2545 9988 ext. 3029 jhoeck@deloitte.dk gcavaleros@deloitte.co.za raychang@deloitte.com.tw
  • 8. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organization of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 150 countries. With access to the deep intellectual capital of 120,000 people worldwide, Deloitte delivers services in four professional areas – audit, tax, consulting, and financial advisory services – and serves more than one-half of the world’s largest companies, as well as large national enterprises, public institutions, locally impor- tant clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas. As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other’s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names “Deloitte,” “Deloitte & Touche,” “Deloitte Touche Tohmatsu,” or other related names. © 2006 Deloitte Touche Tohmatsu. All rights reserved. 05/06 – Item #6101

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