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Financials Search for Growth in an Age of Disruption

As asset managers and banks hunt for revenue growth amid moderating global economic activity, new opportunities may be surfacing in China, private markets and reimagined business models.

As 2019 begins, asset managers and banks face a once-in-a-generation call to reinvent their businesses.

The race is on to launch new propositions for clients, gain share by identifying emerging client needs and combat disruption from new entrants.
Betsy Graseck Global Head of Banks and Diversified Financials Research

For asset managers, the growth in low-cost passive investing has further commoditized market investment returns, forcing managers to find less costly ways to serve their clients and seek growth. For banks, headwinds from political gridlock and a weaker outlook for global trading and advisory revenues are demanding a bold pivot to new growth areas and a hard look at which business lines they should defend from disruptors—or skillfully exit.

However, neither of these industries lack for fresh opportunities. A collaborative new BluePaper from Morgan Stanley Research and consultancy Oliver Wyman identifies potential growth pockets in emerging markets and China, reimagined business models and expanding revenue pools in areas such as private markets.

“The race is on to launch new propositions for clients, gain share by identifying emerging client needs and combat disruption from new entrants,” says Betsy Graseck, Global Head of Banks and Diversified Financials Research, “But these moves must be accompanied by an aggressive focus on the bottom line. While retooling the business may carry incremental upfront costs, the urgency has never been greater nor the restructuring alternatives available for wholesale banks across the globe.”

Asset Management at a Crossroads

The asset management industry finds itself in a curious paradox. Over the past five years, industry revenues have grown roughly 4%-5%, bolstered by rising asset values and inflows. By the end of 2018, revenues had hit a high of $326 billion, with more than $80 trillion of externally managed assets under management (AUM).

Despite these numbers, equity market valuations for the industry fell to a 20-year low last year, as investors questioned forward growth potential. A key reason: the shift to passive asset management—which now represents more than 25% of global AUM—foreshadows investors’ growing unwillingness to pay traditional asset management fees. 

Forward Valuations Express Concern
Around Asset Managers' Growth Outlook
(U.S./EU Traditional Asset Mangers - P/E Multiples - Absolute)

Source: Thomson Reuters, Factset, Morgan Stanley Research Note: 1) data as of Jan 31, 2019; 2) analysis done on FY2 P/E multiples; 3) US covered traditionals exclude WETF and VCTR; 4) Whilst for Europe, forward valuations are not at an all time low, current valuations are during a relative positive market backdrop vs. the 2008 financial crisis / market correction

“The growth in passive has commoditized access to market investment returns,” says Michael Cyprys, equity analyst covering U.S. brokers and asset managers. While he cites real risks from the shift to passive, such as market concentration and liquidity, “the reality is the premium fees charged for active asset management are under intense pressure."

Overall, the industry faces a tough outlook. The race to the bottom on fees has largely offset share growth in passive AUM, even as the revenue pool of traditional active management is set to shrink by more than a third over the next five years. However, the report identifies three attractive pockets of growth. 

Emerging Opportunities

First, clients in developed markets represent 85% of current global AUM. That figure could soon shift, as emerging-market clients now account for nearly 35% of new industry inflows, reflecting the change in global wealth generation. All told, capital market development in emerging markets could represent a $30 billion revenue growth opportunity over the next five years.

In China, regulatory changes enacted in late 2018 could further enable foreign asset managers to tap this market. “China is set to drive 50% of future emerging-market revenue growth, and local on-shore AUM could grow at a compound annual rate of 13%, hitting $7 trillion by 2023.” says Richard Xu, Equity Analyst covering Chinese Financials. International asset managers can take advantage of new access to this growing pool of AUM, which over the long term, could provide a growing investor wallet for sell-side operations.

China Third-party Asset Management Products to Grow to $7 Trillion
(Onshore "core", Third-party Managed AUM in China, 2010-2023F, USD Tn)

Source: Oliver Wyman analysis

Private Markets and Solutions

Private markets may offer yet another potential pocket of growth. In recent years, the growth in private capital markets (across equity and debt) has outshined public markets, but the investment into private markets largely comes from a subset of institutional client segments: defined benefit pensions, sovereign wealth funds and endowments.

However, over the next three to five years, a growing proportion of AUM inflow could come from high net worth individuals, insurers and defined contribution plans, such as 401(k)s. Opening access to private markets for these groups through new and more efficient delivery models could drive an additional $23 billion in revenue.

High Net Worth and Insurance Showing
Strong Growth in Demand for Alternatives  
(Total Private Markets AUM $Tn)

Source: Oliver Wyman analysis, Preqin, Morgan Stanley Research

Finally, new technology is set to enable mass customization of solutions, opening up another $7 billion in potential revenues. Rapid evolution in data management and digital automation could bring customized investment management to areas such as mass market retirement savings. However, to win in this arena, asset managers will need to complete against each other—and with technology players and distributors.

While access to these three growth areas could prove challenging for some players, the report notes that these revenue pools may grow at a compound annual average rate of 8% over the next three to five years, from an aggregate 38% to more than 50% of industry revenues.

Wholesale Banks at a Turning Point

Meanwhile, many wholesale banks face a similar need to pivot. Midway through 2018, there was growing optimism that the industry had weathered the worst, and expectations had converged around global revenue growth of about 3%. However, as 2019 unfolds, that global revenue outlook has slowed, held back by moderating economic growth and increasing nonbank competition, particularly in flow and adjacent services.

“In order to overcome an environment of low growth and disruption, management teams will need to act boldly to drive up returns, particularly in Europe,” says Magdalena Stoklosa, Head of Research for European Banks and Diversified Financials. “While industry-wide fee pools could see only a modest path of growth, we also see significant pockets of more attractive growth that could generate new revenues of over $15 billion by 2021 alongside radical re-invention of parts of the business.”

One pocket of growth is in CFO-down type activities like transaction banking, particularly corporate payments and cash management. “Transaction banking is the fastest growing part of the CIB industry and a key battleground. We see further room for growth linked to rising interest rates and underlying corporate activity,” says equity analyst Bruce Hamilton.

Another area of growth is China. Regulatory changes across both the buy-side and sell-side are leading to faster revenue growth in China, which the report estimates at 8% CAGR for Sales & Trading and Investment Banking alone through 2021. Even so, sustained commitment by foreign banks will require significant investments and time to earn a sufficient return.

To fund these growth initiatives, banks first need to target the services, products and clients where they believe they can be leaders, then drive efficiencies throughout these organizations from front to middle to back in both headcount and infrastructure. Along the way, Morgan Stanley analysts expect that banks of varying sizes will increasingly close uncompetitive, value-destructive businesses.

The winners will be those with the investment budgets and decisive leadership to focus on strengths, attack break-out opportunity areas, and exit laggard businesses. Banks with a weaker starting point will have to cut more deeply than others to free up the investment needed to defend their core franchises. That may mean exiting business lines and aggressively skewing resources away from low growth and low profitability areas.

If banks take on the challenge as expected, a combination of new management action, existing current cost programs and modest revenue growth should drive the average return on equity to about 12% by 2021, from 10% today with leaders at 15% and laggards at 9%. 

For more Morgan Stanley Research on the latest trends and outlook for the financial sector ask your Morgan Stanley representative or Financial Advisor for the BluePaper, “Searching for Growth in an Age of Disruption” (Mar 14, 2019), a collaborative report between Morgan Stanley Research and Oliver Wyman. Plus, more Ideas from Morgan Stanley thought leaders.