European asset managers are struggling against fortune. The sector’s average profits fell in 2001¹ for the first time in years—hardly surprising given the general economic slowdown. But our latest survey of these companies² reveals that a considerable number have failed to respond adequately to the changed economic climate. Some European asset managers have made sharp adjustments, but investment strategies geared to growth are still common and not all of the com-panies have their costs under control. As a result, one in five of them operated at a loss in 2001. With no end in sight to the global economic cooling, many asset managers need to get a grip on their costs by streamlining their operations.

In 1999, we began surveying this young European industry to determine, for instance, the profitability of different customer segments in different countries. The first two surveys, based on data from 1998 and 1999, respectively, showed an industry profiting hugely from the scramble for equities. Most participants still reported healthy profits in 2000, but a marked change emerges from the latest figures, drawn from 84 European asset-management businesses,³ with €3.3 trillion ($3.5 trillion) of assets under management—representing 52 percent of the European market.

For the first time since the annual survey began, these companies had less to manage than they did the year before: assets under management decreased by 3 percent in 2001 after growing by 8 percent in 2000 and by 20 percent the year before that. Consequently, as Exhibit 1 shows, average net revenues plunged, not least because investors switched en masse from high-risk, high-margin products such as equities, small caps, and sector funds to lower-risk, lower-income asset classes such as fixed-income securities and money market funds, which generate smaller fees for asset managers. Retail net revenues fell to 42 basis points, from 54 (Exhibit 2).⁴ Although net revenues from institutional investors were unchanged at 20 basis points, they were still well below the US institutional-market average of 30 basis points—a reflection of fiercer competition in Europe.

Not surprisingly, in 2001 the sector’s overall profitability fell by more than 48 percent, and the profitability of retail asset management, though still greater than that of the institutional side, declined sharply, in part because expenditures continued to rise. The profitability of institutional asset management, by contrast, increased slightly after years of decline, though for most players this improvement was hardly enough to cover the cost of doing business. Some, however, are managing to charge institutional clients fees at almost retail levels and to turn aside low-price institutional business.

If asset managers had handled their costs more successfully, their profits might not have fallen so much. On average, costs went up by 1 percent in 2001—nothing compared with the 18 and 20 percent rise in 2000 and 1999, respectively, but still a move in the wrong direction. Quite a few of these companies now seem to have their middle- and back-office costs under control, and they have cut their support costs by slashing IT spending. Yet in 2001, hoping that the market downturn that began the year before had been merely a temporary blip, they continued to invest in sales and marketing. So far, the expenditures have failed to increase sales, because investors continue to worry about stagnant and falling asset values.

That said, the profitability of these companies ranged widely. The best made profits of 80 basis points; only 10 percent of the sample generated more than 30, however, and 20 percent were in the red, with the greatest loss at 40 basis points. On closer examination, large and niche players did reasonably well. The large companies, which manage assets in excess of €100 billion, exploited economies of scale (in fund management, for instance); the niche firms, which focus on a limited range of asset classes or on specific client segments, could charge more because of their specialist capabilities or brand names. But midsize companies struggled to reap benefits from investments—in sales and marketing and fund-management capabilities, for example—that had been intended to bring their operations up to the standards of the biggest; their total costs were 25 percent higher (Exhibit 3). Companies with fewer than 50 funds, for example, spent an average of €115,000 per fund on management, a figure that falls to an average of €76,000 for companies with more than 150 funds and to as little as €50,000 for those with more than 500. The same applies to marketing costs.

Customers are unlikely to return soon to the high-margin asset classes that powered the industry during the boom years. Faced with continuing limited growth in the European market, asset managers would do well to get the most from the operational investments they have already made and to reconsider their focus on investing to develop new business. Unfortunately, for the time being there is no new business to be found.