Three winning strategies are emerging in the US asset-management industry, and firms that pursue any of them are twice as profitable, on average, than those that don't. Moreover, the strategic approaches firms choose will be increasingly important as heightened competition and the slowing growth rate of new asset flows make today's enviable profit levels more challenging to maintain.

Such are the findings of a survey of 68 US retail and institutional asset managers, representing some $5 trillion in assets under management (more than one-quarter of the industry). The survey, carried out in 2005, is the fourth in an annual series that began in 2001. It includes a balanced mix of firms—for instance, retail and institutional, large and small.¹

On the surface, prospects for US asset managers are rosy: average profit margins reached 28 percent in 2004, two percentage points higher than in 2003 and three points above the bear market's trough, in 2002. But we found that, on average, the growth of new asset flows trailed GDP growth for the fourth year running, largely as a result of increased competition from hedge funds and other market participants. In fact, the share of new flows held by traditional managers has dropped to 78 percent, from 93 percent, over the past four years. Moreover, the growth of new assets will likely come under further pressure over the next decade as retiring baby boomers come to need fewer asset accumulation products such as mutual funds.²

Traditional asset managers are thus in the vulnerable position of having to rely on market appreciation rather than on increased new flows to drive profitability. Furthermore, heightened competition has eroded these firms' pricing power (the fees they charge to manage accounts), while industry-wide productivity has failed to keep pace with asset growth (Exhibit 1).

Against this backdrop, we observed that the most successful asset managers (respondents in the top quartile as measured by profits) have followed one of three distinct strategies over the past four years (Exhibit 2). The first group, which we call "at-scale competitors," had profit margins of 34 percent in 2004. As the name implies, these firms, which represent 21 percent of all respondents, rely on sheer size (at least $100 billion in assets under management) to achieve economies of scale in areas such as marketing, branding, and technology. During each of the past four years, they enjoyed a cost-per-asset advantage of around 20 basis points (50 percent) over their smaller competitors, with the most pronounced benefits arising from investment management. As pricing pressures intensify, we believe that this cost edge will become even more valuable to such firms.

Still, size isn't the only way of achieving success. The second group of firms, "multiboutiques"—which have, on average, $60 billion in assets under management—had the highest average profit margins among those we studied: 36 percent. Multiboutiques, such as Affiliated Managers Group (AMG), Mellon Financial, and Old Mutual, accounting for 35 percent of the firms in our sample, operate as parent companies to a collection of smaller, independent money managers. This structure gives multiboutiques the flexibility to diversify their investment styles and to gain scale advantages in targeted asset classes—all while spreading their costs over a large base. In fact, when compared to firms of a similar size, multiboutiques had the lowest costs per asset of any group we studied, as well as the highest levels of institutional sales productivity (measured as assets per sales professional).

Likewise, "focused-asset providers"—firms with at least two-thirds of their assets in fixed-income products or equities and $2 billion or more per product vehicle managed—have also achieved scale within their targeted asset classes. This high degree of focus is evident in the investment-management function, where these providers (21 percent of all respondents) enjoy productivity levels almost 25 percent higher than those of an average firm of the same size. Focused-asset providers are highly profitable, with average margins of 34 percent. But given their relatively heavy product concentration, they also face higher earnings volatility should products go out of vogue.

The remaining 23 percent of the asset managers, which we call the "stuck-in-the-middle" ones, had average margins of only 18 percent. Such firms are neither large nor focused in the asset classes they manage. Indeed, their assets under management per product type were less than half those of the average for firms of similar size. Since their resources are spread across a diversified set of asset classes—many lacking scale—they have higher costs and lower productivity than their peers: for example, their total costs per asset managed are five and six basis points higher than those of focused-asset providers and multi-boutiques, respectively. Productivity levels (for investment managers and the firms as a whole) also lag behind those of top-performing competitors (Exhibit 3).

While the three strategies we identified deliver superior profitability, on average, the large variations in profits apparent among firms pursuing them indicate the importance of execution in any strategy.³ The major drivers of performance gaps in execution were product, cost, and retention management, as well as pricing.

The asset-management industry remains attractive and profitable. Yet the increasing challenges it faces raise the importance of pursuing a winning strategy and executing well. Firms that do both will continue to enjoy above-average profits.