Many asset managers are going to struggle to stay profitable in 2024, according to two leading financial firms.

Firms that want to succeed are going to need to make changes – some radical – in order to stay afloat, EY and McKinsey & Company executives said.

According to EY, “The five-year outlook for aggregate profit margins across the asset management industry is clearly to the downside. Asset managers would need to eliminate 5% to 7% of costs between 2023 and 2027, to maintain operating margins at 2022 levels.”

For a start, asset managers are going to have to be willing to venture into new investment territory to grow and keep clients and are going to be forced to further outsource activities that now are done in-house, Mike Lee, EY global wealth and asset manager leader said in an interview.

In addition, asset managers will need to modernize their distribution operations, and also make sales and marketing a competitive differentiator by using non-traditional data, digital tools and AI for certain tasks, according to McKinsey & Company, a worldwide management consulting firm based in Chicago.

“A growing contingent of asset managers will struggle to survive in their current form, with the pressures being especially acute for second-tier, mid-sized and smaller institutions that lack scale or standout niche capabilities,” Lee noted.

The next few years will see a turnover with mergers and closures thinning the ranks of existing asset managers, but with new firms entering the scene, which will ensure a constant process of reshuffling and renewal, EY said.

“To stand out, asset managers will need to push to personalize their services, while at the same time digitalizing their operations,” Lee said. “Asset managers already have outsourced back-office functions; now they will have to outsource middle-office operations. Some organizations are seeing what compliance functions can be outsourced.”

Asset managers who are not already offering clients alternative and private market investments may want to consider these options in order to compete effectively. As they branch out to new types of investments, managers will need to better communicate with clients about their firms’ differentials, educating clients and ensuring they understand liquidity, EY said.

“Without these types of changes, the top line is going to continue to go down and the bottom line will continue to go up and fees will be further compressed.” Lee said.

McKinsey & Company agrees changes will be needed to remain profitable. According to the firm’s research, “there is a widening gap in organic growth and profitability between top-performing and struggling firms. Only 29% of asset managers were able to generate positive net flows in both 2022 and the first half of 2023, while the share of struggling firms increased to 42%.”

“Firms also need to take a hard look at product strategy – in some cases accelerating product and go-to-market innovations and in other cases conducting aggressive product rationalization,” the consulting firm said. “The industry is undergoing structural adjustments in response to continued higher interest rates. This adjustment presents an unparalleled opportunity for asset managers to expand their roles as financial intermediaries.”

Asset managers also are facing increasing challenges because clients have been reentering the market following the pandemic in lower-fee passive and fixed-income strategies. Higher-fee active equity strategies are seeing outflows, McKinsey & Company said. The gap between the best firms and all the rest is widening in terms of organic growth and profitably.