McKinseyAM2010 Final

Financial Services Practice
Private Equity
Hedge Funds
Emerging
Markets
Traditional Retail DC/IRA

Developed
Defined Markets
Sovereign
Benefit Wealth
REVENUE
ETFs
GROWTH
The Asset Management Industry:

Now It’s About Picking Your Spots
The Asset Management Industry:
Now It’s About Picking Your Spots
Executive Summary 1
Industry Profitability in 2009: Battered but Resilient 5
Structural Shifts Continue to Pressure Core Business 11
Picking Your Spots for Growth 17
Transforming Ideas Into Action: Setting the Management 27

Agenda for 2011 and Beyond
The Asset Management Industry: Now It’s About Picking Your Spots 1
Executive Summary
In the wake of the worst financial crisis in genera-

tions, the U.S. asset management industry remained
remarkably resilient over the past year. Although rev-
enues fell 12 percent in 2009 and profitability
dropped by a third to the lowest level in a decade,
average industry operating margins still ended the
year at 22 percent. While asset management firms
are looking to 2010 and 2011 with a renewed focus
on growth, they remain somewhat cautious about the
market outlook, with growth expectations in the 6
percent range, well below historical norms. Our most
recent benchmarking survey of U.S.-based asset
managers, conducted in conjunction with Institutional
Investor's U.S. Institute, also revealed the following:
• While the industry tightened its belt a notch, cutting costs by an av-
erage of 6 percent, there was a wide variance in approach among
firms. For example, a group of “Decisive Operators” took the oppor-
tunity to fundamentally restructure their cost base and have invested
the proceeds in growth, while a larger group of firms, “Depressed
and in Denial,” adopted a wait-and-see approach to cost reduction,
despite their pessimism about the market, and saw their profits drop
by over 50 percent.
• Some of the business models that excelled over the last decade fal-
tered during the crisis, including multi-boutiques and at-scale gen-
2 The Asset Management Industry: Now It’s About Picking Your Spots
eralists. In contrast, at-scale specialists, retirement-focused players

and niche players continued to grow strongly. The biggest losers
continued to be firms that were “stuck in the middle,” who saw their
ranks rise while their share of assets dropped dramatically.
• Major structural shifts – including declining revenue yields, consoli-

dating distribution and a tougher regulatory environment – continue
to put long-term downward pressure on industry economics, and
few firms have stress-tested their business models in the face of
these changes.
• Growth opportunities abound, and there is a broad industry con-

sensus about which offer the greatest potential: retirement, inter-
national, sovereign wealth, exchange-traded funds (ETFs) and
alternatives. However, the investments in
growth that asset management firms are
making do not match the strength of their Growth opportunities abound,
convictions, and few appear to have a and there is a broad industry
clear sense of how they will differentiate
themselves from their peers. Nonetheless,
consensus about which offer
firms remain confident, with more than 80 the greatest potential: retirement,
percent believing they will gain or maintain international, sovereign wealth,
industry share.
exchange-traded funds (ETFs)
• Only a quarter of asset management firms
consider mergers and acquisitions to be
and alternatives.
important to their overall growth strategy;
of these, 70 percent are focused on small domestic acquisitions to
round out their investment capabilities, rather than large transfor-
mational deals or international expansion.
These findings are based on our ninth annual economic benchmark-

ing survey of U.S.-based asset managers. This survey is a core com-
ponent of McKinsey & Company’s global benchmarking of over 300
asset management firms from North America, Europe, Asia, South
America and the Middle East with roughly $22 trillion in assets under
management (AUM). McKinsey has worked with the U.S. Institute
since 2001 to benchmark the U.S. industry’s financial performance.
In 2009, 110 firms with over $9 trillion in AUM – more than 40 percent
of the industry and over half of the actively managed universe – par-
ticipated in the U.S. survey, which encompasses over 2,000 business

performance metrics. Additionally, we conducted in-depth research
into the industry’s growth potential, incorporating the results of a de-
tailed survey of 40 asset managers and interviews with senior execu-
tives at a dozen leading firms.
Industry Profitability in 2009:

Battered but Resilient
The financial crisis brought an abrupt end to the strong

growth cycle that the asset management industry en-
joyed from 2002 to 2007. The beginning of the end
came in 2008 with the second-worst annual decline in
the history of the S&P 500, followed by negative net
long-term flows for the first time in decades and a year-
over-year decline in AUM of 25 percent by mid-2009.
Operating leverage, long elusive on the upside, was re-
discovered with a vengeance on the downside – with
2009 revenues falling 12 percent and industry pre-tax
operating margins plunging by one-third to 22 percent
from a high of 33 percent in 2007 (Exhibit 1, page 6).
Tough times indeed, but the industry weathered the storm with remarkable
resilience. Bolstered by a partial market recovery that helped to boost 2009
end-of-year AUM to only 8 percent below pre-crisis levels, the asset manage-
ment industry’s cumulative total return to shareholders (TRS) continued to
outperform other financial services sectors (Exhibit 2, page 7). Firms also
tightened their belts a notch, cutting costs an average of 6 percent through a
combination of headcount reductions (5 percent) and non-compensation cost
reductions (e.g., a 10 percent reduction in “other” non-compensation costs).
However, these cost savings paled in comparison with those made by banks
and insurers, who made double-digit cuts. Nor did cost savings keep pace
with a greater than 10 percent decline in average AUM. As a result, costs
over assets crept up – from 26 bps in 2007 and 2008, to 27 bps in 2009.
Broadly, the industry as a whole made minimal cuts, seemingly in the hope
that a rising market would make up the difference.
As with all averages, these results mask divergent individual performance.

In fact, the variability among asset management firms’ profits was the
highest we have seen in nine years of conducting this survey, driven by
widely different decisions made throughout the crisis. While almost all
firms faced steep declines in assets and revenues, a group of “Decisive
Operators” (20 percent of firms surveyed), whose revenues declined by
more than a third since 2007, chose not to waste a good crisis (Exhibit 3,
page 8). They seized the opportunity to restructure their operating mod-
els, cutting costs by 35 to 40 percent over the last two years. To achieve
such dramatic reductions, these firms pulled many of the levers we de-
scribed in our 2009 report, Recovering From the Storm: exiting unprof-
itable investment strategies and teams, sometimes even entire asset
classes, as part of strategic repositioning; redesigning compensation
models; restructuring sales and marketing; and embarking on the lean re-
Exhibit 1
Operating profit margins plunged more than one-third from

2007 high
Pre-tax profit margin for all surveyed firms Profit margin for
Percent same firms in 2008
and 2009 surveys
Percent
33 Margin including
31 31 one-time
30 expenses = 20% 29
28
27 26
25
22 22
2001 2002 2003 2004 2005 2006 2007 2008 2009 2008 2009
Source: 2009/2010 McKinsey/USI AM Benchmarking Surveys
design of middle back-office processes and consolidated enterprise sup-

port operating platforms. Many of these firms are now reinvesting the pro-
ceeds of this restructuring in growth.
Although Decisive Operators saw profits fall by a third from 2007 to 2009,
they fared better than their peers. For example, the largest group of firms (42
percent), “Depressed and in Denial,” experienced more modest revenue de-
clines than Decisive Operators (about 25 percent over two years), but re-
duced their costs by less than 5 percent. Ironically, this more modest cost
reduction was not rooted in “wait and see” optimism – this group was actu-
ally the most pessimistic about the prospects of a sustained market recovery.
Depressed and in Denial firms’ profits tumbled by 60 to 75 percent from
2007 to 2009, leaving little to no margin for reinvestment in growth. Interest-
ingly, even the 20 percent of “Marginally Impacted” firms that managed to
grow through the crisis saw their costs increase nearly twice as fast as rev-
enues. The result is that some quite different operating models are emerging
among asset management firms in the post-crisis environment. Some have
cost bases that are more variable and resilient to future market upheavals,
Exhibit 2
Asset management industry continues to outperform other financial

services sectors
Total return to shareholders (TRS), Jan 1991-Jan 2010 Jan 1991-
Cumulative TRS, Index 01/31/1991 = 100 Jan 2010
CAGR
3,200 Percent
2,800 Asset 18.52
managers1
2,400
Commercial 12.47
2,000 banks2
1,600 Regional 12.17

banks3
1,200
Investment 11.18
800 banks4
400 Total 9.12

market5
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
1
Franklin Templeton, BlackRock, Legg Mason, T.Rowe Price, AllianceBernstein, Janus, Eaton Vance, Invesco, Federated Investors,
Affiliated Managers Group, Calamos, Waddell & Reed, Cohen & Steers
2
Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, Northern Trust, BNY Mellon, State Street
3
PNC, U.S. Bancorp, SunTrust, Capital One, Fifth Third
4
Goldman Sachs, Morgan Stanley, Barclays, Lehman Brothers, Bear Stearns
5
Datastream Defined U.S. Total Market Index
Source: Datastream
Exhibit 3
Facing steep declines in assets and revenues, Decisive Operators

seized the opportunity to restructure their operating models
Percent change 2009 versus 2007
“Decisive Operators” “Trimming the Sails” “Depressed and in Denial” “Marginally Impacted”
AUM Rev- Costs Profits AUM Rev- Costs Profits AUM Rev- Costs Profits AUM Rev- Costs Profits
enues enues enues enues
20-25
10-15 10-15
(20)-5
(0-5)
(10-15)
(15-20)
(20-25) (20-25)
(25-30)
(30-35)
(35-40) (35-40)
(35-50)
(50-65)
(60-75)
20% expect profits to 20% expect profits to 42% expect profits to 18% expect profits to
increase 15% in 2010 increase 10% in 2010 increase 10% in 2010 increase 5% in 2010
Source: 2009/2010 McKinsey/USI AM Benchmarking Surveys
others are hoping that the market will save them, and still others have in-
vested heavily throughout the crisis to secure future growth.
While the financial crisis caused firms to reassess their cost structures, the
industry remains focused on the top line, with firms looking for growth in
2010 and beyond to help restore profitability. In the last growth cycle (2002-
2007), buoyant markets benefited the industry as a whole. Even so, as we
have noted previously, three winning business models emerged and grew
faster: at-scale firms (with average AUM above $300 billion), multi-boutiques,
and niche specialists (smaller or mid-sized firms with more than two-thirds of
their AUM in a single asset class). During the crisis, some of these winning
models struggled. While niche specialists continued to gain share, multi-bou-
tiques faltered under the strain of a softer M&A environment, incentive align-
ment and organizational complexity. Also, only certain sub-categories of
at-scale firms managed to win over the past decade: at-scale specialists,
which increased share from 27 to 35 percent, and retirement players, which
grew share from 11 to 13 percent. The models that suffered most over the
past decade were at-scale generalists – large firms without a unifying client
Exhibit 4
Firms with advantaged business models have captured a

disproportionate share of growth
Change in share of top 300 U.S. asset managers by business model, 2002-2009 2002
Percent of AUM
2007
At-scale players1 2009
35
32
27
25
19
16 17
15 14 13 14 14
13
11 11
9 8
7
At-scale At-scale At-scale Multi- Small/niche “Stuck in

asset class retirement generalists boutiques focused2 the middle”2
specialists2
1
Firms with AUM > $300B
2
At-scale specialists and Small/niche defined as firms with >67% of AUM in any one type of asset class (e.g., index/ETFs, equities).
Small/niche ~ 50% of firms; “Stuck in the middle” ~ 40% of firms
Source: Institutional Investor
or asset class focus lost 2 percent of share – and the “stuck in the middle”
firms, which now account for 40 percent of the firms in the industry but only
14 percent of assets compared to 25 percent at the start of the decade (Ex-
hibit 4).
The industry survived 2009 battered but resilient, with most firms approach-
ing 2010 and 2011 with a sober sense of optimism. The market environment,
however, remains uncertain, and the secular forces now shaping asset man-
agement are neither uniformly good nor unfavorable. Looking ahead, firms
must adapt their models to these secular pressures while investing in a few
select growth pockets that will drive growth disproportionately in the future.
Structural Shifts Continue to

Pressure Core Business
Throughout the crisis, asset managers rightly focused

on managing the impact of cyclical changes – for many
firms their survival was at stake. However several major
structural shifts have continued to buffet the industry
over the past year and will put long-term downward
pressure on economics and growth in the core part of
asset management. While each of these structural
changes seems incremental, together their impact on
the asset management business in 2011 and beyond
could be significant.
1. Net revenue yields continue long-term decline

The crisis triggered a rapid decline in overall asset management net revenue
yields (revenues over AUM), which dropped from a cyclical high of 39 bps in
2007 to 35 bps in 2009. Much of this change was due to short-term changes
in product mix, but price declines are part of a longer-term shift, and most
asset managers have not yet adapted their distribution models to respond to
this challenge.
Retail net revenue yields, for example, have dropped by more than 25 per-
cent since 2001 with most of the decline (13 bps) occurring during the boom
years (Exhibit 5, page 12) and driven by regulation and more demanding rev-
enue-share arrangements. While retail yields recovered slightly in 2009, much
of the bounce-back was the result of clients cautiously beginning to switch
back into equity from fixed-income and money market products. However,
we expect the long-term yield trend to continue, driven by distributor consoli-

dation and revenue share pressure, a continued movement toward lower-fee
passive and ETF products, and regulatory changes. As a result, the gap be-
tween retail and institutional pricing, which narrowed from 26 bps in 2001 to
10 bps in 2009, will continue to shrink. Most retail managers, however, have
not fully internalized the implications of supporting large and expensive retail
sales and marketing groups at increasingly institutional prices.
Institutional net revenue yields, which increased 9 bps between 2001 and
2006, as investors flocked to higher-yielding alternatives products, such as
hedge funds and private equity, fell a remarkable 6 bps (17 percent) over the
past two years as investors quickly retreated to the safety of lower-yielding
fixed-income investments (Exhibit 5). The long-term pricing and yield trend
here is mixed: investors will continue to shift to lower-fee fixed-income prod-
ucts, largely as a result of liability-driven investing and passive investments;
at the same time, however, we expect institutional appetite for higher-fee al-
ternatives to recover. Our 2010 Global Survey of Alternatives Investing, con-
ducted with Russell Investments, found that institutions expect a steep
Exhibit 5
Net revenue yields recovered slightly in retail but continued to

decline in institutional
Retail net revenues/AUM Institutional net revenues/AUM
Bps Bps
59
53 54
51
48
45 46 45
43
42 41
39
36 37
34 35 35
33
2001 2002 2003 2004 2005 2006 2007 2008 2009 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: 2010 McKinsey/USI AM Benchmarking Survey
recovery of their allocations to alternatives, but it will take several more years
for levels to return to their 2007 peak. Moreover, when investors do return to
these higher-yielding products, they are more likely to do so with specialist
alternatives managers, rather than traditional asset managers and, particu-
larly, investment banks. Pricing is also under pressure, with institutions ex-
pecting declines in private equity and infrastructure fee structures and for
some types of hedge funds. So while the long-term pricing trend in institu-
tional is more positive than in retail, the impact on individual firms (depending
on their equity-bias and their ability to compete with alternatives specialists)
will likely be significant.
2. Distributors’ power growing, but as yet unexercised

Following the wave of consolidation that occurred during the financial crisis,
the five leading advisory platforms – Morgan Stanley Smith Barney, Bank of
America/Merrill Lynch, Schwab, Fidelity and Wells Fargo – collectively con-
trolled roughly 55 percent of U.S. household assets in 2009, up from 40
percent five years earlier. Their enhanced bargaining power, coupled with
major differences in profitability between wealth managers and asset man-
agers, will make renegotiating revenue-sharing a high priority for brokerage
firms. In their strongest years, some of the leading brokerage firms earned
a 21 percent margin, while many top firms today
have margins in the low teens. In the worst year
Almost all the retail asset
on record for the asset management industry, the
managers we surveyed (88 average firm earned a 22 percent margin.
percent) believe distributors will We do not believe this discrepancy in margins is
capture an increased share of sustainable, nor do most asset managers. Change
will come, and it is only the magnitude that is in
asset management revenues over
question. Almost all the retail asset managers we
the next two to three years. surveyed (88 percent) believe distributors will cap-
ture an increased share of asset management rev-
enues over the next two to three years. Most expect these increases will be
about 10 percent, which would cut their profit margins by about a percent-
age point (Exhibit 6, page 14). The reality is that bridging even half the margin
gap between asset managers and distributors would result in a profit decline
for asset managers of several times that amount. While the negotiations will
play out over the next year, few asset managers have “stress-tested” their
models under a scenario in which their distribution partners seek more than a
10 percent increase.
3. Regulatory changes underway but full implications unclear

It is small consolation for the asset management industry that thus far it is
one of the financial sectors least impacted by regulatory reform. With a few
thousand pages of legislation already passed and many more thousands of
pages of regulations yet to be written, the implications for the industry are
likely to be significant. It is important to recall that even small changes in
regulation can have major implications (for example, the entire $4-trillion
defined contribution [DC] market was created almost by regulatory accident
in the early 1980s) and regulatory change can create opportunities as well
as challenges.
In the near term, the challenges will be real as new regulations drive up costs
for asset managers and heighten pricing pressure. Higher costs will result
from increased disclosure requirements (e.g., in prospectuses, shareholder
reports), systems upgrades related to compliance, and litigation related the
new regulations themselves. In addition, the SEC’s proposed 12(b)2 rule,
which would cap certain mutual fund fees, would negatively impact pricing
(particularly if distribution incentive costs once passed along to clients are
Exhibit 6
Asset managers expect increased revenue-sharing with retail

distributors to squeeze profit margins
Revenue-sharing expected to increase… …Reducing asset manager profit margins1
Asset management firms’ expectations Profit margins for retail asset managers
regarding level of distribution fees Percent
Percent of firms
31%
All firms Retail firms ~100 bp
profit
margin
Increase >10% 6 13 30% impact
Increase 0 - 10% 75 75
No change 16 13
At current With 10%

revenue-sharing increase in
Decrease 3 0 average revenue-sharing
1
Key assumptions: Current revenue-sharing average = 13% of gross revenues; profit margin = 31%
Source: 2010 McKinsey/USI AM Benchmarking Survey
now paid by managers), as will increased scrutiny and disclosure of fees (in-
cluding the Department of Labor’s focus on cost for qualified accounts). Fur-
thermore, increased transparency and fiduciary
More fundamentally, the Volcker responsibility could make advisors’ reluctant to
recommend certain products when lower-cost al-
Rule, Basel III, Solvency II
ternatives exist.
and the increased regulation of
More fundamentally, the Volcker Rule, Basel III,
money funds will impact business Solvency II and the increased regulation of money
models for many bank- and funds will impact business models for many bank-
and insurance-owned asset managers and money
insurance-owned asset managers
market funds. Even in its watered-down form, the
and money market funds. Volcker Rule will force many bank-owned alterna-
tives businesses (with significant bank capital) to
divest, and Basel III and Solvency II will impose additional capital constraints
on banks and insurers, putting countervailing pressures on these firms: a
desire to grow their asset management business for the sake of its high cap-
ital productivity, and the need to divest asset managers and minority stakes
to raise capital for core businesses or Tier-I capital purposes.
While the final outcome is far from certain, asset managers should begin
preparing for change now, by taking tactical steps to address the potential
cost increases (e.g., reviewing compliance infrastructure, identifying neces-
sary disclosure requirements, building out IT capabilities) and exploring
strategic opportunities that might arise (e.g., acquisitions of bank- or insur-
ance-owned asset management and alternatives firms, money fund roll-ups,
and even new types of products).
Picking Your Spots for Growth
While pressures on the core business will continue,

asset managers remain focused on growth, although
with a more sober sense of optimism than in the
past. The firms we surveyed expect industry growth
over the next three years to average 6 percent
annually, slower than in past recovery cycles (11 to
14 percent) and below the 20-year long-term
average of 11 percent. And they overwhelmingly
agree that growth will be concentrated in five areas:
retirement, international investing, sovereign wealth
funds, ETFs and passive investments, and
alternatives. Our own projections support asset
managers’ expectations (Exhibit 7, page 18).
While there seems to be broad industry consensus about the areas and con-
centration of growth, three findings from our research are particularly striking:
• Asset managers’ investments in growth do not come close to matching their

stated growth convictions. While more than two-thirds agreed that the vast
majority of industry growth would be concentrated in the five areas men-
tioned, few are investing sufficient resources to tap those opportunities. For
example, the average firm in our survey was investing $5 million to $10 mil-
lion per year (2 to 3 percent of costs) to grow organically across these
growth areas. Most firms surveyed are investing more in the growth of their
existing businesses than in the biggest potential growth markets. Also, few
firms are pursuing these five growth pockets with a differentiated approach
or a projected time horizon for reaping the rewards of growth. While these
averages mask differences among firms, the clear result is that the industry
has not yet “walked the talk” when it comes to investing in future growth.
• Nonetheless, most asset managers are confident about their own growth
prospects. Over half the firms surveyed believe they will increase their
share of AUM over the coming two to three years, and 30 percent believe
they will retain their current share. While this confidence strains mathe-
matical logic, it also suggests a disconnect between managers’ beliefs
about growth and what they are doing about it.
• Finally, 28 percent of asset managers surveyed consider acquisitions es-

sential or somewhat important to their overall growth strategy. Yet, most
of them (70 percent) are focused on small, domestic acquisitions to round
out their investment capabilities as opposed to efforts that would support
growth in any of the five opportunities mentioned above.
1. Retirement: Defined contribution/IRA

Qualified assets, comprising DC plans and IRAs, represent nearly one-third of
U.S. household assets, more than retail mutual funds held outside of DC
plans and ETFs combined. We expect the DC/IRA market to grow from over
Exhibit 7
Growth opportunities concentrated in five areas

Revenue margin Size of bubble
Percent of AUM = 2009 AUM
2.3
Hedge Funds,
1.0 Emerging
Private Equity
Markets
(global)
0.9 Investing
0.8
Developed Markets
0.7 Traditional Retail MFs Investing (ex U.S.)
(ex DC/IRAs)
0.6
Sovereign
0.5 Wealth
DC/IRA (global)
0.4 Defined ETFs
Benefit (U.S.)
0.3
0.2
0 1 2 3 4 5 10 11 12 13 14 15 16 17 18
2009-2014 AUM estimated growth rate
Percent
Source: ICI, IFSL, HFR, Strategic Insight
$8 trillion in AUM in 2009, to roughly $13 trillion by 2015 (Exhibit 8). More im-
portantly, large parts of this market will be up for grabs. First, about $1.3 tril-
lion of 401(k) assets will change recordkeepers due to plan switching (47
percent of 2009 401(k) assets) over the next five years. Second, $3.3 trillion
will move to new asset managers (over 120 percent of 2009 401(k) assets),
as plans change providers for specific asset classes and participants rebal-
ance allocations. Finally, a whole new suite of target-driven solutions (e.g.,
target risk, target return, target income, target date) will account for 40 to 60
percent of DC assets by 2015. As a result, investment-only DC (IODC) play-
ers will control half of the DC market by 2015.
The size and growth rate of the retirement market is no secret and the over-
whelming majority of asset managers we surveyed are gearing up to target
the qualified funds opportunity. One hundred percent of the integrated retire-
ment players and 68 percent of IODC players reported increasing their invest-
ments in the DC/IRA market – but only selectively so, with investments in the
single-digit, million-dollar range. Most of these investments will go toward
more salespeople and adapting coverage models to better respond to in-
creasingly sophisticated plan sponsors. While most firms also report develop-
ing retirement income solutions, most of these efforts have been
project-based rather than major strategic investments.
Exhibit 8
DC/IRA market likely to reach $13 trillion by 2015
DC assets IRA assets

$ trillions $ trillions 1.1
2.4
1.5
2.0 0.1
1.9 1.5
7.2
5.5
4.3
4.1
2009E Contri- Market Rollovers/ 2015E 2009E Roll- Contri- Market Distri- 2015E
assets butions appre- withdrawals assets assets overs butions appre- butions1 assets
ciation1 ciation 1
1
Assumes post-fee returns of 5.5%
Source: ICI; Cerulli
Asset managers’ actions in DC and IRA are largely incremental in nature and
at odds with how those markets are developing. For example, mega-plans
continue to be a favorite stomping ground for most firms, despite pricing
pressure and expected outflows in the hundreds of billion of dollars. Few
firms are investing in the less competitive segments that will gather meaning-
ful inflows (e.g., mid-market plans). And while IODC players will benefit
through 2015, few are investing in the specific asset classes that will benefit
most from the combined effects of lower fees, automated investing and de-
mographics. Finally, while IRA rollovers will contribute $1.5 trillion over the
next five years, few firms are putting their money behind the innovations nec-
essary to develop a range of target-driven solutions and ensure that con-
sumers understand and adopt them.
2. International investing
The U.S. asset management market is large and mature, with a projected
compound annual growth rate in AUM of 8 percent from 2009 to 2012. How-
ever, international markets are growing even faster and net new flows outside
the U.S. could well outpace those within the U.S. in the next five years. Al-
ready in 2009, non-U.S. mutual fund net flows were up 1 percent in contrast
to U.S. net flows of -1 percent, a dramatic reversal from 2005, when non-
U.S. net flows were 2 percent compared to U.S. net flows of 5 percent.
Strong international flows are driven, of course, by the many emerging mar-
ket economies – led by Asia (excluding Japan), Latin America and parts of
Eastern Europe – that are likely to see AUM growth rates two to three times
that of the U.S. (Exhibit 9). The rapid expansion of domestic investable as-
sets in these markets is a significant opportunity for asset managers with a
local presence.
Interest by U.S. investors in non-U.S. investment products is also growing

fast. The share of international equity and fixed-income assets has grown
from 15 percent of U.S. AUM in 2002, to 24 percent in 2009. The theoretical
ceiling for the share of international equity (i.e., the non-U.S. share of the
S&P 1200) is two-and-a-half times today’s levels (60 percent). The relative re-
cent outperformance of emerging market economies and strong comparative
GDP growth projections make these markets an increasingly attractive
source of opportunity for U.S. investors.
Asset managers are well aware of the potential in international investing, but
few are pursuing the opportunity in a differentiated way. Nearly all firms sur-
veyed (94 percent) offer, or plan to offer, international or emerging market

products, making it difficult for all but true international equity or fixed-income
specialists to successfully gather meaningful assets. Moreover, about half of
all firms report plans to establish or strengthen their local presence abroad,
primarily to distribute investment products. However, firms are investing be-
hind this strategy on a shoestring – projected annual investments are in the
$5 million range (about 1 to 2 percent of costs), an amount insufficient for
building a meaningful presence in even one country let alone across multiple
international markets.
Given that the majority of future capital formation is expected to occur out-
side the U.S., all asset managers need to decide if they will participate di-
rectly in international and emerging markets or remain “U.S. specialists.”
Currently only 20 percent of the U.S.-based, domestic-oriented firms we sur-
veyed (i.e., firms without an international presence) report they are looking to
establish a local presence abroad. Moreover, very few of these firms are fo-
cusing or investing in the long-term on two or three markets where they can
become “local for local.” While growth rates in much of Asia and Latin Amer-
ica will be swift, U.S. firms will face stiff competition from local providers and
other international asset managers. To gain a meaningful foothold abroad, a
firm needs to commit significant financial resources over a number of years,
Exhibit 9
Emerging markets will produce fastest asset management growth

Selected markets
Global AUM by region CAGR 2009-2012E Incremental AUM
$ trillions Percent $ billions
51
Rest of Poland 25% 52
2
the world 18% Mexico 20% 47
Asia 8 Brazil 16% 336
Pacific
1 38
Western China 37% 586
Europe 12
6 Taiwan 24% 98
North
America Indonesia 21% 10
8 12% Korea 19% 205
India 19% 63
Singapore 11% 54
29 Japan 9% 413
22
13% U.K. 13% 967
8% U.S. 8% 5,829
2009 2012E
Source: McKinsey; Institutional Investor
explore joint ventures or acquisitions, or place a sharper focus on a few spe-

cific countries and segments than they have done to date.
3. Sovereign wealth funds

The institutional landscape is undergoing significant change, with sovereign
wealth funds (SWFs) set to replace large U.S. pension plans as the largest
source of institutional assets. SWF assets dropped only slightly during the
crisis, from $3.9 trillion in 2008 to $3.8 trillion in 2009, and we estimate that
the market will approach $5 trillion by 2013. Moreover, although sovereign
funds of varying size and sophistication continue to emerge, the market is a
relatively concentrated “money in motion” and revenue opportunity for asset
managers: roughly 10 institutions have AUM greater than $50 billion and
about 60 percent of AUM are in the Middle East.
A surprisingly large number of asset managers – 85 percent of the firms we

surveyed – report having some sovereign wealth efforts underway, with
slightly more than half with plans to selectively invest in the market over the
next two to three years. Of these firms, 61 percent are building a local pres-
ence, 45 percent are adopting a structured team-based approach that in-
cludes product managers or product specialists, and the same percentage
are carving out a distinct SWF sales force.
In reality, most asset management firms are still finding their feet, and treating
SWFs as a “hobby” rather than making a true strategic commitment. They are
likely to regard sovereign funds as demanding institutional clients and serve
them with regionally-based generalist institutional sales professionals. Only
one-fifth of the firms who say they are targeting sovereign funds are creating a
differentiated sales and service strategy that combines greater coverage by
senior executives, a local presence, increasingly dedicated sales resources
and a strong team-based approach emphasizing service and support, as well
as best-in-class investment expertise. Firms are also woefully under-investing;
among the 50 percent of firms making incremental investments into the SWF
space, the average annual commitment is in the low single-digit millions.
Given the opportunity in the market, this is nowhere near enough.
4. Exchange-traded funds/passive assets

The market for ETFs has remained a bright spot during the challenging crisis
period, particularly for a few firms. Over the past three years, passive ETFs
grew from 5 percent of U.S. mutual fund AUM to 7 percent (Exhibit 10). Net
flows into ETFs have been among the largest of any major asset class over
the past three years; in 2009 they totaled $117 billion, more than five times
the flow into equity products.
The secular outlook for U.S. ETFs and passive products remains strong
thanks to several underlying trends: an increasing focus on investment
costs and transparency; the growing appetite among many institutional in-
vestors (not just hedge funds) for passive investments and ETFs in particu-
lar; a growing preference for ETFs among fee-based advisors; and an
increased recognition among advisors and consumers of ETFs’ advantages:
better tax-efficiency, lower cash drag and lower distribution costs relative to
mutual funds.
These trends will help passive ETFs continue to grow, but the benefit will ac-
crue to only a handful of firms. In the U.S., the top five players still control over
90 percent of assets. Opportunities are greater in Europe and Asia, with faster
expected growth rates, but the competitive barriers for a “me too” offering are
challenging there as well: in Europe the top five players control roughly 80 per-
cent of the market; the top five in Asia own more than 70 percent.
Given the daunting competitive barriers in the passive part of the market,
many firms are looking at active ETFs as a potential game-changer. However,
a number of pieces would need to fall into place for this to be a truly disrup-
Exhibit 10
ETF assets and net flows holding up well relative to active funds
U.S. mutual fund AUM1 CAGR U.S. mutual fund net inflows by asset class
2007-
Percent $ billions
2009 0% to 5%
$11.8 $9.5 $11 5% to 25%
trillion Total -3 -5% to -25%
trillion trillion
-5% to 0% 25% to 65%
5 3 6 3 7 3
14 16 Balanced -10 Total 1,046 610 -26
19
Money 653 609 -507
26 ETF, ETN2 +13 market
40 29 Fixed- 101 22 350
Fixed- +13 income
income
Equity 141 -170 21
Money +2
51 market Balanced 1 -28 -8
36 41
Equity -13
ETFs 149 176 117
2007 2008 2009 2007 2008 2009

1
Excludes funds of funds and variable annuity sub-accounts
2
ETN (Exchange-Traded Notes)
Source: Strategic Insight
tive trend: regulatory clarity, effective structuring/manufacturing methodology,

compelling incentive structures for advisors, and something to break the iner-
tia of mutual fund investors. Firms would also need to establish track
records. Finally, asset managers are likely to have to invest for the long haul.
While there have been some successful recent active ETF launches, it took
well over a decade for passive ETFs to grow from the level that active ETFs
are at today ($2 billion) to current levels.
The view on ETFs from our survey is mixed. While the majority of firms be-
lieve the passive game is over and that niche/exotic or active products will
not get to scale, 40 percent of firms surveyed believe ETFs will be one of the
fastest-growing product categories over the next three years, and a quarter
of all firms are seriously considering entering the market. Of these, 80 per-
cent plan to develop or launch new value-added active products (largely to
hedge their bets in case demand materializes) and 60 percent are consider-
ing launching non-U.S. ETFs. Over 800 applications for active funds are cur-
rently on file with SEC for exemptive relief review.
Overall, very few firms are going beyond a “just in case” ETF strategy to take
a hard look at the risks of ETFs to their core active business, or preparing a
plan B in the event the active market takes off. Very few well-positioned firms
with strong brand profiles have disclosed making real investments to secure
a first-mover advantage in the active fund space. There is also real money at
stake for the leading passive players. As competition heats up, a well-bal-
anced portfolio across styles and strategies and asset classes will be crucial
for preserving revenue and earnings consistency.
5. Alternative investments
Prior to the crisis, alternative investing – in the form of hedge funds, private
equity, structured products and real estate – was one of the biggest growth
engines for revenues and profitability in the asset management industry. Our
2007 benchmarking survey revealed that a full two-thirds of all traditional
asset managers operating in the institutional market were offering “higher
alpha strategies” and that these products accounted for an astonishing one-
third of their total institutional revenues, up from almost zero five years prior.
How quickly things have changed. McKinsey’s 2010 Global Survey of Alterna-
tives Investing, conducted with Russell Investments, showed that institutional
investors’ allocations to alternative investments dropped precipitously in
2009. Traditional asset managers in turn saw their institutional revenues from
higher alpha strategies shrink to roughly 20 percent in 2009, as asset values

and performance fees plunged.
Most institutional investors globally expect a steep recovery of their alloca-

tions to alternative investments to near 2007 levels over the next two to three
years. In 2008, alternatives represented about 18 percent ($1.3 trillion) of all
institutional AUM and most published reports expected alternatives to grow
in the 10 to 20 percent range annually for the next few years. However, insti-
tutions now expect their biggest increases in allocations will be to “real as-
sets,” including private equity, infrastructure and real estate. Hedge funds will
also benefit from a pick-up in demand, as institutional investors look to close
their asset/liability gap and seek equity and fixed-income exposure, and as
the smaller retail segment takes off – in 2009 alone, one dollar of every six in
long-term net flows went to alternatives.
Even with rapid growth, the dynamics in the alternative investment industry
are shifting in favor of investors. As noted previously, prices are falling. For
example, over the next two to three years, institutional investors expect to
see both lower private equity management fees (in
the 1.5 percent range) and changing performance
Even with rapid growth, the fee structures (e.g., carried interest being paid at
dynamics in the alternative the close of the fund), as well as smaller private
equity fund and deal sizes. Institutions also report
investment industry are shifting
increasing their direct investments in hedge funds
in favor of investors. over hedge funds of funds, and using more costly
separate accounts to mitigate co-investor risk.
They are also reducing the number of hedge funds they invest with and
showing a much stronger preference for hedge fund managers with estab-
lished track records and institutional brand names.
Some asset management firms with large, well-known alternative investment

brands are well-positioned to capture growth in the lucrative alternative in-
vestment market. But strong investor preference for specialist alternative
shops with established track records means that most traditional asset man-
agers will struggle to gather meaningful share. Investment managers are re-
portedly dusting off plans to offer new alternatives fund products to retail
investors, but this will likely remain a niche segment over the next few years,
dominated by firms with the strongest alternatives brands.
Transforming Ideas Into Action:

Setting the Management Agenda
for 2011 and Beyond
In the wake of the financial crisis, the asset management

industry was resilient at a macro level, but highly diver-
gent at a micro level. Individual firms responded with radi-
cally different approaches to pressures on the core busi-
nesses: some aggressively restructured their cost base
and appear well-positioned to move forward; others
seemed to stand still. Looking ahead, there is broad intel-
lectual alignment around five major areas of growth, but
there appears to be limited conviction (or ability) in many
firms to invest in these opportunities and carve out differ-
entiated, leadership positions.
In light of the uncertainties and opportunities ahead, we would encourage man-

agement teams to put three items at the top of their business agendas for
2011. First, firms need to ensure that their core business model can withstand
future market volatility. Forty percent of firms adopted an incremental “wait and
see” approach to costs over the past two years, resulting in profits falling by
more than half and inhibiting their ability to invest in growth and talent going for-
ward. While the market could help come to the rescue of these firms in 2011,
the outlook remains highly uncertain and fortune favors the prepared. Second,
irrespective of market changes in 2011, firms need to retool their core busi-
nesses such as traditional U.S. retail, which will come under increasing secular
pricing, distributor and regulatory pressures. Finally, firms will need to “walk the
talk” and invest behind their convictions in developing a few growth busi-
nesses where they can carve out a meaningful position over the next two to
three years.
Ensure core business model is flexible and resilient amid market

volatility
Responding to the pressures of the past few years and the potential for fu-
ture volatility, a small group of asset managers have made their business
models more resilient and flexible. Actions they have taken include stan-
dardizing the core operating platform (e.g., oper-
ations, technology, HR, finance, legal and While most asset managers
compliance), rationalizing their geographic foot-
print, eliminating unsuccessful and unprofitable
have intellectually played these
products to reduce unnecessary complexity, out- trends forward, only a few are
sourcing and offshoring middle and back-office retooling their core business
functions at a rate comparable to other financial
services sectors and, finally, applying lean princi- models in light of the changes.
ples to eliminate wasted effort with a focus on in-
vestment operations and technology. These firms have turned the crisis to
their advantage and are now in a position to invest in growth. Against this
backdrop and looking ahead to 2011, management teams should ask
themselves three questions:
• What changes should be made to our core business model to make it

more resilient and flexible, and how would our model cope with a 10, 20
or 30 percent decline in AUM?
• Where do we have unnecessary duplication, complexity and waste in the

firm (especially outside the core investment platform) and how can we
capture the opportunities?
• What value would we create by standardizing and reducing complexity,

and how much currency for growth would be created?
Retool core businesses to sustain growth and profitability in face

of secular pressures
The financial crisis and the resulting market declines, distributor consolidation
and changing regulatory environment have accelerated a number of secular
trends that have been underway for years. While most asset managers have
intellectually played these trends forward, only a few are retooling their core
business models in light of the changes. For example, in U.S. retail, leading
firms are shifting emphasis (and compensation) to net as well as gross flows,
restructuring their sales forces (including internal and external wholesaler
models), focusing on the profitability of distributor and advisor relationships
(given product mix, persistency of assets and cost-to-serve) and taking a
more systematic approach to marketing spend. Some leaders are even tak-
ing a more scientific investment-driven approach toward distribution; for ex-
ample, applying “sales alpha” techniques to measure the effectiveness of
their sales efforts (given a particular product portfolio). Against this backdrop,
management teams should be asking themselves:
• What businesses will be most affected by pricing pressure and micro-reg-

ulation (e.g., U.S. retail, mega-plan DC, active equity funds), and what will
the magnitude of the impact be?
• How resilient will revenues and profits be, especially if these changes play
out rapidly over the next two to three years?
• What actions should we take now to ensure that these businesses are
profitable and growing? And what can we learn from our competitors?
Make considered choices to deliver profitable growth

While pressure on their core business continues, asset managers remain fo-
cused on growth to help restore profitability to pre-crisis levels. However,
firms overwhelmingly agree that growth will be concentrated in five key
areas: retirement, international investing, sover-
eign wealth funds, ETFs and passive investments,
Firms that do not make clear
and alternatives. In addition, unlike the past
choices backed by appropriate decade when the rising tide of strong markets
investment levels will face further lifted all boats, asset managers now need to
make deliberate choices about where to focus
erosion of their market share.
and how much to invest to generate profitable
growth. “Hobbies” and incremental notions will
not attract meaningful flows in a highly competitive and concentrated envi-
ronment. Instead, asset managers need to follow a more considered course
of action, building convictions around specific opportunities, defining the
role they can play, and investing at a level consistent with their aspirations.
Indeed, firms that do not make clear choices backed by appropriate invest-
ment levels will face further erosion of their market share. Regarding growth,
management teams should ask themselves these questions looking ahead
to 2011:
• Which two or three mega-growth areas will drive more than half of our fu-
ture growth over the next couple of years, and how will this change the
business mix we have today? What are the unique advantages we have in
these growth areas that will enable us to take share from competitors
(e.g., choice of clients, products, geographies, marketing approach)?
• How much of our budget is dedicated to growth in general and in particu-

lar to the two or three mega-growth areas? Is this proportionate to the op-
portunity and our firm’s ambition?
• Does the firm have some of its most capable leaders slotted against these
mega-growth opportunities?
• What initiatives will we cut to create financial capacity and leadership

bandwidth to fuel our targeted growth ambitions?
***
The asset management industry routinely warns its clients that past invest-
ment performance is no guarantee of future results. While the industry re-
mained resilient through one of the worst financial crises in generations,
management teams would be wise to keep this warning in mind for their own
business performance. Underneath the macro-level resilience of the past
year, firms had radically different responses to the crisis, leaving some better
positioned moving forward. A number of micro trends are also shaping and
defining the competitive landscape. While the industry deserves to breathe a
collective sigh of relief as it emerges from the storm, leaders are maintaining
a sense of urgency to refocus and retool their businesses and to pick their
spots for growth in 2011 and beyond.
About McKinsey & Company
McKinsey & Company is a management consulting firm that helps many of
the world’s leading corporations and organizations address their strategic
challenges, from reorganizing for long-term growth to improving business
performance and maximizing profitability. For more than 80 years, the firm’s
primary objective has been to serve as an organization’s most trusted
external advisor on critical issues facing senior management. With
consultants in more than 40 countries around the globe, McKinsey advises
clients on strategic, operational, organizational and technological issues.
McKinsey’s asset management practice serves leading asset managers

globally on issues of strategy, organization, operations and business
performance. Our partners and consultants in the Americas have deep
expertise in all facets of the business. Our survey of the industry – now in its
10th year – is the only one of its kind, covering 300 firms globally, and 100 in
the U.S. (with $9 trillion in assets under management).
To learn more about McKinsey & Company’s specialized expertise and

capabilities related to the U.S. asset management industry or for additional
information about this report, please contact:
Pooneh Baghai David Hunt

Director Director
(416) 313-3939 (212) 446-7708
pooneh_baghai@mckinsey.com david_hunt@mckinsey.com
Céline Dufetel Salim Ramji

Principal Director
(212) 446-8081 (212) 446-7393
celine_dufetel@mckinsey.com salim_ramji@mckinsey.com
Onur Erzan Nancy Szmolyan

Principal Senior Knowledge Expert
(212) 446-7172 (212) 446-7793
onur_erzan@mckinsey.com nancy_szmolyan@mckinsey.com
The authors would like to acknowledge the contributions of

Matthieu Grosclaude and Raksha Pant to this report.
Financial Services Practice
September 2010
Designed by Hudspith Design
Copyright © McKinsey & Company
www.mckinsey.com/clientservice/financial_services

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Financial Services Practice

Traditional Retail DC/IRA

The Asset Management Industry:

Industry Profitability in 2009: Battered but Resilient 5

Structural Shifts Continue to Pressure Core Business 11

Picking Your Spots for Growth 17

Transforming Ideas Into Action: Setting the Management 27

In the wake of the worst financial crisis in genera-

eralists. In contrast, at-scale specialists, retirement-focused players

• Major structural shifts – including declining revenue yields, consoli-

• Growth opportunities abound, and there is a broad industry con-

These findings are based on our ninth annual economic benchmark-

ticipated in the U.S. survey, which encompasses over 2,000 business

Industry Profitability in 2009:

The financial crisis brought an abrupt end to the strong

As with all averages, these results mask divergent individual performance.

Operating profit margins plunged more than one-third from

design of middle back-office processes and consolidated enterprise sup-

Asset management industry continues to outperform other financial

1,600 Regional 12.17

400 Total 9.12

Facing steep declines in assets and revenues, Decisive Operators

Source: 2009/2010 McKinsey/USI AM Benchmarking Surveys

Firms with advantaged business models have captured a

At-scale At-scale At-scale Multi- Small/niche “Stuck in

Structural Shifts Continue to

Throughout the crisis, asset managers rightly focused

1. Net revenue yields continue long-term decline

we expect the long-term yield trend to continue, driven by distributor consoli-

Net revenue yields recovered slightly in retail but continued to

2. Distributors’ power growing, but as yet unexercised

3. Regulatory changes underway but full implications unclear

Asset managers expect increased revenue-sharing with retail

At current With 10%

Picking Your Spots for Growth

While pressures on the core business will continue,

• Asset managers’ investments in growth do not come close to matching their

• Finally, 28 percent of asset managers surveyed consider acquisitions es-

1. Retirement: Defined contribution/IRA

Growth opportunities concentrated in five areas

DC/IRA market likely to reach $13 trillion by 2015

DC assets IRA assets

Interest by U.S. investors in non-U.S. investment products is also growing

veyed (94 percent) offer, or plan to offer, international or emerging market

Emerging markets will produce fastest asset management growth

explore joint ventures or acquisitions, or place a sharper focus on a few spe-

3. Sovereign wealth funds

A surprisingly large number of asset managers – 85 percent of the firms we

4. Exchange-traded funds/passive assets

2007 2008 2009 2007 2008 2009

tive trend: regulatory clarity, effective structuring/manufacturing methodology,

higher alpha strategies shrink to roughly 20 percent in 2009, as asset values

Most institutional investors globally expect a steep recovery of their alloca-

Some asset management firms with large, well-known alternative investment

Transforming Ideas Into Action:

In the wake of the financial crisis, the asset management

In light of the uncertainties and opportunities ahead, we would encourage man-

Ensure core business model is flexible and resilient amid market

• What changes should be made to our core business model to make it

• Where do we have unnecessary duplication, complexity and waste in the

• What value would we create by standardizing and reducing complexity,

Retool core businesses to sustain growth and profitability in face