COVID-19 and its economic and social disruptions have given new urgency to the challenges facing mutual funds. Last year, in our publication Mutual fund outlook: the time to act is now, we highlighted trends we expect to see from 2019 to 2025, such as slower growth and shrinking fees. These trends have all accelerated, and mutual fund managers need to move even faster to maintain and improve their positions.
With the pandemic in mind, you may now be rethinking your forecasts and expectations for the near- and mid-term future. But this isn’t just about playing defense: There are steps you can take now to help you prosper over the next five years.
Organic growth in the US mutual fund industry has continued to slow, despite upside surprises in the overall market. The long-term outlook is under stress, too, from downward pressure on fees, reduced profit margins and changing investor preferences. Adding a pandemic to the list deepens the challenge for asset managers trying to remain competitive.
Clearly, asset managers can’t depend on AUM (assets under management) growth and the fees it generates to sustain their business as they once did. Last year, we estimated US AUM growth would average 5.6% annually between 2018 and 2025; we now forecast such growth to hit only 3.1% between 2019 and 2025. There’s a much more difficult road ahead. Meanwhile, the market keeps shifting into passive funds. In 2019, passives accounted for 39% of total US mutual fund/ETF industry assets. By 2025, we estimate they’ll account for 55% of the industry’s total assets (see Figure 1).
While this shift to passive inherently results in lower revenues for managers, downward fee pressure isn’t new. By 2025, we calculate that expense ratios across active and passive funds will be about a third lower than their already low levels in 2019 (see Figure 2). The ongoing decline in total expense ratios (TERs) for both active and passive funds means fund managers could find it hard, or impossible, to find any profit margin improvement.
Lastly, there is one trend that is consistent across fund products and the workplace: the rise of environmental, social and governance (ESG) funds. Consumers are demanding it, and workers are expecting it. In fact, we anticipate that total assets of ESG-based funds will grow an average of 10% annually between 2019 and 2025.
"The disruptions occurring in the industry, the economy and society as a whole bring both challenges and opportunities for US mutual fund managers. This is a call for action."
Peter Finnerty, US Mutual Fund Leader
Prediction 1: AUM growth in US mutual funds will slow to approximately 3.1% annually between 2019 and 2025, reaching $26.8 trillion, down from 10.2% between 2011 and 2019.
Prediction 2: Passive funds will account for 55% of total US mutual fund industry AUM by 2025, up from 39% in 2019.
Prediction 3: Combined active and passive fund expense ratios will decline by a third by 2025.
Across all asset management, consolidation continues, and the pandemic doesn’t seem to be slowing M&A appetites. We now expect that up to 20% of today’s mutual fund firms could be bought or eliminated by 2025. Mega managers, the top five US mutual fund managers, will take most of the growth, accounting for 68% of mutual fund AUM by 2025, up from 53% at the end of 2019.
This will affect products, too. Along with firm consolidations, we see changing investor preferences and demand for lower fees leading to closure of roughly one in seven mutual funds between now and 2025. New products, such as a 30% growth in ETF funds, will likely offset some of these closures, so we now expect a 6% net reduction in the overall number of registered fund products. Most mutual fund managers will face some difficult decisions in the days ahead, as they try to maintain consumer interest while competing with mega managers’ scale.
Prediction 4: The industry will undergo a significant consolidation, with up to 20% of existing firms being acquired or eliminated by 2025.
Prediction 5: Mega managers will account for 68% of US mutual fund AUM by 2025, compared to 53% at the end of 2019.
Prediction 6: We expect the closure of approximately 15% of existing mutual funds between now and 2025 to be partially offset by new products (such as a 30% growth in ETF funds), leading to a 6% net reduction in the overall registered fund products.
Many US mutual fund managers had already been making sizable digital investments when the COVID-19 pandemic hit. This helped them switch their teams to working from home (WFH). Our June 2020 Remote Work Survey found that 69% of financial services (FS) executives surveyed felt their firms’ employees were at least as productive after the abrupt shift to WFH.
The pandemic won’t last forever, but the pre-pandemic workplace is unlikely to return any time soon; the need to reduce costs won’t allow it. Some 70% of FS companies will have the majority of their employees work from home at least once a week. We now predict a 10% reduction in mutual fund employment over the period from 2019 to 2025, tied to cost trimming, fund consolidation, and increased automation and outsourcing.
Firms will likely lean heavily on digital labor and third-party service providers. For example, we expect that mutual fund accounting outsourcing could nearly double to around 80% by 2025. Tax outsourcing could rise from 70% in 2019 to 90% by 2025.
Lastly, to continue to attract a workforce with the kinds of skills their firms need to continue to grow in the digital economy, mutual fund managers will have to consider how they are recruiting and training employees, aligning corporate and employees’ values, addressing sustainability and corporate responsibility, and their overall investment thesis in the market.
Prediction 7: Approximately 70% of FS companies will have the majority of their employees work from home at least once a week.
Prediction 8: We expect that there will be a 10% workforce reduction in mutual funds over the period from 2019 to 2025.
Prediction 9: Mutual fund accounting outsourcing will nearly double to roughly 80% by 2025, and mutual fund tax outsourcing will rise from 70% in 2019 to about 90% in 2025.
Tighter margins, more consolidation and a changing workplace: There could be some tough years ahead, especially if your funds aren’t particularly differentiated. But client needs aren’t going away, and there will be winners. Your success could depend on how you position your firm, use technology, define your workforce and create value.
“Where the economy goes from here, no one can say for certain. Part of being a future-fit fund manager includes being prepared for the continued disruptions in the market.”
Rachael Bradley, US Asset & Wealth Assurance Leader
With this pressure, you have to give clear and consistent direction to your employees, investors and regulators. For many, this means questioning what products you offer, where you compete, which distribution channels you use and how you tell your story.
As funds with less complex investment strategies get squeezed, look for ways to stand out with more differentiated products. Some of the most promising areas will likely include more exchange-traded funds (ETFs), smart-beta funds, periodically disclosed active ETFs, and ESG and outcome-oriented funds.
Maybe more ... Large firms have the advantage of scale, but bulking up indiscriminately isn’t the only way to boost your long-term business prospects. You may turn to M&A more selectively: to expand relationships with investors, deepen niche product offerings, access technology and streamline operations. Depending on your position, smarter deals may lead to more growth than bigger deals.
What does your firm really need to own? Savvy executives will use combinations of outsourcing, insourcing and co-sourcing. Don’t just cut costs; consider sourcing impacts, such as oversight risks and decision-making control. As you explore options for non-core services like data management, accounting, compliance and tax, look for partners that can help standardize processes, use data and technology, and bring expertise to the table.
If you aren’t modernizing your technology infrastructure, it will be increasingly obvious to your clients. That’s because asset managers now depend on technology and high-quality data to reduce costs, analyze risks, make better investment decisions, deliver higher returns to investors and increase profits. You’ll want to stay on top of these key development areas:
However you approach tech transformation, your program’s success will likely depend on access to high-quality data. You’ll need to source and develop reliable, consistent, quality data — to support sound analysis and decision-making, produce new revenue streams, drive M&A activity and align with third-party vendors to make sound right-sourcing decisions.
Lastly, as more FS work is done remotely, if you’re not keeping up with technology, it can be hard to know how you’ll succeed. This isn’t just about day-to-day execution of the job. You should think about digital upskilling, cybersecurity, feedback and other digital programs that have become a high priority for remote work.
Now that remote work could be with us for a long time, you’ll need to address technology — but it’s also time to identify and update processes, job roles and cultural changes that need to occur to make this shift work.
You’ll want to consider broader trends. As automation techniques improve, you may need fewer back-office employees to cover key roles, even as you expand your bench with more employees skilled in data analytics, cybersecurity, vendor oversight, and productivity and wellness.
Lastly, the nature of the workforce in the mutual fund industry is still changing, regardless of the pandemic. Firms that are succeeding have a diverse workforce that is capable of using the latest technology in a host of areas, such as data and analytics. In order to retain these valued workers, winning firms have had to alter their culture to stay competitive in the talent race, such as by improving work-life balance and becoming more socially conscious in their approach to investment.
These days, investors want it all: superior returns, excellent client service and programs that are socially conscious. You’ll want your offerings to give the value that your specific clients care about the most.
While ESG investing has existed for some time, it keeps gaining traction with both existing and potential clients. It’s getting regulatory attention, too. For now, there are no standard definitions for ESG investing in the US, but investors will expect enough visibility to understand your approach for themselves.
The industry still suffers from a loss of trust stemming from the 2007 financial crisis. Now, with societal shifts tied to the pandemic, we’re all confronting society’s broader issues more directly. This is shaping up to be a bigger issue than lower AUM growth and fee suppression. It’s also a chance to differentiate your offerings by redefining your firm’s relationship with its employees, boards and society at large, by:
Competing based on purpose rather than price has its own challenges, but it may help your clients and society. Some fund complexes’ long-term survival may even depend on it.
Investors understand the need to pay for services, but as many valuable services are now available at low or no cost, the fund value proposition just isn’t as reasonable to them. You may want to consider how performance-linked and/or fulcrum fee structures could better align your managerial ability with investor value. You may also explore new ancillary services, such as automated tax-benefit advisors, financial wellness tools and more complex analytical guidance. In addition to generating revenue, these services are sticky — embedding firms in the daily lives of their clients and increasing customer loyalty.
You may already have access to your “secret weapon,” if you can put it to work. Good data is essential to identifying and understanding investor value, as well as a firm’s ability to deliver it. Data can give you valuable insights into what investors want and need. You may also be able to monetize it, creating new revenue sources, such as subscription services, and using data to identify ways to reduce costs.
Prediction 10: We expect total assets of ESG-based funds to grow an average of 10% annually through 2025.
Last year, we saw that the mutual fund industry was hitting a wall. Now, COVID-19 is magnifying and accelerating the challenges facing the sector. We are still seeing a fee crunch and slower AUM growth, but the compression is happening over a shorter timeline and with more severe results.
Mutual funds that make it to the other side of this market need to be future-fit:
It’s obviously a tall order. But your clients are counting on you to give it everything you’ve got.
“More than ever, the future is uncertain. But, the mutual fund industry should look at this uncertainty as an opportunity to remake itself, providing new value to the investor and sustainability for society.”
Bernadette Geis, US Asset & Wealth Management Leader
Mutual Funds Leader, PwC US
Asset and Wealth Management Leader, PwC US
US Mutual Fund Assurance Leader, PwC US
Asset and Wealth Management Assurance Leader, PwC US
Mutual Fund Tax Leader, PwC US
Asset and Wealth Management Advisory Leader, PwC US