US Institutional Fixed Income Asset Management Industry

Market Size

# The U.S. fixed income market is one of the largest securities markets in the world with more than $29.2 trillion in outstanding debt according to SIFMA as of September 31, 2007.
# The average daily dollar value traded rose from $274.0 billion in 1996 to $508.9 billion in 2001 and $889.8 billion in 2006.

Market Segmentation

# The retail fixed income market accounts for approximately 70 percent of the total fixed income transactions and is expected to expand as 75+ million baby boomers enter retirement and begin shifting investment assets from growth to preservation strategies. Institutional fixed income market accounts for the remaining 30% of the total market share. (Source: Knight Capital Group, Inc.)

Institutional asset management industry has become an important feature of modern financial markets, with the scale of this business’s importance readily apparent from the size of assets under management by different types of institutional asset managers. The growth of the professional asset management industry has been a key feature of the structural changes in the international financial system, a development with implications for many different aspects of the financial landscape - market turnover, securities issuance, international capital flows, market stability, industrial organization and corporate governance. A wide variety of institutional investors, with professional asset managers, has emerged - pension funds, insurance companies (life and non-life), and investment companies (of all kinds).

Market Trends

The sources of profitability & growth in the industry are shifting rapidly as evidenced by the following major trends:

=> With asset management involving a delegation process, shaping appropriate incentive structures is essential for aligning the incentives of owners of funds with those of the institutional managers of these funds.

=> As the industry is still regarded as an evolving business, its strong recent growth is expected to continue well into the foreseeable future. As a result, structural changes in the industry, to the extent that they affect asset managers’ incentives, are likely to have their effect on their decision-making and, possibly, market outcomes. Ongoing industry trends have therefore an obvious potential to change institutional investor behaviour in ways that can be important for global financial markets.

=> Traditional products are now trapped in a vise-like squeeze, with higher alpha and "cheap beta" products again capturing almost all asset growth;

=> The most successful traditional firms dramatically grew both their revenues and profits from alternatives, with these products now accounting for more than one-third of institutional revenues – up from almost nothing only five years ago;

=> As a result of both these trends, retail and institutional net prices have now almost fully converged, with major implications for client segment attractiveness;

=> The defined benefit market is far from dead, but flows are undergoing a radical shift, with higher-alpha, fixed income and cheap beta products the main sources of growth.

Consequences

While the industry overall remains highly profitable, firms that are unable to adapt to these changes will have a hard time maintaining future growth and profitability. Indeed, a direct consequence of the shifting sands of growth and profitability is that most firms continue to struggle to gain real operating leverage.

=> Even in this rapidly moving environment, the effective use of scale remains the dominant characteristic of the most successful asset management firms. Players pursuing any one of three "winning" business models – at-scale, multi boutique and focused-asset players – remain almost twice as profitable as those that do not. Moreover, firms following these models appear better positioned than their peers to adapt to the shifting sources of industry growth and profitability.

=> These rapid industry shifts pose a real challenge for firms' middle and back offices. Indeed, operations and technology have taken on a new strategic imperative, in particular around innovation, customer service, and efficiency; with leading asset managers already recognizing that the payoff for aggressively managing O&T has never been more compelling than it is today.

=> Broadening array of asset classes: The rise in professionally managed assets, both in absolute terms and as a share of overall financial wealth, was complemented by rising interest in non-core markets and, recently, some growth in funds placed with unregulated asset managers.

Sources: McKinsey and CGFS