Man entering a foggy landscape with directional signs leading in every direction. Symbol of uncertainty. / Gremlin

This article appears in the Mid-November 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

The asset management industry was a chief beneficiary of the market boom that followed the extraordinary fiscal and monetary policy response to the pandemic. Now, with a recession on the horizon and markets in retreat, the industry’s future is uncertain.

Mutual fund assets under management (AUM) have been in steady retreat after soaring above $2 trillion in the fourth quarter of 2021 on the strength of robust global markets. According to data from the Investment Funds Institute of Canada (IFIC), at the end of Q3 2022, mutual fund AUM was about $1.75 trillion — almost exactly where it was at the start of 2021.

The net sales picture also has shifted sharply. In 2021, mutual fund net sales hit records, topping $112 billion. This year, sales have reversed alongside weak markets. Through Sept. 30, $18.6 billion was redeemed from mutual funds ($22.3 billion was pulled from long-term funds, but money market funds made $3.6 billion).

ETF AUM also peaked at the end of 2021, reaching $347.4 billion, and has fallen to $287.6 billion at the end of the third quarter. (More recent data from National Bank Financial Inc. indicates that ETF AUM climbed back above the $300-billion mark in October.)

Aside from a blip in June, ETFs have seen positive net sales each month this year for a total of $20.9 billion through three quarters, down from $43.6 billion in the same period last year. Yet, the sales picture weakens when you look by asset class: long-term ETF sales slumped to $15.8 billion compared with $44.6 billion in the same period last year; money market sales accounted for more than $5 billion in net sales compared with almost $1 billion in net redemptions in 2021. Sales represent almost half of money market ETF assets, which totalled $11.4 billion by the end of Q3 2022.

For both mutual funds and ETFs, the decline in AUM has come largely from market activity as equities and bonds have dropped in tandem.

Mutual fund AUM is down by $326 billion so far this year — a decline of 15.7% from the beginning of the year — and only $18.6 billion of that is from redemptions. ETF AUM was down by almost $60 billion at the end of Q3 despite positive net sales.

Facing high inflation and rising interest rates, the industry may be wondering whether it’s facing a secular change rather than a cyclical one.

A report from New York-based McKinsey & Co. stated the North American asset management industry is undergoing a “Great Reset” as economic, monetary and fiscal landscapes are recalibrated after the unprecedented global policy response to the pandemic and new geopolitical realities.

“The Great Reset of 2022 has loosened some of the foundational assumptions behind several of the past decade’s defining trends, including the internationalization of products, clients and capital sources; rapid growth of risk-on and leverage-oriented business models; and a wave of commoditization borne out of the surging demand for bulk beta — assumptions on which the North American asset management industry had built its growth trajectory,” the report stated.

Not only is the asset management industry facing more challenging business conditions, its clients — both retail and institutional investors — may be forced to revisit their own plans in light of portfolio losses and the diminishing prospect of easy investment returns.

McKinsey considered three scenarios for the industry over the next few years: a soft landing, stagnation and stagflation.

In the first scenario, central bankers bring inflation back under control without a deep or prolonged recession. The asset management business could return to its pre-pandemic trajectory: organic growth averaging 2%–5% per year through 2026, McKinsey said, with annualized revenue growth of 5%–10%.

Traditional equity funds, along with growth-focused alternative strategies such as private equity and venture capital, would prosper while fixed-income products probably would face continued outflows amid higher rates.

In the stagnation scenario, McKinsey envisioned a North American equivalent of Japan’s “Lost Decade” of the 1990s, when economic growth ground to a halt following a sharp rise in interest rates. When policymakers tried to correct the problem by cutting rates again, they failed to reignite growth, leaving the economy limping along for years.

In this climate, the asset management industry could expect little to no growth, McKinsey said, with “a strong rotation toward income-and yield-generating assets.” Money market funds would account for a greater share of net flows “as capital remains on the sidelines and investors seek yield over and above what is available from deposits. Multi asset strategies could also benefit as investors seek to outsource asset allocation and look for creative sources of yield.”

The toughest scenario would be stagflation: a return to the 1970s, when interest rates and inflation were high but economic growth was weak or negative. For the asset management business, this would not only pressure AUM but probably result in a “protracted period of industry outflows,” the report suggested, with redemptions averaging 2%–3% per year and revenue dropping by 10%–15% over the next five years or so.

The lack of return potential in traditional assets in this scenario could increase demand for higher-fee alternative strategies, such as commodities, real assets and private equity or private debt investments, the report stated. Still, these conditions “would likely result in a period of restructuring and consolidation.”