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Declining Margin Trends Signal Maturing Industry

By Eric Daugherty

In prior blog pieces (see here) we have looked at quarterly margins and seen that they are largely driven by movement in the markets. However, over longer periods, it becomes clear that our industry, like other maturing industries, is experiencing margin compression.

Using the earnings results of publicly-traded asset managers, we examined the operating margins (operating income/revenues) and net margins (net income/revenue) since 2000. While the firm-to-firm margins vary wildly over these spans, industry margins have come down. Note that at both the beginning and end of this period the broad market Wilshire 5000 has been near the same level. However, industry operating margins have decreased from 39% to 29%, and net margins have declined from about 27% to 20%.

This compression is exactly what we would expect to see in a maturing industry. Competition and a shift from easy growth of the market, to fighting for a share of a slower-growing pie, mandate shrinking margins. It happens in all industries eventually and will continue in the U.S. financial services industry.

So, what can/should firms do about it? There are a few options:

Prop up margins by:

a.) Focusing on higher revenue products, geographies, or segments

• Differentiated products with believable alpha stories that sustain higher fees


• Go international, into less mature markets with less price competition


• Focus on market segments where the firm has a competitive advantage (e.g. retirement, where no one is an acknowledged leader)

b.) Cutting costs at a given level of revenue, like using the Web to drive efficiencies

Live with decreasing margins, and make money on volume (we've been talking about scale a lot)
a.) Compete on price on commodity-like beta products
b.) Get scale via acquisitions and organic growth of core funds

Long-term, there will be a shakeout, as stronger firms survive and thrive, while others wither. This may not happen for ten years, as making 30% operating and 20% net margins is still fairly attractive. Short-term, we expect firms to fight to maintain margins by ramping up marketing and striving for organic growth. However, the tea leaves are clear - margin compression has begun.