A lot can change in a decade. In 2002, asset managers were still smarting from the fact that Yahoo! did not, in fact, take over the world. Institutional investors were firing balanced managers and replacing them with specialized ones. Liability-driven investing was just a buzz word, and exchange-traded funds (ETFs) were a new, niche product area with little potential. Private equity and hedge funds were hot, and consultants insisted that funds of hedge funds were the best model for investors. Spreading risk through the use of structured vehicles like collateralized debt obligations was considered to lower risk, not increase it. And it was generally agreed that Alan Greenspan was the wisest man in the world.

Of course, things look different now. It is safe to say that very few people saw this decade coming. But where does that leave asset managers who want to ensure that they are prepared for the next 10 years? A few key trends may be signals of things to come.

According to Casey Quirk, a U.S.-based consultancy firm for investment management firms worldwide, operating margins have still not returned to their 2007 level but have recovered from their 2009 lows, with a median of 32% in 2011. So, asset management remains profitable, but not as much as in the past. “This is an industry where revenues have gone up year in, year out for a very long time. Our view is that revenues are not going to grow nearly as fast as they have and margins in this business will become compressed,” says Kevin Quirk, founding partner of Casey Quirk. The firm has partnered with Institutional Investor’s U.S. Institute and McLagan (provider of compensation consulting services for the investment management industry) to conduct a survey of 96 fund managers worldwide overseeing US$21 trillion in assets. It found that profit margins since the financial crisis have been managed by controlling compensation and benefits expense.

Global consultancy Cerulli Associates points out that, although asset management revenues were set to exceed US$200 billion by 2015, this achievement now looks unlikely. “There is a dramatic shift out of higher-margin products into lower-margin products,” says Shiv Taneja, managing director of Cerulli Associates. “The share of equity on a global basis is falling. This has two significant impacts. If clients are getting out of higher-margin products and into lower-margin products, that will have an impact on fund managers' profitability. In the past, we've also said that owning stocks and stock investments will get you to your retirement quicker. That is not the case anymore.”

So, what do increased competition and lower margins mean for product development?

For one thing, the ETF market will continue to grow and so will passive strategies as a whole. ETFs already account for over US$1.3 trillion in assets, according to Cerulli. Enhanced indexation, or engineered beta, will take on market share, growing from its current estimated market share of US$200 billion. A report released in June 2012 called “Innovation in the Age of Volatility” by asset management advisory CREATE-Research and Principal Global Investors predicts growth in products that will serve the defined-contribution scheme market. The study forecasts that target-date funds will see significant innovation and morph into a more comprehensive solution.

If the financial crisis has been kind to ETFs, it has been less so to hedge funds, which charge higher fees. Five years ago, hedge funds were widely expected to reach US$5 trillion in assets under management by now, but in 2011, the industry had US$2.46 trillion in assets under management “The asset management industry as a whole is changing, and the fund-of-hedge-funds sector is going through a transition as well. We see adjusting business models and consolidation amongst the players,” says Lisa Fridman, CFA, head of European research at fund-of-hedge-funds investment firm PAAMCO. “In general, the traditional ‘select and compile’ approach is being put under pressure as end investors are developing their own hedge fund programs.”

Quirk believes that successful asset managers will have to offer either unique alpha or unique, cheap betas. Firms that offer whole solutions provision (that is, advice, portfolio management, asset allocation strategies, and customized solutions) also will benefit.

These trends explain why fiduciary managers are posting significant gains in assets. Nearly two dozen European fiduciary managers have seen a €110 billion increase in assets under management as of October 2012, according to an annual survey conducted by Investments & Pensions Europe magazine.

In general terms, fiduciary management refers to the outsourcing of pension fund management to a single third party that takes control of the fund or part of the fund from the scheme’s trustees, providing advice on manager selection, investment strategy, and portfolio services. It is an area where traditional investment consultants like Towers Watson and Mercer have established businesses and where boutique consultants are also drawing market share.

“We understand client needs because we come from a consulting background,” comments Andrew Drake, CFA, managing director of P-Solve, an investment advisory and fiduciary manager. He suggests that "contemporary,” or future-focused, asset managers are realizing that they have to put their clients first and then work backwards, starting with what clients need and then creating suitable products for them, which will make customization a key ingredient for the next decade. With a plethora of boutique consultant/fiduciary management firms on the market that , it seems inevitable that the large, mainstream asset managers will buy the solutions-driven expertise they need rather than build it in-house. In a low-fundraising environment, however, any M&A activity might take a while, given that managers might struggle to make big purchases in the near future.

In a low-return environment, fee structures also will continue to come under pressure. “We have a lot of big challenges ahead of us if we are going to do a decent job for our clients. If we are going to be in a world of nominal returns, we’ve got to make sure the level of charges our clients are paying is kept reasonable. If returns are just going to be, on average, 6–7%, you can’t have 150 basis points taken out in charges. It’s too much of the pot,” says Alan Brown, FSIP, senior adviser to Schroder Investment Management and governor of the Wellcome Trust. Brown is also a member of the 300 Club, a group of senior investment professionals from around the globe who have “joined together to respond to an urgent need to raise uncomfortable and fundamental questions about the very foundations of the investment industry and investing.”

Brown has many concerns about the future, particularly about educating investors. “In a world that is increasingly dominated by defined by contribution,” he says. “I am very worried about Illustration by Timothy Cook how we manage the real-world outcomes for individuals. We are heading for a generation who will face a fairly miserable retirement.”

Brown also points out that not everyone missed the crisis. Bill White, a Canadian economist who served as head of the economic and monetary department at the Bank for International Settlements, predicted the crisis before the subprime market collapse. In 2003, he famously argued directly with Alan Greenspan at the Federal Reserve Bank of Kansas City’s annual meeting in Jackson Hole, Wyoming. White contended that interest rates ought to be raised when credit expands too fast, forcing banks to build up cash cushions for leaner times. The argument fell on deaf ears.

Some industry participants envisage a world in which mainstream asset management has hedge fund–type fee structures, where the bulk of the charge is based on performance. “I’m a bit ambivalent about fee structures. One way that they could change is to become more performance related so you end up paying if the value add is achieved,” says Andy Barber, partner in Mercer’s investment consulting business.

The idea may be good in theory but doesn’t sit well with investors at the moment. “The idea of getting paid more if your assets go up is an interesting one,” says Drake. “We’ve tried a number of different, innovative ways of potentially charging our clients. But they have basically said, ‘That’s interesting but we’ll just carry on as we have been.’”

Barber believes that demand for less-constrained strategies will continue to grow. “There is some academic evidence to suggest that less-constrained managers do better on any kind of risk-adjusted basis, so the days of index plus 1 or 1.5 are gone,” he says. “People are no longer expecting their managers to hold BP because it is a big part of the benchmark.”

Andreas Utermann, global chief investment officer and co-head of Allianz GlobalLDQ]*OREDO ,QYHVtors, agrees. “There is going to be a return to more fundamental investing. There will be less EHQFKPDUNGULYHQLQYHVWLQJµKHVD\V+HDOVR points out that lower fees have other implications. “We are in a low-return environment with margin compression in the industry, making it less lucrative.”