McKinsey on

Investing
Perspectives and research for the investing industry

Number 8, December 2022

McKinsey on Investing is written Editorial Board: McKinsey Practice Publications
by experts and practitioners Pontus Averstad, Pooneh Baghai
at McKinsey in the Private Equity Alejandro Beltrán de Miguel, Marcel Editor in Chief:
& Principal Investors, Wealth & Brinkman, Alistair Duncan, Chris Lucia Rahilly
Asset Management, Capital Gorman, Martin Huber, Duncan
Projects & Infrastructure, and Kauffman (lead), Arshiya Khullar, Executive Editors:
Real Estate Practices, and Rob Palter, Vivek Pandit, Gary Bill Javetski,
at Fuel, a McKinsey company Pinshaw, David Quigley, Marcos Mark Staples
focused on growth businesses. Tarnowski, Brian Vickery
Copyright © 2022 McKinsey &
To send comments or request Editor: Arshiya Khullar Company. All rights reserved.
copies, email us:
[email protected]. Contributing Editors: This publication is not intended to
Heather Andrews, Cam MacKellar, be used as the basis for trading in
Cover image: Katy McLaughlin, David Schwartz, the shares of any company or for
© Eugene Mymrin/Getty Images Mark Staples undertaking any other complex or
significant financial transaction
Art Direction and Design: without consulting appropriate
Leff professional advisers.

Managers, Media Relations: No part of this publication may be

Alistair Duncan and Drew Knapp copied or redistributed in any form
without the prior written consent of
Data Visualization: McKinsey & Company.
Nicole Esquerre-Thomas,
Richard Johnson, Matt Perry,
Jonathon Rivait, Jessica Wang

Managing Editors:
Heather Byer, Charmaine Rice,
Venetia Simcock

Editorial Production:
Nancy Cohn, Roger Draper, Gwyn
Herbein, Drew Holzfeind, LaShon
Malone, Pamela Norton, Kanika
Punwani, Charmaine Rice, Dana
Sand, Sarah Thuerk, Sneha Vats,
Pooja Yadav, Belinda Yu
McKinsey on
Investing
Perspectives and research for the investing industry
Number 8, December 2022

1
Contents
Building a better investment firm

7 12
‘Making the world a better place never feels Forging your own path: Sandra Horbach on building
like work’: An interview with chief DEI officer a career in private equity
Indhira Arrington The cohead of US buyout and growth at Carlyle shares
Ares Management’s first global chief diversity, equity, thoughts on the state of private equity, the path forward on
and inclusion officer talks about how she is building the diversity and inclusion, and advice on building a successful
company’s DEI strategy from the ground up. career in the industry.

17 22
How an acquisition invigorated an asset The state of diversity in global private
management leader markets: 2022
Jenny Johnson, president and CEO of Franklin Templeton, New research captures regional differences in the state
explains how the firm’s acquisition of Legg Mason positions of diversity in private equity and discusses the role of
it for the next phase of growth. institutional investors as a catalyst for change.

35 41
‘If you’re going to build something from scratch, Infrastructure investing will never be the same
this might be as good a time as in a decade’ Traditionally staid and stable, infrastructure investing has
In an interview with the editorial director of the McKinsey been shaken up by revolutions in energy, mobility, and
Quarterly, venture capitalist Bill Gurley explains the promise digitization, making it imperative for investors to reassess
and perils facing start-ups at a moment of economic the strategy’s risk and return dynamics.
uncertainty and reveals why hybrid work may be the most
interesting technology of all.

49 63
US wealth management: A growth agenda for It’s time to become a digital investing organization
the coming decade AI and other digital technologies are ushering in the
Mounting hopes of postpandemic recovery signal an next horizon of performance differentiation. Here’s how
imperative to prepare for the changes in technology, to level up.
consumer needs, and society that will shape the future of the
wealth management ecosystem.

2
Exploring investment themes

70 85
Highlights from McKinsey’s 2022 sector research Why private equity sees life and annuities as an
enticing form of permanent capital
Private acquisitions of in-force books are growing. Here’s a
71 Advanced electronics 79 Financial services playbook for those considering market entry, those already
in, and insurers wondering how to respond.
72 Aerospace and defense 80 Healthcare systems
and services
73 Agriculture
81 Life sciences
74 Automotive and assembly
82 Oil and gas
75 Capital projects and
infrastructure 83 Retail

76 Chemicals 84 Travel,
transportation,
77 Consumer
and logistics
78 Engineering, construction,
and building materials

93 100
Digitally native brands: Born digital, but ready Climate risk and the opportunity for real estate
to take on the world Real-estate leaders should revalue assets, decarbonize,
By applying the right criteria, investors can identify and create new business opportunities. Here’s how.
digitally native brands with the potential to outperform.

108 Innovating to net zero: An executive’s guide to

climate technology
Advanced technologies are critical to stopping climate
change—and the drive to develop and scale them
is accelerating. Here are five themes that could attract
$2 trillion of annual investment by 2025.

3
Introduction
Welcome to the eighth volume of McKinsey on Investing, our flagship compendium of insights relevant to
investors. These perspectives have been contributed by McKinsey colleagues across the globe who are experts
in a diverse array of disciplines, including asset management, institutional investing, and private markets.

It’s a turbulent—and busy—time in private markets. Portfolios are fuller than ever and there is significant dry
powder across the industry. Yet fundraising and deal making for larger transactions are well off 2021’s highs.
Further, the slowdown in exits, coupled with declining public market valuations and the resulting denominator
effect, has shifted investor allocations. As a result, the current fundraising environment is far more challenging
than in the past several years. Finally, the availability of debt has fallen even as its cost has grown rapidly, making
transactions difficult.

In times like these, value creation in a portfolio becomes a crucial differentiator for firms and funds, focusing
minds on pricing, procurement, and supply chain resilience and reconfiguration. Though financing is challenging
and uncertainty high, we continue to see our clients pursue opportunities even as they manage for uncertainty
in their portfolio companies. This strategy has yielded results in the past: firms that were more aggressive with
integrations, capital reallocation, and investing for growth during previous corrections were able to accelerate out
of the downturn. We will continue to publish insights as private markets evolve; if your fund would like a preview of
our perspectives, please write or call and we will be pleased to arrange a discussion.

This issue of McKinsey on Investing steps back from the immediate challenge of the market— and the broader
macroeconomic and geopolitical uncertainty— to present a longer-term perspective on how investment firms
are evolving and the thematic ways investors have and will put money to work. We are also pleased to include new
research that captures the state of diversity in private equity while discussing the role of institutional investors as
a catalyst for change.

We hope you enjoy this collection and discover in it ideas worthy of your consideration. You can find these and
other perspectives relevant to investing at McKinsey.com/Investing and in our McKinsey Insights app, available
for Android and iOS.

The Editorial Board

Pontus Averstad Chris Gorman Vivek Pandit

Pooneh Baghai Martin Huber Gary Pinshaw
Alejandro Beltrán de Miguel Duncan Kauffman David Quigley
Marcel Brinkman Arshiya Khullar Marcos Tarnowski
Alistair Duncan Rob Palter Brian Vickery
 Notable facts and figures
Despite market uncertainty, leaders are adapting their search for investments
and their firms’ operations to uncover unique opportunities.

$3.5 trillion
Total capital deployed across private market asset classes in 20211

$2 trillion $52 billion

Annual investment toward Venture capital investments
next-generation climate in the biotech industry from
technologies by 20252 2019 to 20213

$10
billion 48%
Private equity entry-level
Private funding in space- roles globally that were filled by
related companies in 20214 women in 2021 5

3,500 $1.5 trillion

to
Number of global investment managers
and institutional investors who signed the
$1.6 trillion
Annual investment in energy supply
UN-supported Principles for Responsible
and production by 2035 to meet
Investment in 20216
emission-reduction targets7

1
Private markets 2022: Private markets rally to new heights, McKinsey, March 2022.
2
Tom Hellstern, Kimberly Henderson, Sean Kane, and Matt Rogers, “Innovating to net zero: An executive’s guide to climate technology,” McKinsey,
October 28, 2021.
3
Olivier Leclerc, Michelle Suhendra, and Lydia The, “What are the biotech investment themes that will shape the industry?,” McKinsey, June 10, 2022.
4
Ryan Brukardt, Jesse Klempner, and Brooke Stokes,“Space: Investment shifts from GEO to LEO and now beyond,” McKinsey, January 27, 2022.
5
“The state of diversity in global private markets: 2022,” McKinsey, November 1, 2022.
6
Private markets rally to new heights, March 2022.
7
Global Energy Perspective 2022, McKinsey, April 2022.
Building a better
investment firm
7
‘Making the world a better
place never feels like work’:
An interview with chief DEI
officer Indhira Arrington

12
Forging your own path:
Sandra Horbach on building
a career in private equity

17
How an acquisition
invigorated an asset
management leader

22 35
The state of diversity ‘If you’re going to build
in global private something from scratch,
markets: 2022 this might be as good
a time as in a decade’

41
Infrastructure investing
will never be the same

49
US wealth management:
A growth agenda for the
coming decade

63
It’s time to become a digital
investing organization
‘Making the world a better
place never feels like work’:
An interview with chief DEI
officer Indhira Arrington
Ares Management’s first global chief diversity, equity, and inclusion officer talks
about how she is building the company’s DEI strategy from the ground up.

7
 The business case for diversity, equity, and change beyond our own walls. And we know that if
inclusion (DEI) is stronger than ever, but many we can help our portfolio companies become more
companies’ DEI programs are stalled or have slipped inclusive, more equitable, that can help drive long-
backward. That’s because intentions aren’t the term performance. Before I was hired, DEI at Ares
same as execution and process infrastructure— was largely employee driven. But our leadership
something that Indhira Arrington learned in her first recognized that we needed a formal structure. And
year at the global alternative asset management so my role reports to both talent, meaning HR, and
firm Ares Management (Ares), for which she is the the CEO.
managing director and first global chief DEI officer
(CDO). Arrington believes that Ares needs to embed We’re operationalizing DEI through our people and
DEI into many aspects of what it and its portfolio culture, as well as our business and investment
businesses do, including human capital, business, process. We’re ensuring that we have the
and investment processes. infrastructure, strategy, plans, goals, and KPIs to
hold ourselves and select portfolio companies
In an interview with McKinsey’s Diana Ellsworth accountable. We drive DEI in our investment
and Drew Goldstein, Arrington discusses why it’s process because we believe it can lead to better
important to listen and gather data before creating ROI, and so we have a DEI lens when we make
a DEI strategy and why she’s focused on building a investments. We’ve intentionally woven DEI into our
culture of representation, especially when it comes procurement processes, working to identify current
to recruitment, retention, and talent development. diverse spend and then find areas where we can
As an immigrant from the Dominican Republic, transfer spend to diverse suppliers. We’re seeking
Arrington feels an enormous responsibility to open to lead by example so that we can be in a position to
doors for others, as sponsors and mentors did for offer advice to our portfolio companies and create
her. “Making the world a better place never feels like a playbook for how they, too, can approach supplier
work,” she says. The following is an edited version of diversity. We’re also looking at the impact we have
their conversation. on our communities through our philanthropy,
maximizing our giving, our employee volunteerism,
McKinsey: Why is DEI important to Ares? and our matching of employee donations.

Indhira Arrington: The whole point of our DEI What I love about our approach is, at the core, we’re
strategy is to be a force for good for Ares, for data driven. We’re setting KPIs, and we’re holding
the companies in which we invest and in the ourselves accountable for the change we want to
communities in which we operate. We recognize see—because we believe that what gets measured
the power and influence that we have to create gets done.

‘We’re holding ourselves accountable

for the change we want to see—because
we believe that what gets measured
gets done.’

8 McKinsey on Investing Number 8, December 2022

Indhira Arrington Bank of America
(2014–15)
Vital statistics
Senior vice president, head of diversity recruiting
Born in 1977 in Santo Domingo,
relationship management
Dominican Republic
(2012–14)
Married, with 2 sons
Senior vice president, diversity and inclusion
sponsorship management
Education
Holds an MBA from New York
(2010–12)
University Stern School of Business
Vice president, diversity and inclusion, executive
and a bachelor’s degree in economics
diversity recruiter
from Rutgers University
(2009-11)
Is a Cornell Certified Diversity
Vice president, diversity and inclusion, global
Professional/Advanced Practitioner
banking and markets
(CCDP/AP)
Fast facts
Career highlights
Serves on the board of directors of Poly Prep,
Ares Management Corporation
the Committee for Hispanic Children and Families,
(2021–present)
and the Council of Urban Professionals
Managing director, global chief
diversity, equity, and inclusion officer
Sits on Milken Institute’s Diversity, Equity, and
Inclusion in Asset Management Executive Council
Wells Fargo
(2018–21)
Member of Omicron Delta Epsilon, Phi Beta Kappa
Senior vice president, head of
Society, Association of Latino Professionals for
targeted sourcing
America (ALPFA), and PRIMER Network

Enjoys yoga and watching her children play sports

McKinsey: As your organization’s first CDO, how did took a very pragmatic approach and made the first
you begin? 90 days about data gathering.

Indhira Arrington: I came in focused on listening. We began with a quantitative and qualitative
In this job, there’s work to be done everywhere you assessment of the starting point for us and a cohort
look. It’s difficult not to rush in and start trying to of our portfolio companies. When I think about
get things done right away. And I’m super type A, so data from a human capital perspective, I keep
it drives me crazy not to jump into execution. But I things simple. For me, it’s a + b – c: recruiting plus

‘Making the world a better place never feels like work’: An interview with chief DEI officer Indhira Arrington 9
 promotions minus departures. Cut that by a diversity We then worked with these portfolio companies
dimension and by title, and you can clearly see at to create strategic plans for each individual firm, in
any point what your representation looks like. It’s addition to further refining Ares’s own strategic
a nice way to start mapping out which people you plan. Each developed a three-year DEI plan of
need to spend time with and which processes to its own, with a vision, objectives, initiatives, and
evaluate to understand how we got to where we are. metrics to monitor. In total, more than 200 DEI
initiatives were planned. Some targeted, for
I met with over 120 team members one by one. I instance, increased representation of women and
was after three things: to see how they felt about Black, Indigenous, and people of color colleagues
working at Ares, where they thought we were on at the manager level and above. Some targeted
our DEI journey, and what they thought success increased diversity among suppliers. We upskilled
should look like from a DEI perspective. I also our own team members who sat on those portfolio
looked at some external surveys to glean insight company boards so they could help drive DEI from
into how employees were experiencing the the boardroom. We prepared each company to add
organization through the dimension of diversity. DEI to the board agenda on a quarterly basis and
Finally, I met with functional leaders. are supporting them to execute on it. We’ve set up
a community with members from each firm, which
The most challenging part of being a CDO is that meets monthly to share best practices.
you don’t own any place where the work gets done.
You don’t own any of the functions. I’m meant to McKinsey: Where have you seen the DEI strategy
drive change through influence, which is awesome make the most difference?
but can also be challenging. So I sat with functional
leaders from recruiting and HR to understand our Indhira Arrington: One process we were able to
talent management process and with business change within Ares—and make it the new way we
leaders to understand how they viewed DEI from do business—was in our recruiting. We set out to
a business perspective and the procurement increase representation where we have gaps. We
function. I worked to gather as much information found that we weren’t seeing enough diversity at
as possible. the job seeker and qualified-candidate levels. We
also saw that not enough candidates were getting
McKinsey: How did you create your strategic through our funnel and making it to first-round
DEI plan? interviews. We decided to change our process.

Indhira Arrington: Once we understood where we We began implementing diverse talent slates at first-
were from a DEI perspective, we set out to form round interviews. We launched a pilot in the US where
a strategic plan. Together with a core set of our we require a minimum of four candidates in first-
portfolio companies, we went through a pipeline round interviews, and at least half must be diverse.
assessment to help identify our diversity gaps, an We worked with our recruitment team to source
infrastructure assessment to see whether we had diverse talent for the slate and with our search firms
the infrastructure in place to operationalize DEI, so they also can support the diverse-slate mandate.
and an inclusion assessment that included a global
inclusion survey across all participating firms. That We are also extremely proud of launching the
last assessment gave us quantifiable inclusion AltFinance Investing in Black Futures initiative.
ratings, as well as our gaps by diversity dimension, The asset management industry is one of the least
line of business, title, and location. We could look diverse in the US, with a substantial lack of Black
within our firms and be very surgical about how we talent. We decided to help solve this industry
were going to narrow those gaps. problem. Through the Ares Charitable Foundation,

10 McKinsey on Investing Number 8, December 2022

 along with two industry peers, Apollo Global to create a curriculum for students to understand
Management and Oaktree Capital Management, the different verticals and careers within the
we jointly committed $90 million over a period of asset management industry, get through industry
ten years through the Ares charitable foundation to case study interviews, and hopefully join us
start a nonprofit focused on engaging, attracting, for a successful summer internship.2 And then it’s
and creating a pathway for HBCU [historically about converting the interns to full-time employees
Black colleges and universities] students to join and working with the recruiting teams at our firms
the asset management industry.1 It also provides to hire the students and set them up for success.
need-based scholarships. I’m excited to share that we and other firms
recently welcomed our first cohort of interns.
AltFinance Investing is partnering with the
Wharton School of the University of Pennsylvania

Indhira Arrington is a managing director and the global chief diversity, equity, and inclusion officer of Ares Management.
Diana Ellsworth is a partner in McKinsey’s Atlanta office, and Drew Goldstein is an associate partner in the Miami office.

Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or
positions of McKinsey & Company or have its endorsement.

Copyright © 2022 McKinsey & Company. All rights reserved.

1
Miriam Gottfried, “Apollo, Ares and Oaktree team up on initiative to lure Black talent,” Wall Street Journal, June 15, 2021.
2
“Apollo, Ares and Oaktree to launch $90 million initiative for students at historically Black colleges and universities,” Wharton School,
University of Pennsylvania, June 15, 2021.

‘Making the world a better place never feels like work’: An interview with chief DEI officer Indhira Arrington 11
 Forging your own path:
Sandra Horbach on building
a career in private equity
The cohead of US buyout and growth at Carlyle shares thoughts on the path
forward on diversity and inclusion, and advice on building a successful career
in the industry.

12 McKinsey on Investing Number 8, December 2022

This conversation between Sandra Horbach, In terms of recruiting, I would say that we see
managing director and cohead of US buyout and more focus on specialization. When I started in the
growth at Carlyle; Rodney Zemmel, senior partner business, everybody was a generalist because,
and global leader, McKinsey Digital; and Alexandra first of all, there weren’t that many of us and the
Nee, partner and global head of diversity, equity, and businesses were much smaller. But today, amid so
inclusion for the Private Equity & Principal Investors much competition, you really have to have an area in
Practice was recorded on October 26, 2021. It was which you specialize.
part of McKinsey’s Women in Private Equity Global
Forum, held virtually, with an audience of 143 women The second thing I would say is I think that firms
investors from 46 firms across North America and are looking for people coming out of different
Europe. The following is an abridged transcript. backgrounds, so not just necessarily the traditional
consulting or investment banking backgrounds. I
Rodney Zemmel: While Sandra Horbach certainly think people are opening the aperture to people
needs no introduction in a group like this, I’m thrilled to with industry experience or other types of
have the cohead of US buyout and growth at Carlyle functional experience.
with us. Ms. Horbach oversees Carlyle’s three largest
private equity funds, with approximately $60 billion in The last thing I would say is there are a lot of other
capital under management. Prior to joining Carlyle, Ms. important players who create significant value, both
Horbach was a general partner with Forstmann Little in the diligence process and post-acquisition, during
& Company and also worked in the M&A department the value-creation process. Those are some of the
of Morgan Stanley. She earned her MBA from Stanford functional experts that I mentioned on the digital
University and BA from Wellesley College. I’m thrilled side, on the talent side, IT, et cetera. They drive a lot
to introduce Sandra to you all and look forward to our of value. So that’s going to be, I think increasingly, an
conversation today. Welcome, Sandra! area where people are leaning in and where we’re
even hiring data scientists.
Alexandra Nee: Sandra, one of our first questions is
this: As we think about how the private equity industry Alexandra Nee: You made partner initially at
has changed recently, we would love to get your Forstmann Little and then obviously have been
thoughts—for some of the women investors we have tremendously successful at Carlyle since. Is there
joining us—on how private equity has changed as a any advice that you have for other women looking to
career over the last decade. And how will recruiting advance to [the] top levels of their firms?
into these private equity roles be affected by this
going forward? Sandra Horbach: It was a very different era when
I made partner. At Forstmann Little, I was the first
Sandra Horbach: I would say one thing that has been woman, but there were only five other people
a welcome change is a lot more focus on diversity. there when I joined, so I was the sixth investment
Unfortunately, a lot of investment firms are still not professional. Fortunately, I was in a growing industry;
anywhere near where they need to be, especially at and it’s always great to be in a business or a sector
the senior levels, in terms of having diverse teams. We with tailwinds because as you grow, you can take on
really think diverse teams result in better investment additional responsibility and advance very quickly.
decisions. I’ve seen it over and over again: when we Today, private equity is a more mature business. The
bring in diverse perspectives, we come out with a firms are more established, and they have more people,
better outcome. That’s true of investment decisions. and so it does take longer to go through that path.
It’s also true of business decisions at the board level
and within portfolio companies. So, we still have a I also think the skills that we’re bringing as investors
long way to go as an industry, but I’m thrilled to see are so much more sophisticated than when I started
that there is definitely a lot more focus on diversity. out investing back in the late ’80s. The value creation

Forging your own path: Sandra Horbach on building a career in private equity 13
 that sponsors are bringing to portfolio companies, I’d appreciate if you can talk about why this is
and the complexity of the world, and the diligence important and what challenges, if any, your firm has
that we do has completely changed. As a result, it had in implementing this. And also, are there things
takes time to get to the level where you’re able to that you’ve learned which other firms looking to
master all of that to run and lead deals, which is really follow suit can do to be successful here?
our definition of what an MD [managing director]
should be able to do. Sandra Horbach: Yes. I have learned that it must start
at the top, and you have to be serious about it if you
So, in terms of advice, I would say the most important want to see change because it’s so much easier just
thing is to be brave, be your own advocate, and don’t to hire somebody who looks just like you and went to
cower away from the challenging assignments. One the same school and same fraternity or worked in the
of the most significant assignments I ever had was same investment banking group and what-have-you.
going in to look at a turnaround that we’d invested a So, you really have to be committed to it. We’ve been
lot of capital in. It was almost a bet-the-firm type of committed to it for over a decade.
investment that had gone south. I thought, “I can’t
believe they’re asking me to do this, because what do I would encourage other firms that are truly serious
I know?” But I jumped in, and I lived at this company about diversity to set the policy and enforce it. We’ve
for three or four months, trying to understand the seen that’s the only way it works, and it’s not going to
problems so I could make my best recommendations happen at the speed that we all are looking for it to
for the changes we had to make. We were successful happen if we don’t.
in the end, and it turned out to be one of our most
successful investments. It was one of the best things For the past eight years, all our incoming classes
that could have happened to me because I was on my team have been at least 50 percent diverse.
thrown in, and it was tough. That’s our pipeline of future leaders. Also, for
all lateral hiring, we require a diverse slate, and
But if you are successful in those types of situations, that actually goes through our Diversity, Equity
you get a lot of credit, and you’ll advance your career. & Inclusion Council, which I’m a member of. The
You learn so much more, usually, in those situations council is led by our CEO, and all the senior fund
where you’re struggling. So, don’t be afraid of a tough leaders in the firm are members, so that obviously
assignment; in fact, volunteer! speaks to how we view its importance.

The last thing I’d say is, I always tell the folks at Carlyle, Rodney Zemmel: Another question from the
“Use your voice and own the room.” I mean, you have audience just starts with a thank you for being such
to feel as though you deserve to have a seat at the a role model in the investing industry for so many
table. And I’m telling you right now, you all do. But women. Then it goes on to ask, “How is Carlyle
you have to own it and be responsible for that and approaching work-life balance in the new COVID-
manage your own careers. 19 normal, or the hopefully soon post-COVID-19
normal—and particularly for working moms?”
You can’t expect somebody else to be looking out
for you. It’s nice if they do; it’s nice to get sponsors— Sandra Horbach: Flexibility is the most important
that’s great; mentors are great. But at the end of the thing you can give. Carlyle is back in the office now,
day, it’s on all of us to decide what we want to do and but we have gone back in a hybrid model, so we
how forward-leaning we want to be. And then we are giving a lot of discretion to managers. For my
just have to lean in. As I always say, “When someone teams, we are back three days a week, but each team
opens the door, walk right through it, and go for it.” can choose which three days those are, and those
include travel days. If you’re out traveling for three
Alexandra Nee: Sandra, at Carlyle, you’ve initiated a days at board meetings, when you return, you can
charge to make sure at least 50 percent of the firm’s work remotely from home. What we, and I think all
incoming class are women or minority [candidates]. companies, learned in the pandemic is we can trust

14 McKinsey on Investing Number 8, December 2022

our employees: they are awesome and driven. I guess It’s also on all of us to speak up. It’s about using your
if you’re in this industry, it’s safe to say you probably voice so that if you have an issue, you shouldn’t just
all are. Based on what we’ve seen, people worked as hold onto it yourself and think you’re going to have to
hard, if not harder, during the pandemic. figure it out alone. Because I know people who ended
up quitting because they couldn’t handle certain
We have dedicated employees, and they want to things, but they never raised [those issues]. So, make
get their jobs done, but they do want flexibility and sure you ask for help if you need it and understand
they deserve it. We all work really hard, so the more that if you’re doing a great job, firms want to keep you,
flexibility we can give to our teams, the better. so they’ll work with you to adjust things accordingly.
It will help not only you, but [also] the whole firm’s
In terms of work-life balance, I do worry that the culture of inclusivity.
increased velocity in deal timelines that we’re seeing
really takes a toll on the team. What used to be an Alexandra Nee: What do you think private equity
already intense four-to-six-week process is now investment professionals don’t spend enough time
condensed into a three-week process. That’s going on when looking at deals? What are the common
to hurt us over the long run. It’s going to hurt morale. missteps or the errors that cost them?
But I think it’ll especially hurt women. Because, let’s
face it, we do carry a little bit more responsibility, in Sandra Horbach: I think it’s the people side,
most cases both at the office and at home. because I think a lot of private equity folks are very
transactional. Now, with this compressed time frame,
You can have the best policies in the world, but you it’s hard to get quality time with management teams
also need a culture that supports diverse employees. that are going to be your partners over the next four
In order to retain talented women, I think the most to five years. When I started in this business, you
important thing you can give, especially now that basically lived at the company for a month while
firms understand you can be very effective working you were doing your diligence. You really got to
remotely, is flexibility (especially when someone’s understand the culture, people, and strengths of an
earlier in their career and they are trying to balance organization before you made the investment, as well
family, work, and other responsibilities). So, for us, if as, naturally, the opportunities for improvement. It’s
someone wants to take an extended period of time very hard to do that in today’s marketplace.
off beyond our standard parental leave policy, we
hold the position open for them when they come back. The most successful PE leaders are those who
To me, it’s less about the policies you put in place than continually develop their network and relationships
the culture and the attitude that embraces people’s so that they have a relationship with someone before
circumstances. we get to the point where we’re talking about an
investment. I always say, “If you meet a management
In the early days, people would say, “Do you think team for the first time at a management meeting, you
she’s going to come back after maternity leave?” I have already lost the deal.” Because someone else
would respond, “Would you ever ask that of a man? was there, and they’ve got a leg up, an advantage in
No. Of course, she’s going to come back.” She didn’t that transaction.
go to Harvard Business School or the Stanford
Graduate School of Business and work four years That is actually good advice for women because
before that and work here for the last eight years, just I think men do it better than women because we
to walk away now. have so many other things we’re juggling. But you
have to take time to develop and advance your
So, it’s a long journey, but it’s about shifting the mindset network, keep it current, and cultivate it. It’s so easy
and creating a truly inclusive culture. This is the respon- to just get absorbed doing work all the time, and
sibility of the leaders of an organization. If you say one the relationship cultivation can always be put off till
thing and you are acting differently, people see that. tomorrow. But over the long run, over your career,

Forging your own path: Sandra Horbach on building a career in private equity 15
 those relationships are really going to serve you well if Tenacity, resiliency, grit—they pay off over a career.
you’ve been a good partner. And it’s been a two-way
street in terms of what you’ve given to those other The other piece of advice is just that there is no
professionals. substitute for hard work. Many people ask me, “How
do you get to this or that level?” I always have the same
Rodney Zemmel: What [are] one or two pieces response: “Do the best job you can in the current job
of career advice, particularly for women who are you’re in.” That’s how you get to the next level—really
building careers in PE, that you’d want to pass on? distinguish yourself and make sure you become
indispensable in some area. And try to have fun too!
Sandra Horbach: I would say, “Keep at it.” If you feel
like your career is going to be limited in your current
firm or you don’t like the culture, don’t stay there,
but don’t leave the industry. Go and find another Don’t take yourself too seriously. There are tons of
firm. Believe me, there are so many firms out there bumps along the road. My career looks like it was
now. Just redirect and pivot. It doesn’t have to be a just straight lines. But it wasn’t, and no one’s is. You
name brand firm where you can go and get a positive, have to go with it to be able to deal with setbacks
great experience—because this industry is so much and failures and not let them get you down. I wish
fun. I mean, we get to see so many different types everybody well, and again, I’m happy to have been
of businesses and situations, with so many amazing a role model for many years. I just want to see a lot
management teams and people, all while working more women in senior roles be able to play that role
with really smart people within our own firms. You are for their organization as well.
never bored in private equity. I’ve never been bored in
30 years.

Thank you for reading the abridged transcript of the conversation between Sandra Horbach, Alexandra Nee, and Rodney Zemmel.

For more information on the work of McKinsey’s Women in Private Equity Global Forum, visit our page, “Women in private equity.”

Sandra Horbach is managing director and cohead of US buyout and growth at Carlyle. Alexandra Nee is a partner in
McKinsey’s Washington, DC, office and head of diversity, equity, and inclusion globally for McKinsey’s Private Equity &
Principal Investors Practice. Rodney Zemmel is a senior partner in the New York office.

The authors wish to give special thanks to Carlyle’s Michael Mazza and McKinsey’s Chris Gorman, Theodora Koullias, Anna
Pione, and Jessie Shortley for their help orchestrating this October 26, 2021, fireside chat with Sandra Horbach as part of
McKinsey’s Women in Private Equity Global Forum.

Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or
positions of McKinsey & Company or have its endorsement.

Copyright © 2022 McKinsey & Company. All rights reserved.

16 McKinsey on Investing Number 8, December 2022

How an acquisition
invigorated an asset
management leader
Jenny Johnson, president and CEO of Franklin Templeton,
explains how the firm’s acquisition of Legg Mason positions it
for the next phase of growth.

17
 Jenny Johnson grew up in the investment acquiring new capabilities. In some situations, a
management business, rising through the ranks CEO may face pressure from investors who look
of Franklin Templeton (a firm founded by her for short-term gains versus taking a long-term
grandfather) for 32 years before taking over from perspective, but we had the benefit of having long-
her brother as president and CEO in early 2020. term shareholders. I was more confident than ever
Within days, she announced the biggest transaction about our future.
in the company’s history: the acquisition of
Baltimore-based competitor Legg Mason. Robert Byrne: The merger closed earlier than many
expected. How did you manage the integration?
The $4.5 billion transaction roughly doubled Franklin
Templeton’s assets under management (AUM) to Jenny Johnson: The integration was about laying
$1.5 trillion and made it the sixth-largest independent out and communicating very clear goals, and
investment manager in the world. The merger brings we’re proud of the progress we have made toward
to Franklin Templeton additional expertise in core achieving them. One of the merger’s goals was to
fixed income, equities, and alternatives, and expands infuse talent into the firm, and getting people to be
its multi-asset investment solutions. McKinsey’s open to that was really important.
Robert Byrne spoke with Johnson recently about the
challenges of blending cultures in a merger of equals, When you are picking talent for new roles, you want
the disruptions coming to the asset management to be able to do that in person and I was fortunate
industry, and the need to democratize access to to have arranged a two-week trip to visit all of Legg
high-return investment opportunities. An edited Mason’s investment boutiques that ended right
version of their conversation follows. before the lockdowns in March 2020. That made a
huge difference because even that limited interaction
Robert Byrne: This acquisition seems like a baptism helped build trust and move things along in the
by fire for you as a new CEO. A few weeks after integration. In an acquisition, everybody is nervous
you took over and announced the acquisition, the about their future roles. As you get further up in
pandemic hit. What was it like to go through so the organization, there is only one seat for certain
many experiences at the same time? functions and in an acquisition of two equally sized
firms, there are two candidates for many roles. In
Jenny Johnson: We were all very excited about the some cases, we didn’t go with a Franklin Templeton
Legg Mason announcement and what it meant for candidate, and those were tough conversations.
our respective companies, and of course thousands
of employees, clients, and shareholders. For me Robert Byrne: Your father, former longtime CEO
personally, it served as big news to start off my of Franklin Templeton, had said that Franklin does
tenure as CEO, but it was definitely a team effort. what’s right for the client and the business takes
I had the benefit of still having the former CEO of care of itself. How did that philosophy inform your
Franklin Templeton as executive chairman and our approach to client retention?
CFO had experience with many transactions.
Jenny Johnson: The clients’ primary concern was
We had been working on the Legg Mason that the merger would be a distraction for us, so
transaction for about eight months and I was very it was important for us to keep them informed
involved. It was part of a multiyear strategic plan about the progress. Early on, we developed a more
where we identified key growth accelerators for adaptable regional distribution model which pushed
our business. And when the pandemic hit, we never decision making and resources closer to our clients
looked back. For us it was a growth story, from filling to be more responsive to their needs. We also
product gaps to providing client diversification to

18 McKinsey on Investing Number 8, December 2022

invested significant time training our sales teams strengths in separately managed accounts
on the expanded range of capabilities. Once our [SMAs] and customized solutions with the power
clients were comfortable with the decisions we were of custom indexing.
making, they started to ask, “What else is available?
Tell me how this is good for me.” We are seeing the These plus the Legg Mason acquisition have greatly
benefits of cross-selling. expanded our ability to create new solutions—now
it’s like being a chef walking into the best-stocked
Naturally, we expected there would be some kitchen. Another area that’s exciting, but will take
growing pains. We had to change the relationship time to unlock, is the diverse expertise that specialist
managers for some clients, which is always hard investment managers can learn from each other.
for people. Half the financial advisers have a new
wholesaler supporting them and it will take time Robert Byrne: You opted to not fully integrate Legg
for those relationships to be established. Mason’s independent boutiques, aiming rather
to create what you have described as a “cross-
Robert Byrne: How will you define and measure the fertilization.” What impact does this decision have on
merger’s success as you continue the integration? the culture of the merged entity?

Jenny Johnson: It’s many of the traditional Jenny Johnson: Some of the Legg Mason
measurements in the industry: Are we growing the investment teams are quite independent, and are
business? Do we see positive net flows? Are our fully functioning businesses with their own lawyers,
solutions teams sought after as advisers? And we CFOs, and other functions. As a global organization
are seeing positive developments, with organic we can be helpful but rather than imposing this
growth in a number of key areas. With the recent help on them, we let them opt in. Our philosophy
announcement of the acquisition of Lexington has always been that the investment management
Partners, we now have top-tier specialist investment teams are completely independent and the chief
managers in all the key alternative categories. When investment officer determines the investment
we close the Lexington transaction next year, we process. At the same time, we have provided
expect our alternative assets under management incentives to leaders of the investment teams to also
to approach $200 billion. We also recently focus on the success of the broader organization.
announced plans to acquire O’Shaughnessy Asset A transaction gives you the flexibility to implement
Management, which will complement our existing that, which would have been hard otherwise.

‘Investment bankers will tell you why a

transaction is a great strategic fit and
has a great price, but they will never talk
about culture. Yet, in our experience,
deals succeed or fail based on whether
the cultures mesh.’

How an acquisition invigorated an asset management leader 19

 Remember that we were essentially buying nine you got a smartphone and thought it was cool but
cultures that we did not fully understand: the did not appreciate its full capabilities. Now, you
investment side had eight teams with unique probably use it more than your computer.
cultures, plus the parent company. Investment
bankers will tell you why a transaction is a great Robert Byrne: Do you see asset managers being
strategic fit and has a great price, but they will never in the vanguard of bringing these innovations to
talk about culture. Yet, in our experience, deals the masses?
succeed or fail based on whether the cultures mesh.
Jenny Johnson: Well, I don’t know how many are
Robert Byrne: Let’s turn to broader industry trends. paying attention. Franklin Templeton already has
The impact of blockchain and the arrival of digital a money market fund built on blockchain. Many
assets have long been topics of speculation. How people think this is further off, but overnight it could
disruptive will these changes be? coalesce. Is that two years from now? I don’t know,
but once it starts, it will take off.
Jenny Johnson: Blockchain is the biggest disruption
I have seen in my 30 years in this industry. Take, Robert Byrne: Where do you see pockets of
for instance, tokenization: an individual can build demand for alternative investments and will the
ownership rules into code that allow them to distribution model change?
transfer illiquid assets much more easily. You can
fractionalize ownership and then provide additional Jenny Johnson: Our clients deserve the broadest
services through nonfungible token [NFT] validation. range of investment choice, and expanding into
To put this concept into a real-world example, alternatives helps to provide all clients with access
the Empire State Building could be sold to a million to performance and return drivers that differ
different people and those investors wouldn’t from more traditional investments. For an asset
need to do an ownership transfer; it’s all there in manager, alternatives also provide for the potential
that token. of higher margins.

This phenomenon will unlock and democratize My team and I recently discussed some of the more
assets in a way we have never seen. It will be complex issues that we as a manufacturer face in
fundamental to bringing alternative investments order to get private-market products to the hands
to the retail space, which needs to happen. The of retail investors—whether through their financial
illiquidity premium has been so significant that it’s professional or even inside a 401(k) plan. How do you
dangerous for us as a society to only allow wealthy value a private company daily? What about liquidity?
people to benefit from those returns. But it’s a Seventy-five years ago, Franklin got into mutual
running-with-scissors scenario: NFTs are great funds because back then the little guy didn’t have
tools but, boy, if used incorrectly, smaller investors access to the market. Mutual funds were hard to
could potentially get hurt. explain and took a long time to be embraced. It was
30-plus years before Franklin raised the first billion
The other concept I find fascinating is decentralized dollars, so firms have to be patient and committed.
finance [DeFi]. Today, if I want to create a new
company, I pitch it to friends, family, and venture Fast forward to today and we’re seeing the
capitalists and they become my equity providers same concept play out with alternatives. There
before I launch the product. DeFi instead gives is a massive amount of money available to keep
equity to the customers who help you build the companies private longer. Let’s face it: when you go
business. When you become a user of my code, public, the scrutiny soars, so many companies prefer
I can pay you in tokens that become valuable over to wait. If that growth trajectory is not available to
time. This will change the traditional equity model, the retail investor, that will be a huge problem.
but we are only scratching the surface. It’s like when

20 McKinsey on Investing Number 8, December 2022

Robert Byrne: There has been an awakening in the Passive tends to do well in a momentum market,
past few years about corporations’ responsibility but we cannot sustain the current level of central
to society. Do you think the focus on purpose, bank intervention and when that stops, there will be
stakeholder capitalism, and environmental, social, more differentiation in returns, which is where active
and corporate governance [ESG] issues will persist, management does better.
and what impact does that have for your industry?
I also think data will be more and more important.
Jenny Johnson: A leading publication did a CEO Anybody making active decisions, whether at a
survey a year ago asking, “Is stakeholder capitalism macro or individual-company level, will be looking for
new and here to stay?” And I was one of the few who nontraditional sources of data to gain an edge. That
said no. I said that because stakeholder capitalism data is expensive because in data analysis there are
has always existed. Good companies have always far more dead ends than positive signals you can act
paid attention to their clients, their community, and on. Active asset managers will have to be as good as
their employees, who are your biggest assets. Google is at understanding how to get insights from
All those stakeholders have to be in the minds of data. Scale allows you to share those costs across
successful leaders—it’s certainly how my father a broader asset base and that will be one element
ran the business. We are just doing a better job of that pushes M&A. Additionally, distribution partners
articulating it today. worry about risk management, compliance, and
technology investment. Investment companies will
ESG and sustainable investing are also here to want to make sure that their partners are investing
stay, and it’s to the advantage of active managers in those critical areas because if one of them sinks,
because ESG data is hard to get, it’s not consistent, it splashes back on them. That is another factor that
and there is a lot of window dressing. I think we will will drive M&A.
see a shift to investment products that truly dig in to
measure ESG performance. Clients will be asking, Robert Byrne: You are now 20 months into your role
“How did I do in my returns and what impact did I as CEO. Is there anything you know now that you
have?” I have five kids and I see it with them: they are wish you knew when you started?
willing to be uncomfortable to save the environment.
My daughter will not use a plastic water bottle; she Jenny Johnson: Being willing to move people out of
will forgo water if that’s the only option. This roles can be hard but very important. In basketball,
generation will demand that their managers go if you have the point guard playing the center
thoroughly through the data and measure the position, that person will not be effective, even if he
impact. People will smell it if you’re not genuine. or she is the greatest point guard ever. You need the
right people in the right seats and a team that trusts
Robert Byrne: Do you expect M&A to play a role each other.
in bringing some of the shifts you have been
describing to the mainstream marketplace?

Jenny Johnson: First and foremost, I believe the

next decade will not be dominated by passive
investment management like the last decade was.

Jenny Johnson is president and CEO of Franklin Templeton. Robert Byrne is a senior partner in McKinsey’s Bay Area office.

Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or
positions of McKinsey & Company or have its endorsement.

Copyright © 2021 McKinsey & Company. All rights reserved.

How an acquisition invigorated an asset management leader 21

 The state of diversity
in global private
markets: 2022
New research captures regional differences in the state of diversity in
private equity and discusses the role of institutional investors as a catalyst
for change.

This article is a collaborative effort by Pontus Averstad, David Baboolall, Alejandro Beltrán, Eitan Lefkowitz,
Alexandra Nee, Gary Pinshaw, and David Quigley, representing views from McKinsey’s Private Equity and
Principal Investors Practice and Diversity, Equity, and Inclusion Service lines.

© Cecilie_Arcurs/Getty Images

22 McKinsey on Investing Number 8, December 2022

Our new report, The state of diversity in global — Even when they make it to senior investing ranks,
Private Markets: 2022, builds on prior McKinsey women and ethnic and racial minorities may
research on diversity in the workplace to explore still not hold the same position of power as their
diversity in the global private markets industry, counterparts. PE investment committees (ICs)
with a focus on private equity (PE) firms and report 9 percent women globally and 9 percent
institutional investors (IIs). We surveyed 42 PE ethnic and racial minorities in Canada and the
firms and IIs around the world and conducted United States—three to eight percentage points
interviews with several industry leaders to lower than their share of investing MD roles.
supplement the data we received back from these
firms. Participating PE firms directly employ more Given data collection limitations, this report
than 60,000 people globally. remained largely focused on gender and ethnic
or racial diversity within PE firms. We recognize
This report provides insights into three areas for there are several other categories that contribute
the industry: a view of IIs’ evaluation of diversity on to the diversity of employees. Future reports hope
investing deal teams today; II’s preference toward to broaden the categories examined, as well as
more diverse deal teams when allocating capital to expand to include PE firm Portfolio Companies,
PE firms; and today’s baseline of diversity for PE among other segments within private markets. The
investing teams in terms of gender diversity for the inaugural survey findings highlight the importance
Americas, Asia–Pacific (APAC), and Europe, and to IIs of having diverse talent in PE and the progress
ethnic and racial diversity for the United States the PE industry has made over the course of 2021
and Canada. (for more, see sidebar “Institutional investors in the
private market ecosystem”). It also provides clear
Key findings include: areas of focus as the industry continues to prioritize
diversity, equity, and inclusion.
— Chief investment officers (CIOs) of leading IIs
said they would allocate twice as much capital
to the more gender diverse PE firm if choosing Institutional investors as catalysts
between two otherwise comparable firms. More for change
ethnically and racially diverse PE deal teams As key players in private markets, given the amount
would receive 2.6 times as much capital. of capital IIs allocate annually to PE firms, IIs could
be real catalysts for change on topics like diversity
— While 23 percent of all investing roles are held of talent in PE—if they decide this matters (for more
by women at PE firms globally, by the managing on IIs, see sidebar “Institutional investors in the
director level, only 12 percent are women. private market ecosystem”).

— PE firms’ employee diversity varies widely. At Based on our study, it seems they do. IIs are
diversity leaders, 32 percent of MDs are women increasingly asking for and receiving diversity data
and 32 percent of MDs are ethnic and racial from PE firms seeking to raise funds. Moreover,
minorities. Diversity laggards have no women and once a PE firm begins to provide diversity data as
2 percent ethnic and racial minorities at the MD level. part of fundraising, the firm is likely to continue
providing diversity data for subsequent funds’
— Geographic differences are also notable. PE capital raises. The director of environmental, social,
offices in the Americas have the highest share and governance (ESG) of a US-headquartered
of women in the C-suite and possibly the PE firm said, “We used to get a lot more requests
fewest obstacles to advancement for women; on emissions and environmental metrics than on
APAC leads the regions in investing women’s diversity. But there has been an uptick in DE&I
representation in the middle of the corporate requests, and we share what we are doing, and talk
ladder; and Europe leads slightly at entry-level about the initiatives we have in place.”
investing roles.

The state of diversity in global private markets: 2022 23

Institutional investors in the private market ecosystem

“Institutional investors” is a broad term funds, lenders, growth or expansion funds, for instance) for the companies they will
used to describe a range of types of hedge funds, and venture funds. deploy this capital to.
companies that manage assets of groups,
typically by allocating capital to various These IIs often directly allocate capital to Since PE funds raise significant capital from
investment vehicles to grow value over various Private Equity companies when IIs, they are motivated to align their actions
time. Here we use the term IIs to include, they are raising funds for a new tranche and strategies to IIs’ priorities, especially
but not limit to, state or local pensions (for of investments. These Funds often have during capital raises. Data PE funds provide
example, for teachers or police), Sovereign specific themes (for example, Buyout) during fundraising can range from past funds’
Wealth Funds, Private Family Offices, and even at times a strategic focus (this performance to the talent composition of
Foundations, Endowments, Real Estate could be based on industry or geography, investment teams and firms’ ICs.

The main challenge for both the IIs and PE firms is and therefore often not able to be used in allocation
a lack of standardized metrics, which makes the decision making.
reporting process unwieldy and labor-intensive for
PE firms. As the head of DE&I at a midsize US PE firm The consensus among IIs that participated in our
said, “I am a big proponent of the need to streamline survey is that the state of diversity in PE today
and consolidate what we are asked to report. It is is poor. IIs believe that PE firms have significant
hard for organizations like ours to respond to so many opportunity to improve the representation of
requests for different data in different forms.” underrepresented groups on their investing teams,
specifically on the dimensions of gender, ethnicity
Meanwhile, IIs are left to wade through a mix of data and race, socioeconomic background, and sexual
from multiple PE firms that is difficult to compare orientation (Exhibit 1).

Exhibit 1
Institutional investors surveyed think private equity firms can be more diverse.
Institutional investors surveyed think private equity firms can be more diverse.
Institutional investor perception of representation of groups within the private
equity deal team, by group,¹ average score of respondents, scale of 1–10

1 2 3 4 5 6 7 8 9 10

Gender minorities²

Ethnic and racial

minorities

Raised in low-income
households

LGBTQ+³

1Question: “Thinking about private equity investment teams across the industry, how well do you feel that the following groups are represented?” Scale of 1–10,
where 1 = not at all represented and 10 = very well represented.
²Gender minorities include women and nonbinary individuals.
³LGBTQ+ includes lesbian, gay, transgender, and queer individuals.

24 McKinsey on Investing Number 8, December 2022

IIs signaled that PE firms could do more to diversify metrics except for the investing team’s diversity, on
their ICs and the management teams at the helm average, IIs would allocate twice as much capital to
of portfolio companies where they hold majority the deal team with more gender diversity and 2.6
ownership (Exhibit 2). times as much to the team with more ethnic and
racial diversity. Not only would the more diverse
Standardizing diversity metrics will take time. deal team receive more money, all else equal, the
However, it is clear that IIs are increasingly data suggested there may be a penalty for PE firms
considering PE investing teams’ diversity in capital that lag peers on diverse talent: one II reported
allocation decisions. Will Goodwin, Head of Direct that they would not allocate any funding to the less
Investments at New Zealand super fund said, “When diverse PE fund when the alternate funds’ historical
we look to allocate, we ask PE funds for statistics on performance was the same.
DE&I, such as gender pay gap and representation.
In our opinion, programs, like parental leave, are just Surprisingly, in a scenario where the diversity leader
good hygiene and table stakes these days.” lagged on historic performance rate, 40 percent
of IIs still allocated more capital to the PE firm
While the sample size of IIs was small, our data with greater gender diversity, in spite of its lower
suggests that the diversity premium can be historic returns; 50 percent of IIs allocated more
significant in some scenarios. Ten chief investment to the firm with lower historic returns but higher
officers representing IIs with assets under ethnic and racial diversity. Given the challenges of
management (AUM) ranging from $20 billion to gathering data and comparing apples-to-apples
$460 billion were asked to allocate a fixed amount metrics from all firms, it is too soon to quantify the
of capital between two hypothetical PE funds. extent to which this is occurring today in IIs’ actual
When two hypothetical PE firms had identical allocating. However, responses from surveyed IIs

Exhibit 2
Institutional investors’
Institutional investors’ views
viewsvary
varyononhow
howsatisfied
satisfiedthey
theyare
arewith
withthe
theactions
actionsPE
PEfirms
firms
are taking to improve their diversity and the diversity of their portfolio companies.
are taking to improve their diversity and the diversity of their portfolio companies.
Institutional investor satisfaction with actions taken by private equity firms to improve diversity,
by group,¹ average score of respondents, scale of 1–10

Within private equity firms Within portfolio companies

10 9.0 9.0 9.0

9 8.0
8
7
6 5.3 5.2
4.9
5
4.0
4
3
2.0
2
1.0 1.0 1.0
1
Investment committee Investment team Boards of Management
decision makers members directors teams

1On a scale from 1-10, 1 = highly dissatisfied and 10 = highly satisfied.

The state of diversity in global private markets: 2022 25

 Exhibit 3

more represented
Women are more representedin
innon-investing
non-investingroles
rolesatatevery
everylevel.
level.

All women¹ Women in investing roles Women in non-investing roles

0% 100%

C-level (L1)
14%

Managing director (L2)

12% 20% 39%

Principal (L3)
16% 29% 43%

Vice president (L4)

28% 39% 57%

Associate (L5)
26% 40% 57%

Entry level (L6)

34% 48% 57%

Total
23% 33% 52%

1Based on data provided by 31 private equity firms. Responses cover more than 11,000 employees. Unique firm count by region: Americas = 26; Europe = 16;
Asia–Pacific = 11.

suggest that diversity does matter to these firms, Women in PE continue to experience obstacles to
and a willingness to allocate accordingly exists if their career advancement. The share of minorities
the comparative diversity data and historic fund (on the dimensions of gender, ethnicity/race, or
performance is provided by PE firms. an intersection) within PE Investing teams often
declines with seniority. One consequential result
is that even senior women struggle to break into
Gender diversity in global private equity “the room where it happens” in PE: today, women
Globally, PE firms have almost achieved gender make up only 9 percent of IC members despite
parity in entry-level roles. As of year-end 2021, comprising about 12 percent of managing director-
48 percent of all entry-level roles in PE globally level investment staff (L2) and 14 percent of C-suite
are filled by women (for more on job levels, see roles (L1) (Exhibit 4). (For more on the role of ICs, see
sidebar “Job levels in private equity”). However, sidebar “The role of investment committees in the
disaggregating this figure into investing and non- private equity industry.”)
investing employees reveals only 34 percent of
entry-level investing roles are held by women, The fact that women’s representation on ICs is lower
compared to 57 percent in non-investing entry- than their presence in these senior ranks (ie, L1
level roles (Exhibit 3). and L2) may reveal an unspoken cultural dynamic

26 McKinsey on Investing Number 8, December 2022

Job levels in private equity

We classify jobs in private equity into six levels. For most of these levels, we include
multiple possible job titles. In descending order of seniority, the roles are:

L1. C-level executives and fund L3. Principals, directors, and senior L5. Associates and managers. We refer
heads. We will be referring to this level vice presidents. We refer to jobs at this to these as associates.
as the C-level. level as principals.
L6. Entry level.
L2. Managing directors or partners. L4. Vice presidents and senior managers.
We will refer to jobs at this level as We refer to these jobs as VPs. For the sake of simplicity, we will refer
managing directors. to each level with only one title.

Exhibit 4

comprise 99percent
Women comprise percentof
ofinvestment
investmentcommittees
committees globally.
globally.

Women Men Women in investing roles Men in investing roles

Global talent pipeline for higher-level roles,¹ Global talent pipeline for higher-level roles by region,²
share by gender and by level, % share by gender and by level, %

Americas 9 91
Investment
9 91
committee
Europe 7 93

Americas 15 85
C-suite
14 86
(L1)—All
Europe 13 87

Americas 13 87
Managing
director 12 88 APAC 16 84
(L2)—Investing
Europe 7 93

1Based on data provided by 31 private equity firms. Responses cover more than 11,000 employees. Unique firm count by region: Americas = 26; Europe = 16;
Asia–Pacific = 11.
²Asia-Pacific investment committee and C-suite details unavailable due to insufficient number of organizations reporting data for investment committee and
C-suite.

The state of diversity in global private markets: 2022 27

 in which women are still not in the same positions compared to the industry average of 23 percent
of power as 91 percent of their male counterparts, (Exhibit 5).
even at the MD or C-suite levels.
Regional differences in gender diversity
Globally, gender diversity in investing, particularly The dynamics of the PE industry as a whole may
at the senior levels of PE firms, has a ways to go. Yet affect the number of women in investing. However,
even today there is a significant spread among PE regional variations also exist (Exhibit 6).
firms that lead on gender diversity and those that
trail. When looking at the MD level (L2), the top 10 These regional differences impact different levels
percent of PE firms on gender diversity average 32 within the PE hierarchy.
percent investing women MDs, while the bottom 10
percent of firms in 2021 had zero investing women PE offices in the Americas have low share of women
MDs. What’s more, women’s representation at the in entry- and associate-level investing roles
top seems to impact gender diversity throughout PE offices in the Americas have the highest share
the organization: PE firms that lead on percent of of women in the C-suite and possibly the least
women MDs also had significantly higher shares obstacles to female advancement, with the smallest
of total investing women versus the industry as a drop-off in share of women from associate (L5)
whole—a difference of 10 percentage points higher to MD (L2); APAC leads the regions in women’s

Exhibit 5

Globally, private equity

equity firms
firmsthat
that lead
lead on
on diversity
diversityatat the
the managing
managing director
director
(L2) level
(L2) level also
also beat the
the industry
industry benchmark for allall investing
investing roles.
roles.

Women in investing roles Men in investing roles

Representation of women in investing roles at Representation of women in investing roles at all

the managing director level for diversity leaders levels for diversity leaders and laggards, global, %
and laggards,¹ global, %

68 67
77
88 86
100

32 33
23
12 15

Leading firms Average PE firm Lagging firms Leading firms Average PE firm Lagging firms

Note: Figures may not sum to 100%, because of rounding.

1“Diversity leader” is defined as the top 10% of PE firms by representation of women in investing roles at the managing director level (L2) globally. “Diversity
laggard” is defined as the bottom 10% of PE firms by representation of women in investing roles at the L2 level globally.

28 McKinsey on Investing Number 8, December 2022

Exhibit 6

Gender diversity in
in private
private equity
equityvaries
variesby
byregion.
region.

Private equity talent pipeline by gender, Women Women in investing roles

share of women and men in investing roles by level, %¹ Men Men in investing roles

Americas, year-end, % Entry Vice Managing

All level Associate president Principal director C-level
investing (L6) (L5) (L4) (L3) (L2) (L1)

–8 +3 –9
Change in women’s
–6
representation
between levels, 23 33 25 28 19 13 15
percentage points

77 67 75 72 81 87 85

Difference in women’s
representation between +2 +9 +3 +2 +1 –1 +2
beginning and end of 2021,
percentage points

Europe, year-end, % –10

–3 –9
Change in women’s –6
35 25 7
representation 21 22 13 13
between levels,
percentage points
65 75
79 78 87 87
93

Difference in women’s
representation between 0 +10 –1 –1 –1 –2 +1
beginning and end of 2021,
percentage points

Asia–Pacific, year-end, % +9 –30

–2
+6
Change in women’s 33 31 40 10
26 16
representation Benchmark
between levels, unavailable²
percentage points
67 69 60
74 84
90

Difference in women’s
representation between 0 +2 –11 +12 –7 –2
beginning and end of 2021,
percentage points

1Based on data provided by 31 private equity firms. Responses cover more than 11,000 employees. Unique firm count by region: Americas = 26; Europe = 16;
Asia–Pacific = 11.
²Benchmark data not available due to low number of reporting companies.

The state of diversity in global private markets: 2022 29

 representation in the middle of the corporate ladder in APAC offices, as the share of women plunges by
(L5 and L4); and Europe leads slightly at entry-level more than 30 percentage points in the step up from
investing roles (L6). VP (L4) to principal (L3); that is a 4.2x drop in the
percentage of women advancing to principal (L3) in
Offices in the Americas boast the highest share APAC offices. This broken rung for women from VP
of women in top-of-the-house roles: the share of to principal was made more severe by a promotion
women in the equivalent of the C-suite is 15 percent. gap between women and men (2 percent women vs
Moreover, of the regions, offices in the Americas 20 percent men from the available pool promoted) in
have the smallest drop today (12 percentage points) 2021 and attrition of women at the L3 level in APAC.
between the share of women in Investing at the
associate level (L5, at 25 percent) and the MD level European offices have the highest share of
(L2, at 13 percent). However, the region also ties with women at entry-level Investing
APAC for lowest share of women at the entry level (L6) Europe leads the regions, though marginally, in women
and Europe for lowest share at post-MBA associate entering in entry-level Investing jobs, with 35 percent.
(L5) level. While American PE does comparatively well However, women in Europe at the MD (L2) level have
with retention and promotion of Investing women, this the lowest representation—7 percent—compared to
small base of women entering the profession may all other regions and the steepest decline from post-
constrain progress in the ability to advance a greater MBA associate level, with a 17-percentage point drop
share of women to MD over time. from L5 to L2. Given more than a third of entry-level
investing staff are women, European PE offices have
APAC offices have the highest share of women at a real opportunity to improve their gender diversity at
the mid-level the higher ranks by evaluating sponsorship throughout
APAC leads the regions in share of women investors the funnel and promotion rates of women out of the
at post-MBA associate (L5) and VP (L4) ranks. entry-level Investing role. However, there are positive
Representation for women at the associate level signs. In 2021, Europe has the smallest gap compared
(L5) in APAC offices is 31 percent, five percentage to other regions between promotion rates for men and
points higher than the global benchmark; and women at the mid-level to senior ranks. Even though
representation for women at the VP level (L4) is promotions still favor men, in Europe, the difference in
40 percent, 11 percentage points higher than the promotion rates between men and women into VP and
global benchmark. However, 2021 data shows a principal is less than four percentage points.
“broken rung” in the career progression for women

The role of investment committees in the private equity industry

In private equity (PE), ICs are where While several other operations—such Standing IC members are generally invited
investment decisions happen. Firms often as raising new funds or setting their from the C-Suite (L1) and MD (L2) ranks.
take pride in their IC process. The intellectual investment strategies—are of comparable
debate and discussions that occur over importance, the discussions and decisions
potential assets to purchase, prices to pay, made in regular IC meetings form the
the level of EBITDA growth needed over the intellectual backbone of PE firms. Therefore,
holding period, and how to create that value, who consistently sits at the IC table matters.
all are raised and decided in ICs.

30 McKinsey on Investing Number 8, December 2022

Exhibit 7
Peoplefrom
People from ethnic
ethnic and
and racial
racial minority
minority groups
groups are
are less representedat
less represented atthe
thetop
top
levels in private equity.
levels in private equity.
Representation of ethnic and racial minority employees in Canada and the United States,¹
by ethnicity and race, % by level

White Asian Black Hispanic, Latino, Multiple ethnicities

or mestizo or races

1 2 1 1
1
5 3 3 3
5 12

Investment L2
L1
committee (investing
(all)
only employees)

88 83
91

Ethnic and
racial minority, 9 12 17
% by level

Women,
9 15 13
% by level

Note: Figures may not sum to 100% because of rounding.

1Based on data from 24 firms. Responses cover about 7,500 employees in Canada and the United States.

Successes and challenges for ethnic roles remains around or above 22 percent until it
and racial minorities echo those drops seven percentage points from the VP (L4) into
facing women the principal level (L3)—and even further thereafter
Based on data from PE firms’ US and Canadian offices, to 12 percent of MDs and 5 percent at the C-suite
like women, ethnic and racial minorities only make up level. It also should be noted that Asians are the
9 percent of IC members even though they make up only ethnic and racial minority whose share of roles
almost 17 percent of Investing MDs (L2) (Exhibit 7). declines substantially from L2 to L1—as White,
Black, and Hispanic/Latino/Mestizo (hereafter
White or Caucasian (hereafter “White”) professionals “Hispanic”) representation increases or remains
remain the largest group in Investing roles in Canada relatively constant from the MD to C-suite levels.
and the United States. They hold 70 percent of all
investing jobs, with White men being more than eight On the surface, Black and Hispanic professionals
times as likely as White women to be MD (L2). have similarly low representation across all levels
of PE investing, starting at 4 to 7 percent of the
People of Asian descent (hereafter “Asian entry and post-MBA associate levels. Both groups
professionals”) are the largest racial minority group also lose roughly three to four percentage points
in PE Investing roles. They hold 28 percent of these from post-MBA to MD levels (L5 to L2). With 3
Investing roles at the associate level. However, the percent Hispanic and 1 percent Black principals
share of Asian investing professionals declines to 12 (L3), PE lacks Hispanic or Black role models in the
percent at the MD level. Asians’ share of investing leadership ranks for more junior professionals. One

The state of diversity in global private markets: 2022 31

 chief human resources officer (CHRO) commented, particular; firms are also falling short in retention
“If I were a Black person looking at PE, I don’t think and promotion of Black and Hispanic women at the
I would see a lot of people who look like me, and I principal and MD levels.
don’t know if I would want to work there.” Despite
the low numbers of Hispanic and Black principals, However, this analysis speaks to the industry
each group retains the small share through the averages on ethnicity and race in Canada and the
top leadership ranks, with 3 percent and 1 percent United States. Of course, there is a spectrum of
of leaders, respectively, in MD and C-suite roles. PE firms, with the top firms close to doubling the
However, looking more closely at the trends, there industry average share of ethnic and racial minorities
are some differences in the Black and Hispanic at the MD level, with 32 percent, while more than
experience in PE. 98 percent of MDs at the least diverse firms are
White/Caucasian. As we saw with gender, diversity
Black professionals comprise 7 percent of entry-level at the top does have an impact on the ability to retain
Investing roles, close to double the share of Hispanic diverse talent throughout the deal team (Exhibit 8).
professionals. This number drops sharply to 4 percent
for the associate (L5) class in the US and Canadian While the industry average was 30 percent people
PE offices. Black gender composition seems to from ethnic and racial minorities, industry laggards
mimic the overall PE Investing gender story only at on MD-level ethnic and racial diversity were, on
the post MBA and VP levels, where Black women are average, eight percentage points below industry
just under a third of all Black Investing professionals. average, at 22 percent ethnic and racial minorities
As of the end of 2021, only 1 percent of all PE MDs across their entire investing team.
(L2) in these offices were Black, significantly lacking
representation from Black women. That share of
Black women does increase slightly in the C-suite— The path forward
though Black representation (men and women) is Our findings suggest a few critical areas for leaders who
still only a little over 1 percent of all US and Canadian want to make progress toward diversifying the industry:
reporting firms.
1. Evaluate IC diversity. PE firms should take
The Hispanic experience in PE Investing also begins a critical lens to the diversity of their ICs to
with low representation in entry-level investing roles, understand if and why they are not more
at 4 percent. However, unlike Black professionals, reflective of the makeup of their C-Suite and
this number grows to 7 percent at the post-MBA managing directors.
associate (L5) rank. Thereafter, there is more
Hispanic talent compared to Black talent at senior 2. Consider region-specific obstacles to diversity:
levels of PE firms, with 2.5 times and 3.9 times as
many Hispanic principals and MDs, respectively. • Offices in the Americas could strive for
And yet, despite comprising 3 percent of MD and gender parity in hiring and attract more Black
C-suite roles, Hispanic representation on ICs was and Hispanic talent for post-MBA investing
less than 1 percent. The gender imbalance for positions. PE firms may need to take a critical
Hispanic professionals in PE Investing is larger look at possible causes, such as barriers to
than it is for Black professionals: Hispanic women entry or an unattractive culture, that results
only comprise about 16 percent of Hispanic in low levels of representation of Black and
professionals from post-MBA to principal (L5 to L3), Hispanic professionals even at entry levels of
dropping by nine percentage points to 7 percent of firms’ deal teams. For the current talent pool,
all Hispanic MDs. While it is clear that PE firms could firms could continue to improve promotion
work on attracting Hispanic and Black professionals, parity of women, Asian professionals, and
the data shows there is the most room to improve Hispanics professionals into VP, principal, and
in attracting post-MBA Hispanic women, in MD roles.

32 McKinsey on Investing Number 8, December 2022

In Canada
Exhibit 8 and the United States, private equity firms that lead on ethnic and
racial
In diversity
Canada in L2
and the rolesStates,
United also beat theequity
private industry benchmark
firms forethnic
that lead on all investing
and racial
roles.
diversity in L2 roles also beat the industry benchmark for all investing roles.

White or Asian Black Hispanic, Latino, Multiple ethnicities Ethnic and racial minority
Caucasian or mestizo or races

Ethnic and racial minorities in managing Ethnic and racial minorities in entry-level
director roles in private equity (PE) firms, %¹ to managing director roles, %¹

1 3 2
1
17
12 22
30
1 34

14

98

83
78
68 70
66

Leading Average Lagging Leading Average Lagging

firms PE firm firms firms PE firm firms

Ethnic and racial

minorities, %¹ 32 17 2 34 30 22

Note: Figures may not sum to 100%, because of rounding.

1Based on data provided by 24 private equity firms in Canada and the United States. Responses cover about 7,500 employees; leading firms are the top 12.5%
of companies on % of ethnic and racial minorities (including people of Asian descent) in managing director roles, and lagging firms are the bottom 12.5% of
companies on % of the metric. Average PE firm is the average of the entire data set.

• APAC offices can mend the broken rung breadth of their women colleagues at L6, by
from VP to principal by evaluating barriers to striving for promotion parity for that first step
apprenticeship, sponsorship, and promotion up from entry level to associate level, as well
of women, as well as by working to reduce MD as in external hiring for mid-tenure levels
and principal female attrition. (L5 to L3). Finally, examining the office culture
with an eye towards potentially improving
• European offices may reduce the loss of retention of Investing women.
women from L5 to L2 and leverage the

The state of diversity in global private markets: 2022 33

 3. Gather more intersectional diversity data. PE Increasing the diversity of PE Investing teams takes
firms’ CHROs and Heads of DEI should push to time. While there are no quick fixes, the value to be
improve the granularity of the data collected gained by taking effective action could motivate
around the world, where possible, and devise sustained focus on the goal. Creating an equitable
solutions with these intersectional groups in mind. and inclusive culture will be the key to retaining a
diverse workforce over time. The Head of HR for a
4. IIs can use standardized—and simplified— European firm shared, “By humanizing the culture a
diversity metrics to evaluate PE funds. This bit more, we will be able to make private equity firms
will likely require collaboration among IIs. a place to spend a career for reasons beyond just
Furthermore, if not already asking, IIs should money. By doing that, you may automatically get more
consistently require diversity metrics from all diverse talent, including at the most senior levels.”
PE firms that approach them during fundraising.

Jerilyn Castillo McAniff, Head of D&I at Oaktree

Capital Management, L.P., a global investment Building a more diverse set of leaders at the helm
manager specializing in alternative investments, of the private markets industry requires sustained,
said, “What we need are consistent metrics and nuanced, long-term effort. However, this research
industry benchmarks so that firms can track shows that progress is being intentionally made
representation and progress. Without these tools, across several PE firms; and rewards come with
we all operate in a vacuum. We can all do our part that diversity, as IIs continue to prioritize and seek
by participating in relevant industry studies and diverse talent to allocate their money to.
benchmarks, which gather data, track trends, and
highlight key themes. Making progress will be a
collective effort.”

Pontus Averstad (he/him) is a senior partner in McKinsey’s Stockholm office, David Baboolall (they/them) is an associate partner
in the New York office, where David Quigley (he/him) is a senior partner, Alejandro Beltrán (he/him) is a senior partner in the
Madrid office, Eitan Lefkowitz (he/him) is a consultant in the New Jersey office, Alexandra Nee (she/her) is a partner in the
Washington, D.C. office, and Gary Pinshaw (he/him) is a senior partner in the Sydney office.

The authors wish to thank Kyleb Bello, Clay Bischoff, Erin Blank, Judy D’Agostino, Chelsea Doub, Alistair Duncan, Diana Ellsworth,
Carlos Esber, Catherine Falls, James Gannon, Amit Garg, Chris Gorman, Wesley Hayes, Sara Hudson, Claudy Jules, Drew Knapp,
Connor Kramer, Alexis Krivkovich, Ju-Hon Kwek, Bola Lawrence, Robin Lore, Andrew Mullin, Surya Narayan, Margret-Ann Natsis,
Hilary Nguyen, Vivek Pandit, Ashley Pitt, Ishanaa Rambachan, Nicole Robinson, Elise Sauve, Jennifer Schmidt, Jeanette Stock,
Monne Williams, Jackie Wong, Lareina Yee, and all the participating private markets firms for their contributions to this report.

We are appreciative of McKinsey and LeanIn.org’s Women in the Workplace study, which has informed the creation of this work.

Copyright © 2022 McKinsey & Company. All rights reserved.

34 McKinsey on Investing Number 8, December 2022

‘If you’re going to build
something from scratch,
this might be as good
a time as in a decade’
In an interview with the editorial director of the McKinsey Quarterly, venture
capitalist Bill Gurley explains the promise and perils facing start-ups at a
moment of economic uncertainty and reveals why hybrid work may be the
most interesting technology of all.”

© Timothy Archibald

35
 Bill Gurley is one of Silicon Valley’s most time of great uncertainty. Many people feel that
respected venture capitalists. As a general partner the externalities affecting so many businesses—
at Benchmark, Gurley has backed a blessing of whether it’s the war in Ukraine, inflation, geopolitics,
unicorns, including Grubhub, Liveops, Nextdoor, changing labor patterns—seem more complicated
OpenTable, and, most famously, Uber. now than they have been in a long time. Do you agree
with that? Do you think we’re entering a period of
Gurley has often been a voice of reason amid Silicon extended uncertainty?
Valley overexuberance and has tweeted regularly
in 2022 about the need for start-ups to be realistic Bill Gurley: It’s funny. Three or four years ago, I felt,
about the current economic environment. While like many others, that the really big problem was
many venture firms have a lot of money to invest, the zero-interest-rate thing, this prolonged period
dealmaking has slowed considerably this year. of near-zero interest rates. I even paid a massive
Average valuations of some fundraising rounds amount of money to end up at this dinner with
have dropped as investors adjust to an economic Warren Buffett, where we each got to ask him one
slowdown and look warily ahead. But being realistic question. My question was, “You know, if interest
doesn’t necessarily mean being pessimistic: in some rates are zero, (1) your DCF model [which emphasizes
ways, says Gurley, this may be a great time to launch discounted cash flow as the basis of valuations]
a start-up. Gurley recently joined Quarterly editorial doesn’t work, and (2) it drives all kind of speculation.”
director Rick Tetzeli for a wide-ranging discussion. And he said, “You betcha!”
An edited version of their conversation follows.
I also spent time tracking down Howard Marks and
Rick Tetzeli: Thanks so much for joining me to talk Stanley Druckenmiller because I think there are
about start-ups at what seems to be a particularly so few people who have proven that they have a
challenging moment. As if to prove the point, an alert valuable point of view on macro. There are just so
just popped up on my screen: Robinhood is laying off many variables with macro. You can fool yourself. I’ve
23 percent of its workforce. felt that ever since my MBA macro class.

Bill Gurley: Wow. Layoffs happen so infrequently. In So I’m hesitant to answer your question. That
’01 and ’09, you had broadscale layoffs, but only now said, clearly you’ve had rates going up, which
are we starting to see them this time around. Well, 23 hasn’t happened in a very long time. That has had
percent is getting into a range that actually makes consequences on car loans and mortgages and
sense. Is this their second layoff? corporate debt. And it should rein in speculation—it
probably has already. China decoupling from the
Rick Tetzeli: Yes, unfortunately. They did 9 percent West is pretty scary, given that sharing and trading
earlier. has a positive impact for both societies. If that
were to escalate simultaneously with, say, Europe
Bill Gurley: See, that’s the thing. I hate the 5 to 10 getting worse and maybe something in Taiwan being
percent layoffs. You don’t get any material impact to provoked, that could all be super bad.
lowering your expenses. Yet you get all the cultural
negatives of having done a layoff. You get 100 Having said all that, I have two things in the back of
percent of the pain and very little gain. And then my mind that relate to start-ups and the start-up
you’re in retweet land—you end up with two or three ecosystem.
of them. Anyway, that wasn’t on your original list of
questions. First, Stephen Covey used to talk about your circle
of influence, and Buffett talks about your circle
Rick Tetzeli: No, it’s not. It just happened. But it’s a of competence. Macro things are not things that
bracing lead-in to talking about how difficult things start-ups can impact or control. So there’s not
might be for start-ups during what seems to be a much reason for them to affect your thoughts about

36 McKinsey on Investing Number 8, December 2022

 whether you would start a company or not. They its whole life, about this before the pandemic. And
might add anxiety, but I don’t know that they have he said that you need to be all or nothing, that when
any real impact. you’re in the middle ground you get into these weird
cases of cultural confusion, where, for example,
Rick Tetzeli: Because it’s still about the idea. And cliques can develop if someone’s not there. That’s
the idea is good regardless. why some people have a rule: all in person or no one
in person. But I don’t know what makes sense.
Bill Gurley: Right. Second, the environment for
launching a start-up was really crazy the past five The number-one thing people at start-ups worry
years. And the truth is that if you’re going to build about is missing out on serendipity—just some
something from scratch, this might be as good a time random conversation between two people who
as you’ve had in a decade. were out visiting a customer and then said, “Oh, wait,
what if we did this?” and it becomes critical to the
Real estate? You can get all the real estate you company’s success. That’s far more likely in a start-
want. People used to fret about lease cost, but up than in a big company. But, ultimately, hybrid is
that’s all gone. And while people get caught up on really a founder-centric decision.
whether the money’s cheap or not, getting rid of the
distraction of all that cheap money may be a good Rick Tetzeli: The pace of IPOs has slowed
thing. That whole mentality of, oh, your competitor enormously this year, and valuations have collapsed.
raised $100 million, now you have to raise $100 Earlier this year, you tweeted, “An entire generation
million. All those things have evaporated—for the of entrepreneurs and tech investors built their
better, I’d say. perspective on valuations during the second half of
an amazing bull market run. The ‘unlearning’ process
A huge thing is that your access to talent is way could be painful, surprising, and unsettling to many.”1
better. It was so hard to get, but now it’s a lot cheaper Is this a reset like 2001 and 2008–09? How painful
than it was. There are layoffs happening. And then might it be? And have you learned things from the
hybrid has opened up the people you can get. past downturns that apply here?
I’ve heard some pretty amazing stories. Jennifer
Tejada, who runs PagerDuty, says they went into Bill Gurley: This one is different in a couple of ways.
the pandemic at 85 percent Bay Area employees In 2001, there were a lot of nascent companies
and came out at 25 percent. If you need an iOS going public with, like, $1 million in revenue. That’s
programmer within 20 miles of your Silicon Valley not the case this time around. Here, you’ve had a lot
location, that’s way harder than if you can shop of companies with huge amounts of revenue, some
globally for that. with massive losses. There has been a huge volume
of capital, and the scale of the companies is radically
Rick Tetzeli: Let’s stick with hybrid for a second. Do different. Some have raised $500 billion, $3 billion—
you think it will affect the culture of start-ups? there was no precedent for sums like that. And some
of that money might be dead money.
Bill Gurley: Whether hybrid is good or bad is one of
the biggest unknowns coming out of the pandemic. Then there’s the fact that this run went on longer
There are some pretty hard-core enterprise-type than people thought. That may well make the pain
founders who say, “Everyone’s back in the office.” a little bit bigger. It also means that there’s less
And then there are people whose business is institutional memory.
positively impacted by hybrid work. It’s all over the
map. I remember asking [Matt Mullenweg,] the CEO The collective venture community needs to get its
of WordPress, which has been 100 percent hybrid head around the new reality as fast as possible. The

1
Bill Gurley (@bgurley), Twitter, April 29, 2022, 1:44 p.m.

‘If you’re going to build something from scratch, this might be as good a time as in a decade’ 37
 more people see what’s really going on, the quicker with that, the better you’ll do. That’s just pragmatic.
that will happen. In ’09, the response to the downturn This goes back to the very first topic we talked about,
was pretty swift. But you had the benefit that ’01 was layoffs. If you’re going to do it, how material does it
only seven or eight years in the rearview mirror. While need to be?
there’s still some institutional memory around the
Valley, it’s been a very long time since 2009. Rick Tetzeli: Layoffs, of course, can be particularly
tough on a company. Don’t you ever worry that
Rick Tetzeli: So what are you telling your portfolio people could cut too aggressively at this point?
companies?
Bill Gurley: I’ve never seen that in my history.
Bill Gurley: I try to convey that they need to get in Everybody says, “We’re getting to the bone.”
front of this. In a couple meetings, I’ve heard an owner Everyone says that. And I know it’s a touchy subject
or founder say, “Well, you know, we just need to because people are losing their jobs. But companies—
buckle down until things get back to where they were.” even small start-ups—are way more resilient than
And I’m, like, “No, the fantasy was the past five years.” people realize. It’s the norm that you cut 30 percent,
and everything keeps going. You don’t lose all your
What we’re in now may just be normal, right? This customers. And some people find, “Oh, wait, we’re
may be average. And that’s very hard for people. It’s moving a little faster.” Sometimes things get better. I
especially hard for a founder. mean, yes, eventually some companies go bankrupt.
But I’ve never seen someone do too much. You can
This will sound trite, but a founder who, say, owns 15 always hire back. I think 95 percent of the time, the
percent of a company that raised a round at $1 billion failure is the other way, of not doing enough.
has done the math. They’ve mentally banked that
they’re worth $150 million—pretax, of course, but Rick Tetzeli: You’ve tweeted that “Benchmark never
they forget that. But now, they’re not! And it’s just changes our investment cycle due to economic
super hard for them to accept that that was from a swings.”2 Why?
fantastical time that’s probably behind us.
Bill Gurley: Well, our firm has a very unique focus.
Rick Tetzeli: So how does that personal shock of Around 85 to 90 percent of our funds are deployed
going from being worth $150 million to being worth on first-money and early-stage investments. And our
$50 million— approach has become even more unique because so
many of our competitors have gone multistage.
Bill Gurley: Or $15 million—
And once you start doing late-stage things, the
Rick Tetzeli: How does that affect how they manage? current environment has a drastic impact. But if
you’re doing early-stage, these kinds of swings don’t
Bill Gurley: Well, if they’re in denial they can make really put you off the next incremental investment.
a lot of mistakes. They don’t cut enough cost. They There have been plenty of great companies started
don’t lay off enough people. They continue to think in the troughs to suggest that there’s no reason to
they can just go raise money, but they don’t realize stop investing.
their cost of capital has changed by 5x. If they do not
fully understand the situation they’re in, that’s super The same thing is true at the peaks. There were
problematic. firms that pulled out in ’96 because they thought
things had expanded too broadly, and they missed
You have to play the game on the field. If everything three of the greatest years of returns in the history
has reset, it has reset. The sooner you get in touch of the business.

2
Bill Gurley (@bgurley), Twitter, June 20, 2022, 6:15 p.m.

38 McKinsey on Investing Number 8, December 2022

We really try to learn from our mistakes. We tried with the market resetting, I don’t think this is on the
to expand internationally once, but it didn’t work SEC’s [US Securities and Exchange Commission]
for us. So in about 2006, 2007, we capitulated and priority list. They’ve got other issues at the forefront.
went back. And our conviction in our focus was even
stronger, because we saw that we did better work There is definitely a category of founders who have
once we refocused. the financial knowledge of how markets work and
how markets should work that prefer it. They know
We had that on our mind as everyone in the Valley that it’s ridiculous that a human would pick the price
started expanding in more recent times. And I will tell and the allocation when an algorithm can do it in an
you, for the six or seven years prior to the past year, auction. I remain convinced that eventually everyone
people would meet with us and tell us that we were will do it.
stupid, that we were leaving money on the table. But
in the past six months, that’s all reverted. Now it’s all, Rick Tetzeli: Is the Bay Area still the hub of
oh, you guys are still brilliant. everything tech, the way it was when you moved out
there 25 years ago?
There is another reason why I like our model. We’re
running much smaller funds than some of our peers, Bill Gurley: First of all, there are places that have
who probably pull down ten times the capital we do had incremental success over the last two decades.
each year. Those firms have massive management Seattle has just been phenomenal for start-ups. New
fees as a result. As an investor, I just take more pride York has had a couple of really big wins. So things
in us doing well when our limited partners are doing have already opened up.
well. So if the majority of our compensation is on the
carry side instead of the fee side, I just feel better Hybrid creates a much bigger question mark for the
about it. Bay Area.

Rick Tetzeli: Are companies still coming to you The number-one risk of being outside the Valley was
seeking frothy valuations, or has that changed from always, “Can I get the executive talent?” You could
a year ago? always get programmers. You could always get
customer support people. Now, with hybrid, maybe
Bill Gurley: I think we’re partially corrected. It takes you can get the executive talent, too. Found your
a while for people to come around to the fact that company in Chicago and hire your executive talent
everything’s been reset. It’s a slow process. It’s also even if they want to keep living in the Bay Area.
why M&A is delayed. People think, “Oh, everything’s
peaked,” so M&A should just take off now. But like The other thing that has reinforced the Bay Area
founders with valuations, late-stage investors that is that, culturally, everywhere you go, you run into
invested at a certain number aren’t going to like it if someone connected to the industry. That creates
you try and sell the company at a third of the price a ton of serendipity outside the office. It leads to
they paid. So things are slow to get corrected. companies being started and people changing jobs,
and it leads to idea propagation. Matt Ridley talks
Rick Tetzeli: You’ve been pushing for direct listings about ideas having sex and how that can impact
and other nontraditional ways of going public. Do you innovation and increase productivity. Silicon Valley is
think that has become a fully accepted part of the a great example of that.
game? Do you think these methods will become even
more customary going forward? The ideas that are relevant can be very ephemeral
and fleeting. Take something like knowing how to
Bill Gurley: I hope so. Both the NYSE and the gain customers on an iOS app. You could have been
Nasdaq have been approved for direct listings with a a marketing guru for 20 years, but if you went on
set of parameters that are still being worked on. But vacation for five years and then came back, you

‘If you’re going to build something from scratch, this might be as good a time as in a decade’ 39
 know nothing, right? You know nothing. There’s a are all kinds of problems that entrepreneurs need to
constant reinforcement of what’s happening that has solve. How do you get the serendipity back? How do
always been an advantage to being in the Valley. you measure productivity? These kinds of Slack- and
Zoom- next-generation things are super interesting
Well, if you’re working on, say, a Web3 project these to me. For instance, I would think that there should
days, you’re probably doing so on a Discord channel. be some kind of new version of LinkedIn because of
They’re all working in Discord. And so that’s where all this.
you’re having those moments where ideas might
have sex on a constant, daily basis, in a Slack-like On crypto, there’s a moment of reckoning right
way that cuts out geography. That’s really interesting. now that I think is highly dependent on regulatory
ambiguity and what happens in Washington. We’re
Rick Tetzeli: You mentioned Web3. We haven’t kind of stuck until that is clarified.
talked much about technology per se, but I’m
wondering if before we close you could tell me what I also think that the crypto industry is in desperate
is the most promising tech trend that you’re looking need of some hard-core proof points. There’s a lot of
at right now? Is it Web3 or crypto or some of the rhetoric. I mean, as everyone says, Bitcoin is its own
other things we hear about? Or is there something thing. It is a proven, hard-core protection against
else that has the greatest potential? your government coming after your money. You
could theoretically escape a dictatorial or tyrannical
Bill Gurley: For me, personally—I’m not speaking for country with your money on this thing—reemerge
my firm—I’m most motivated by all this stuff we’ve elsewhere and still have your money. That’s a real
been talking about around hybrid and the fact that I feature that has been obtained, and people can
can hire someone from around the globe instead of bet on whether that’s valuable. I would call it an
20 miles from my office. Think about the productivity achievement. But I don’t know how many other
and innovation unlock that that might create. There achievements there have been.

Bill Gurley is a general partner at venture capital firm Benchmark. Rick Tetzeli is the editorial director of McKinsey Quarterly
and an executive editor in McKinsey’s New York office.

Comments and opinions expressed by interviewees are their own and do not represent or reflect the opinions, policies, or
positions of McKinsey & Company or have its endorsement.

Copyright © 2022 McKinsey & Company. All rights reserved.

40 McKinsey on Investing Number 8, December 2022

Infrastructure investing
will never be the same
Traditionally staid and stable, infrastructure investing has been shaken up
by revolutions in energy, mobility, and digitization, making it imperative for
investors to reassess the strategy’s risk and return dynamics.

by Marcel Brinkman and Vijay Sarma

© Xuanyu Han/Getty Images

41
 Infrastructure investing has long offered Many next-generation investments are self-evident,
investors the best of both worlds: low-maintenance such as electric-vehicle (EV) charging networks,
investments with predictable risk profiles and strong, battery storage, hydrogen distribution, and smart
consistent returns, even through chaotic periods. motorway and rail technology, 5G telecom networks,
and data centers. These assets offer many of the
The past few months have been turbulent, with characteristics that infrastructure investors look
significant inflation, increases in interest rates, for: real assets, protected market positions, and the
declining equity markets, and a looming threat potential to generate stable cash yields. However, to
of recession. This uncertain panorama comes on get exposure to these new asset classes, investors
the heels of the deep disruptions caused by will have to accept a period of significant investment
the COVID-19 pandemic. While infrastructure and negative cash flow, along with development,
investments are seen as better able than other technology, and commercial risks.
investments to withstand such pressures, investors
in the asset class still have to deal with the impact of Benefiting from emerging opportunities calls for
structural shifts in the economic environment. more active investing. It can be hard to come by
alternative-energy infrastructure deals that meet
Meanwhile, there are deeper, more gradual ways in even the modest $200 million minimum ticket
which the asset class is changing—and investors size for many investors. The few that do are often
need to change with it. Revolutions in energy, exorbitantly priced, with EBITDA multiples reaching
mobility, and digitization are introducing new the mid-20s in some cases. To participate in the
dynamics to existing infrastructure investments that energy transition, investors will need to source deals
previously appeared almost impervious to change. At more creatively and be willing to build businesses.
the same time, economic and social transformations For decades, returns from infrastructure investing
are introducing new types of investments that have been more stable than those in both public
represent opportunity for investors. and private equity markets and have provided a
comforting record of success. But hidden within the
The infrastructure shake-up and the unpredictable steady graph lines are pockets of value destruction
pace at which the energy transition is unfolding that should serve as a warning against complacency.
require investors to scrutinize their existing By being aware of the factors causing the sea
portfolios and ensure that assets are correctly change in infrastructure, and knowing what pivots
rated for risk/return. Some investments viewed as to make in response, investors can best prepare for
low-risk, low-return “super core” assets may carry the future.
more risk than is currently understood, particularly
as entire fuel sources and related assets are phased
out of the economy. On the other hand, maturing The infrastructure shake-up requires
network technology, combined with large-scale investors to scrutinize assets’ risk/
social changes such as the acceptance of remote return profile
working, have moved some digital assets down the Traditional risk-based classifications are being
risk spectrum. Investors need to understand which challenged by fundamental drivers led by the energy
categories assets belong to today and adjust their transition, including sustainability targets, electric
portfolios accordingly. mobility, and digitization. These forces mean that
investors should assess the risk/return profile of
Exposure to new types of infrastructure assets specific assets and potentially recategorize them to
demands that investors manage higher levels of risk. account for new sources of both risk and growth.

42 McKinsey on Investing Number 8, December 2022

 Infrastructure’s traditional taxonomy Core-plus investments carry more risks and can
As the infrastructure investment sector matured offer returns approaching those of private equity
over the last few decades, the asset class branched investments, at 15 percent or more. Such assets
into funds in three categories: super core, core, and mimic the characteristics of classic infrastructure
core-plus. investments (see sidebar, “What is a classic
infrastructure investment?”) but are not universally
Super-core investments are the lowest risk considered part of the asset class. Fish transport,
and lowest return. Traditionally, super core has holiday villages, and crematoria are examples of
included assets such as regulated utilities— core-plus assets.
which have regulated tariffs and little volume
variation—and availability-based public–private Reassessing risk and return
partnership projects. In the past, individual assets sometimes moved up or
down the risk/return spectrum. But with changes in
Core investments are relatively low risk and low energy, mobility, and digitization, more assets need
return. Traditional assets in this category have to be reassessed: assets that have long dwelled
included nonregulated oil pipelines and demand- squarely within an asset subcategory may need to
risk transport-related assets such as toll roads, move to a different bucket today, and there may be
highways, and airports. Some assets that were of big shifts from super core all the way to core-plus.
little interest to infrastructure investors a few years Dramatic reshuffling is occurring because assets
back, such as fiber-optic technology and telecom that were once seen as immutably stable, such as
towers, are now considered core infrastructure. gas pipelines, are now exposed to significant energy
transition risk.

What is a classic infrastructure investment?

Historically, infrastructure investors — are downside protected (meaning — are typically within energy (such as
have looked for investments that have they will perform well irrespective of electricity or power distribution, oil
the following attributes: the economic cycle) pipelines and storage terminals, and
renewables with power-purchase
— are real, capex-intensive assets — provide cash yields (something that agreements); telecom (such as mobile
(something you can touch; that is is operational, profitable, and has towers, fiber, and data centers);
anchored in the ground) sufficient cash flow to pay back to the transport (including seaports,
shareholders) driven by high EBITDA airports, roads, and rail); and certain
— are essential services (such as energy margins that provide risk protection, healthcare and education assets
provision or transport infrastructure) a cushion for up-front capital
expenditures, and higher leverage
— offer steady and stable returns
(and are not exposed to volatile — have barriers to entry, either via
commodity price markets or a regulated monopoly or long-
demand uncertainties) term contracts

Infrastructure investing will never be the same 43

 Examples of recent asset subclass migrations — Digital infrastructure assets (such as mobile
include the following: towers and fiber networks) that have moved down
the risk spectrum as network communications
— Gas networks carrying methane hydrocarbons, technology matures: Digital assets now show
which in a net-zero transition would potentially returns that have moved them all the way from the
need to be phased out in regions where gas is core-plus to the super-core range.
substituted for low-carbon alternatives: while
hydrogen can utilize some of these assets, the — Power networks, which typically have a
general view is that gas distribution will be regulated return and stable revenues, are seen
required less, and that additional money will as super core: However, growing investment
need to be spent to repurpose the networks. demands create deployment and regulatory
These risks mean that gas distribution is moving risks that need to be taken into account.
from super core to core or even core-plus.

— Motorway service areas (MSAs) that distribute A new era demands that investors
fuel for internal-combustion engines (ICEs): as change their approach
the number of EVs increase, fuel consumption Investors should be aware of a broader sea change
for ICEs will likely decrease, but the greater need in the risk/return profile across the whole asset
for EV charging stations presents a significant class. Investors have become accustomed to
business opportunity for MSAs. This potential thinking of infrastructure as a haven. A record of
demand means that MSAs could move from steady returns relative to most other alternative
core-plus to core. asset classes (Exhibit 1), as well as a reputation as an

Web <2022>
Exhibit 1
<Infrastructure>
Exhibit <1> of <4>

Returns from infrastructure

infrastructure investing
investinghave
have been
been stable,
stable, delivering higher
returns than most other
other alternative
alternative asset
assetclasses.
classes.
Annualized quarterly TSR, %

Private equity Infrastructure Real estate Natural resources

60 60

40 40

20 20

0 0

–20 –20
–40 –40

–60 –60

–80 –80
2008 2021 2008 2021 2008 2021 2008 2021

495 312 174 161

Total return, index (100 = Dec 31, 2007)

Source: Preqin analysis of infrastructure funds expectations

44 McKinsey on Investing Number 8, December 2022

asset class that can offer a hedge against economic investors need to move beyond the historical
downturns, enabled infrastructure funds in 2021 to underwriting approach that focused almost
raise close to $130 billion, around 55 percent more exclusively on relatively static technical assessments
than in 2016. and financial models. Today, other factors need to be
layered on for a full-picture understanding.
However, today there are relatively few assets that
promise the steady returns that infrastructure MSAs, for example, were traditionally evaluated
investors became accustomed to in recent decades, based on traffic projections. While traffic is still
leading investors to lower their expectations for important, the impact of EV charging means
future returns (Exhibit 2). investors now need to understand factors including
EV penetration, battery evolution, charging
Moreover, infrastructure contains pockets of value technology, and grid capacity.
destruction—most notably, downturns in telecom-
and transport-related assets caused by the onset Likewise, utilities’ diligence has moved beyond
of the pandemic—that need to be managed wisely technical and regulatory assessments to complex
(Exhibit 3). modeling of the impact of the energy transition
(for example, how hydrogen could be a potential
Investors should adopt a new approach replacement for pipelines that currently carry
to underwriting natural gas). These changes require deal teams to
To manage the new dynamics introduced by the have a different set of skills and capabilities (or a set
energy transition and other structural changes, of experts that can apply its skills during diligence),

Web <2022>
<Infrastructure>
Exhibit 2
Exhibit <2> of <4>

Expectations for
Expectations for returns
returns from infrastructure investments have been
investments have beendeclining.
declining.
Average target 16
internal rate of
return (IRR),¹ %
14

12
High

10

Low
8

6
4–5%
decrease in average
target IRR per year
4

2 20–40%
decrease in target IRR
over the past 10 years
0
2009 2011 2013 2015 2017 2019 2021

¹Low- and high-target IRRs across 20–40 funds per year. The returns are across all primary investment strategies (core, core plus, fund of funds, debt,
opportunistic, and value added).
Source: Preqin analysis of infrastructure funds expectations

Infrastructure investing will never be the same 45

 Web <2022>
<Infrastructure>
Exhibit 3
Exhibit <3> of <4>

Most
Most infrastructure
infrastructure sectors have recovered
sectors have recoveredto
topre-COVID-19
pre-COVID-19levels,
levels,except
except
for
for renewables.
renewables.
Market capitalization, index (100 = Jan 1, 2020) Utilities Transportation Oil and gas Renewable electricity
COVID-19 COVID-19 Second COVID-19
wave in Europe; Third COVID-19 Omicron Russian invasion
infections infections wave and Delta
in China in Europe vaccine rollout variant surge of Ukraine
announced variant surge
140 140

120 120

100 100

80 80

60 60

40 40

20 20
2020 2021 2022

Note: As of July 1, 2022; predefined S&P sector indexes.

Source: Preqin analysis of infrastructure funds expectations

as well as a more proactive approach to developing years to trigger a complete reassessment of their
an investment case. portfolios and a fresh set of priority investment
themes and theses. The speed and uncertainty
Investors can use best-in-class asset of the energy transition, for example, can mean
management and technology to deliver that several critical assumptions underpinning
superior returns an investment (such as EV penetration) move
The days of sitting back and enjoying predictable, in unpredictable directions and at unforeseen
long-term yields have waned. The changing speed. Appropriate and timely interventions may
environment means that investors need to be more be required to preserve value. Investors need
proactive about asset management, revisiting the to actively manage a complex menu of strategic,
risk/return dynamics of key asset classes to ensure operational, and digital initiatives to ensure that
that they have a current understanding of value assets deliver according to the management plan.
drivers and trends.
Smaller investors with a minority stake also need to
Large investors should recognize that there have be cognizant of, and respond suitably to, changing
been enough developments over the past two risk/return equations. In some cases, that could

46 McKinsey on Investing Number 8, December 2022

include exiting assets if they lack sufficient leverage investments need to be large. These concentrated
over management to enforce a strategic shift, or if funds are increasingly vying with one another to
the new risk/return profile no longer matches their raise larger funds and maximize the size of assets
ingoing assessment. under management (Exhibit 4). The upshot is intense
competition for suitable infrastructure targets in a
Investors also need to use operational and digital higher interest rate environment.
levers to create buffers for inevitable downturns,
and to correct course when fundamentals shift.
Our experience suggests that investors can use
digital interventions and analytics to achieve The energy transition is a prime example of a
improvements in a range of situations including large-scale opportunity that could potentially be
reducing airport congestion, enhancing predictive a recipient of these funds. The global economy
maintenance, reducing procurement spending, needs an estimated $9.2 trillion in annual average
reducing hospital waiting times, and improving investment in physical assets to achieve net-zero
telecom network performance, among others. emissions by 2050.1 Yet this sector is growing fast
from a small base, and there are still few investable
targets at scale.
Benefiting from emerging opportunities
calls for more active investing Investors can look for deals in niche markets,
Strong fundraising is likely to increase competition through integrations and carve outs
for assets. At the same time, fundraising is more Investors who want to participate in the energy
concentrated, which means minimum equity transition could get left behind if they sit back

Web <2022>
<Infrastructure>
Exhibit 4
Exhibit <4> of <4>

Infrastructure fundraising
Infrastructure fundraisinghas hasincreased
increased at
at aa faster
faster pace
pace than
than the
the number
number of
of
funds, resulting in
in larger
largerfund
fundsizes.
sizes.
Number of funds Funds raised, $ billion

160 160

140 140

120 120

100 100

80 80

60 60

40 40

20 20

0 0

2010 2012 2014 2016 2018 2020 2010 2012 2014 2016 2018 2020

Source: Infra Investor, May 2022; Preqin

Infrastructure investing will never be the same 47

 and wait for competition to die down, climate tech In addition, some funds are setting up separate
developers to scale, or emerging markets to mature. funds with a different investment profile (typically,
Instead, they can consider more active investing higher risk and smaller ticket size) to go after the
styles that put them in the driver’s seat. energy transition opportunity in its early stages. The
intention is eventually to migrate these assets to
One approach to sourcing proprietary deals is their infrastructure funds when they mature, or to
though detailed insights into niche markets versus sell them to other infrastructure funds.
reactive responses to competitive processes. For
example, some investors in energy services have There are, of course, opportunities outside
developed a proprietary view on creating value by of the energy transition. For example, several
scaling up and consolidating national champions in investors have recently bought large-scale
the nascent energy services space, helping them telecommunications companies to get access to
emerge successful in highly competitive auction fiber and towers, and have proceeded to scale these
processes for scarce assets in the sector. acquisitions or integrations.

Employing roll-up and bolt-on strategies can be

critical to scaling up smaller investments in segments
in which larger companies simply do not exist. In some Strong evidence suggests that despite pressures
cases, investors may set up their own management from the flood of capital and the potential
teams and build businesses from scratch. For consequences of a widely feared recession,
example, a consortium of pension funds established infrastructure remains an attractive long-term
a platform for project investments in renewable- investment avenue for institutional investors.2 To stay
generation assets. The platform now comprises in the race, investors will need to push the boundaries
more than 150 projects across the world with a total of investable assets, while also adhering to the
generating capacity of more than three gigawatts. investment objectives underlying infrastructure as an
asset class—and of their limited partners.
Building relationships with utilities to go after carve-
out opportunities can be a way to build scale quickly
in many areas where credible at-scale investments
are hard to find.

1
“The net-zero transition: What it would cost, what it could bring,” McKinsey Global Institute, January 2022.
2
In 2021, infrastructure and natural resources set all-time highs for fundraising, AUM, and deal volume. For more, see “McKinsey’s Private
Markets Annual Review,” McKinsey, March 24, 2022.

Marcel Brinkman is a partner in McKinsey’s London office, where Vijay Sarma is a senior expert.

The authors wish to thank Arpit Kaur, Alexandra Nee, Anders Rasmussen, August Runge, Eivind Tørstad, Alexander Ugryumov,
and Varun Vijay for their contributions to this article.

Copyright © 2022 McKinsey & Company. All rights reserved.

48 McKinsey on Investing Number 8, December 2022

US wealth management:
A growth agenda for the
coming decade
Mounting hopes of postpandemic recovery signal an imperative to
prepare for the changes in technology, consumer needs, and society
that will shape the future of the wealth management ecosystem.

by Pooneh Baghai, Alex D’Amico, Vlad Golyk, Agostina Salvó, and Jill Zucker

© Eoneren/Getty Images

49
 Wealth management is a growth industry, but it to address as they plan how to flourish in the
is experiencing a set of accelerating disruptions. changing ecosystem. Finally, we offer questions for
While the pandemic challenged the performance organizational self-assessment.
of the US wealth management industry for much
of 2020, the last 12 months have given rise to
optimism that the conditions for a significant Coming out of the crisis: Resilient but
wave of innovation and experimentation across not unscathed
the wealth management ecosystem are in place. At face value, the US wealth management industry
The conditions include rapid technological entered 2021 from a position of strength—record-
advancements, fast-evolving consumer needs and high client assets, record growth in the number
behaviors (accelerated by the pandemic), and an of self-directed and advised clients, and healthy
environment of economic stimulus. pretax margins (Exhibit 1). However, beneath these
strong headline numbers, the story was mixed, with
To thrive in this dynamic environment, firms must the worst two-year revenue growth since 2010, as
prioritize growth, adopt an innovation mindset, well as negative operating leverage. The depressed
and be prepared to reallocate resources rapidly in margins and profit pools that resulted were caused
response to the changing context. Finally, to free primarily by rock-bottom interest rates and uneven
resources for strategic investment and prepare for cost discipline (Exhibit 2).
any potential market downturn, firms can rethink
their cost structures and improve the industry’s Consequently, while the industry is now benefiting
spotty record on cost management. from vigorous market performance, it faces
significant crosscurrents: equity-market and
To guide these efforts, this paper offers a brief interest-rate uncertainty and industry-specific
overview of the US wealth management industry’s challenges including lack of cost discipline,
present conditions and then presents four themes increased competition from new entrants, and an
that define the new growth narrative we foresee. aging and shrinking advisor force.
We recommend agenda items for wealth managers

Exhibit 1
US wealth management entered 2021 from a position of relative strength.
US wealth management entered 2021 from a position of relative strength.

Resilient ...

$38 trillion 16 million ... but not unscathed

Record-high client Record-high net
assets new direct brokerage 1% 3 percentage points
accounts Slowest 2-year Pretax margin decline
1 million revenue growth
Net new advised 22% since 2010 11%
relationships Healthy pretax Profit pools decline
margin 6%
Record-high
single-year
increase in costs

Source: McKinsey Global Wealth and Asset Management Practice

50 McKinsey on Investing Number 8, December 2022

 Exhibit 2
US profit pools declined by 11 percent
US percent in 2020.
2020.

Profit pool decomposition of the US wealth management industry,1 $ billion

Profit margin (basis points) Profit margin (% of operating revenue)

0.7
1.3 -4.0
-1.8
1.3 5.3
-0.3 -8.3

54.0
48.0²

2019 Net flows Market Shift to Change in Change in Change in Change in Changes 2020
profits perfor- advisory lending deposit advisory payments in costs profits2
mance contri- contri- fees from
bution bution product
providers
17.7 bps 13.6 bps

25.2% 22.2%

1
Pretax operating profits. Annual profit pools based on average assets under management.
2
Contributions from funds transfer pricing, payment for order flow, and other factors add up to <$0.1 billion and are excluded from the chart.
Source: McKinsey Global Wealth and Asset Management Practice

Despite this near-term uncertainty, US wealth private banks (1 percent). If interest rates return
management remains a growth industry, albeit with to prepandemic levels, wirehouses and direct
moderating revenue growth projections. McKinsey brokerages will disproportionately benefit, given
modeling suggests industry revenue pools will their reliance on interest income from cash for
grow by about 5 percent per year over the next five profitability, with the overall growth rate for the
years,¹ driven by moderating market performance, industry reaching about 7 percent a year—similar to
moderate net flows, and the continued shift from the growth that occurred between 2015 and 2018.
brokerage to advisory (where revenue yields are
typically higher). However, the growth will not be
equally split among industry segments. We expect A growth agenda for the coming
digital advice models, including robo- and hybrid decade
advisory, to continue growing fastest, potentially Over the last 18 months, the industry has spurred a
even outperforming their historical revenue growth significant wave of innovation and experimentation.
of more than 20 percent per year. Next in terms It is also facing long-standing demographic shifts
of growth will be registered investment advisors that will redistribute wealth among subsegments.
(roughly 10 percent projected annual growth rate), This combination of forces will shape growth trends
followed by national/regional broker–dealers for years to come. We see four key themes: fast-
(6 percent), direct brokerages (5 percent), growth segments, new client needs, new products,
wirehouses (2 percent), and other broker–dealers and new business models (Exhibit 3).
(independent, retail, and insurance owned) plus

1 Long-term asset class forecast, Q2 2021, State Street Global Advisors, April 22, 2021.

US wealth management: A growth agenda for the coming decade 51

 Fast-growth segments offer new potential example, 30 percent more married women are
Three investor segments are showing signs of making financial and investment decisions than five
significant and lasting growth: women, engaged years ago.2
first-time investors, and a segment we call hybrid
affluent investors. A new wave of engaged investors are opening
accounts. The resurgence of the engaged-investor,
Women are taking center stage as investors or active-trader, segment has been one of the most
over the next decade. Today, women control a headline-catching disruptions in the industry. Since
third of total US household investable assets— the start of 2020, more than 25 million new direct
approximately $12 trillion. Over the next decade, this brokerage accounts have been opened, a significant
share will grow. The biggest cause of this shift will percentage by first-time investors. This growth
be demographics: as baby boomer men die, many resulted from a confluence of prepandemic market
will cede control of assets to their female spouses, developments (for example, the elimination of online
who tend to be both younger and longer lived. By brokerage commissions, access to fractional share
2030, American women are expected to control capabilities) and pandemic-related trends such as
much of the $30 trillion in investable assets that high savings rates (enabled by lower consumption).
baby boomers will possess—a potential wealth
transfer that approaches the annual GDP of the While this segment’s exponential growth is likely
United States. At the same time, younger affluent not sustainable (for example, there was a sharp
women are becoming more financially savvy; for decline in trading app downloads and active daily

2
For more on these trends, see Pooneh Baghai, Olivia Howard, Lakshmi Prakash, and Jill Zucker, “Women as the next wave of growth in US
wealth management,” McKinsey, July 29, 2020.

Exhibit 3
Contoursof
Contours ofthe
thenew
newgrowth
growthnarrative.
narrative.

1 Women
Engaged first-time
investors
Hybrid affluent
investors
Fast-growth segments

2 Personalization Omnichannel access

Integrated banking
and wealth
New needs

3 Private markets Digital assets

New products

4 Services to registered
investment advisors
Digital advice models
New business models

Source: McKinsey Global Wealth and Asset Management Practice

52 McKinsey on Investing Number 8, December 2022

$3O trillion
users in the third quarter of 2021), it remains
in investable assets will be
possessed by baby boomers
by 2030, much of it controlled
by women

management of channel conflicts and potential

poised for accelerated growth over the next revenue cannibalization.
decade, given engaged investors’ relatively low
median age of 35.³ The opportunity for wealth New customer needs provide an opening to
managers is to serve this segment by meeting differentiate
their demand for direct brokerage-based investing Investors are increasingly looking for institutions that
and to build deeper relationships with them over can provide them with omnichannel access, integration
time—for example, by recognizing that these new of banking and wealth management services, and
investors tend to express their personal values in personalized offerings. As similar kinds of benefits
their investment decisions. become available from providers of other services,
investors see them more as needs than as luxuries. In
Hybrid affluent investors are an opportunity to fact, fully 50 percent of high-net-worth (HNW) and
differentiate. While headlines have focused on the affluent clients say their primary wealth manager
rise of first-time young investors with typically low should improve digital capabilities across the board.
assets, growth in the hybrid investor segment—
those with at least one self-directed account and Omnichannel access is no longer just ‘nice to have.’
a traditional advisor—has been overlooked. In One of the clearest disruptions triggered by the
2021, a third of affluent investors—households with pandemic has been the sharp acceleration of digital
more than $250,000 and less than $2 million in adoption across consumer segments—including
investable assets—were hybrid (Exhibit 4), a sharp wealthier and older clients who were previously less
increase of nine percentage points in just three digitally inclined with respect to financial advice. As
years. The biggest beneficiaries of this trend have a result, according to McKinsey’s latest Affluent and
been incumbent and new direct brokerages, as well High-Net-Worth Consumer Insights Survey, digital
as some traditional wealth managers with sizable is now the most preferred channel for clients, closely
direct brokerage platforms. followed by remote (Exhibit 5).

The rapid growth of hybrid affluent investors is a This trend is even more pronounced for the HNW
result of two trends that are expected to persist: segment, which we define as households with
investors’ desire for human advice and the ease more than $2 million in investable assets: roughly
and affordability of direct investing. Therefore, to 40 percent of HNW clients say phone or video
foster deep relationships with affluent clients and conferences are their preferred wealth management
prevent them from investing with competitors, channels, and only 15 percent look forward to going
wealth managers of all types need to have both back into branches or resuming in-person visits.
direct brokerage and advisor-led offerings with a Interestingly, the preference for digital and remote
seamlessly integrated experience across the two. engagement among HNW clients is higher than for
Achieving this will not be easy; it will require careful their affluent counterparts.

3
Schwab Generation Investor Study 2021.

US wealth management: A growth agenda for the coming decade 53

 The fastest-growing
Exhibit 4 segment of affluent investors is hybrid—those with
self-directed accounts plus a traditional
The fastest-growing segment of affluent advisor.
investors is hybrid—those with self-
directed accounts plus a traditional advisor.
Use of self-directed accounts and traditional advisors, % of affluent investors1
Change vs 2018,
2018 2021 percentage points

-7 9
1 or more 28 24 1 or more 21 33

Self- Hybrid Self- Hybrid

directed directed
accounts accounts –6 4
None 19 29 None 13 33

None 1 or more None 1 or more

Traditional advisor Traditional advisor

1
Defined as having $250K–$2M in investable assets.
Source: McKinsey Affluent and High-Net-Worth Consumer Insights Survey

Convergence of banking and investing has gone segment: HNW, ultra-HNW,⁴ and older clients tend to
mainstream. Over the last three years, there has consolidate banking with their primary wealth manager,
been a striking increase in clients’ preference to whereas young investors are more likely to consolidate
consolidate their banking and wealth relationships wealth management with their primary bank.
to achieve convenience and better relationship
deals: the share with this preference has risen from Clients’ reasons for consolidating with their
13 percent in 2018 to 22 percent in 2021. The trend primary bank or investment firm vary. High-yield
applies to both wealthy and young households deposits, lower management fees, and seamless
(Exhibit 6). In particular, 53 percent of those aged transactions across accounts are the top three
under 45 and about 30 percent of those with reasons for consolidation—and are basically table
$5 million to $10 million in investable assets prefer stakes. Beyond that, our research has found
to consolidate relationships. that banks generally win on convenience (for
example, an existing relationship with the client,
Banks and wealth managers alike can benefit from customer service tailored to younger clients), while
this trend, but their starting position differs by client investment firms win on products and reputation

40%
4
increase in total direct brokerage
accounts since the start of 2020—
more than 25 million new accounts

In this article we define HNW customers as those with between $2 million and $25 million in investable assets; ultra-HNW have more than
$25 million in investablele assets.

54 McKinsey on Investing Number 8, December 2022

Exhibit 5
Investors
Investors anticipate
anticipateaamore
moremodest
modestrole
rolefor
forin-person
in-personchannels
channelsthan
thanfor
for digital
digital and remote
and remote when
when the the pandemic
pandemic recedes.
recedes.

Anticipated preferred channel post-COVID-19, % of investors

Channels
In person1
Remote2
Digital3
47 48

38 39 38 37 37
32
29
23

16 16

Open an account Manage my portfolio Move money Service my account

and receive advice

Note: Figures may not sum to 100%, because of rounding.

1
Includes respondents who selected “in-branch” or “in-person with financial advisor.”
2
Includes respondents who selected “email,” “phone,” “mail/post,” “SMS/text,” “secure video conference, eg, Zoom, Skype, FaceTime,” or “online or mobile live chat.”
3
Includes respondents who selected “company website” or “mobile app/site.”
Source: McKinsey Affluent and High-Net-Worth Consumer Insights Survey, n = 5,874

(for example, more expansive accounts or products in partnership with fintechs. Full-service wealth
such as securities-based lending, concierge-like managers are upgrading their digital banking
customer service tailored to older clients, and capabilities. And consumer-facing fintechs—with
recommendations). millions of users—are blurring the lines between
investing and cash management.
The increased preference for consolidating
banking and investing has been driven by a flurry Rise of personalized investing. Personalization
of innovation. National banks are building wealth matters. It is a key driver of client satisfaction
management capabilities and closely integrating and the number-three factor for clients selecting
experiences with traditional banking services, often financial advisors. Wealth managers have

50% of clients think their primary wealth

manager should improve their digital
capabilities

US wealth management: A growth agenda for the coming decade 55

 Exhibit 6
Younger
Youngerand,
and,totoa alesser extent,
lesser wealthier
extent, segments
wealthier havehave
segments a strong preference
a strong for
preference
consolidating banking and investing.
for consolidating banking and investing.
Agreement with the statement “I prefer to place investments with a firm where I also have a
banking relationship,” % of retail investors
Investable > 60% 30–60% < 30% Change vs 2018,
assets, percentage points
$ million
Increase in the share
5–25 70 +8 33 +20 14 +3 of retail investors who
prefer to consolidate
banking and wealth
relationships
1–5 49 +32 16 +6 12 +4 +172%
vs 2014

<1 53 +31 21 +10 17 +7 +81%

vs 2018

25–44 45–64 >65

Age

Source: McKinsey Affluent and High-Net-Worth Consumer Insights Survey, n = 5,874

responded to the demand to personalize investment by leading US wealth and asset managers
management with customized, tax-efficient will create further supply-side momentum in
managed accounts. Because of their operational expanding the growth of the category.
complexity, these products have typically been
accessible only to the HNW and ultra-HNW Broader adoption among clients will require further
segments. However, direct indexing, fractional share innovation. For both self-directed and advisor-led
trading, and $0 online commissions are shifting models, offering direct indexing requires a careful
the paradigm by enabling customized portfolios of consideration of the trade-offs associated with
securities at lower minimums. taxes and environmental, social, and governance
(ESG) constraints. All this creates a need for intuitive
Assets under management (AUM) in direct interfaces and analytical tools, which need to be
indexing tripled between 2018 to 2020, reaching integrated into the advisor desktop and workflow.
$215 billion, or 17 percent of the retail separately
managed account (SMA) market. We anticipate
direct indexing volumes to triple through 2025, New products expand ways to serve
given how this new investing technology meets customers
client needs, most notably the growing demand Across industries, transformation arises from
for tax-efficient investing and the desire of some the introduction of new products. In wealth
retail investors, particularly younger clients, to management, we see notable potential in two main
ensure that their portfolio holdings reflect their categories of new products: investments in private
personal values (Exhibit 7). The recent flurry markets and investments in digital assets.
of acquisitions of direct indexing providers

56 McKinsey on Investing Number 8, December 2022

Exhibit 7
to aa lesser
Younger and, to lesser extent,
extent, less
less affluent segments
segments are
are more
more likely to consider
likely to
environmental, social, and governance aspects when choosing investments.
consider ESG when choosing investments.

Split of investors who regard ESG as a top 3 consideration when choosing investments
% of investors
> 40%
Investable
assets, 20–40%
$ million
10–20%
$5M–$25M 25 18 5 < 10%

$1M–$5M 41 15 18

< $1M 41 21 15

25–44 45–64 > 65

Age

Source: McKinsey Global Wealth and Asset Management Practice (2021, n = 3,776 for < $1M, n = 1,709 for $1–$5M, n = 389 for $5–$25M)

Democratization of private markets. In the current managers to facilitate this growth by making it
lower-for-even-longer interest-rate environment, easier for their clients to access private markets.
investors’ appetite for alternative investments is
as high as ever, with the young leading the way: Digital assets going mainstream. The arrival of
about 35 percent of 25-to-44-year-old investors an army of new retail investors has proven to be
indicate an increased demand for alternatives. a boon to the growth of new asset classes that
Within alternatives, private markets (private were incubated in the margins of the market.
equity, private debt, real estate, infrastructure, Nowhere is this phenomenon clearer than in the
and natural resources), an asset class that was realm of digital assets, which have ballooned from
once the preserve of institutional investors, is a combined valuation of $100 billion in 2019 to
making inroads to individual portfolios. Large a market capitalization of more than $2.5 trillion
private-markets firms are building out retail today. They span multiple digital asset classes,
distribution capabilities and vehicles, and home or “tokens,” beyond cryptocurrencies, including
offices make it easier for clients to access private- tokenized equities, bonds debt, stablecoins
markets products, often with the help of fintech (typically pegged to conventional currencies), art,
infrastructure providers. Increased client demand and collectibles. The motivations for investors
and innovations have potential to increase the in digital assets are diverse—experimentation,
share of assets allocated to private markets from speculation, the search for inflation protection,
about 2 percent in 2020 to 3 to 5 percent by 2025, or getting exposure to the building blocks of
representing asset growth of between $500 billion new technology that is increasingly cast as the
and $1.3 trillion. It is imperative for wealth next iteration of the internet (that is, Web3).

US wealth management: A growth agenda for the coming decade 57

 Whatever the motivation, investors’ enthusiastic Advisors’ desire for independence presents an
embrace of digital assets is very clear. For example, opportunity to serve RIAs. The last decade has seen
digital trading platform Coinbase has gathered a a migration of advisors to registered independent
staggering 68 million verified users. advisors, with 24 percent of all financial advisors
being part of an RIA in 2020, compared with 16
For wealth managers, digital assets present both percent in 2010. This shift is expected to continue
an opportunity and a challenge. On the one hand, apace, with the share of advisors affiliated with
the cryptocurrency market has grown too large RIAs growing to 26 percent by 2025. Motivations for
to ignore amid robust client demand; 11 percent advisors’ migration to RIAs include the expectation
of affluent clients and 8 percent of HNW clients of higher payouts plus two other factors: First,
invest in digital assets. On the other hand, three advisors are looking at the RIA channel as the best
broad challenges are associated with offering way to monetize their business, with RIA acquisition
cryptocurrencies. First, regulatory ambiguity—on multiples for top advisors (those with books over
asset classification and tax reporting, among other $1 billion) two to three times higher than retire-in-
issues—has lingered, often creating uncomfortable place incentives at traditional wealth managers.
levels of risk exposure for wealth managers. While Second, technology and services firms, working
it is still early days, the advent of crypto exchange- in conjunction with the major custodians, have
traded funds (ETFs) could help address some lowered barriers for advisors to launch their own
of these challenges. Second, the infrastructure firms. Moreover, advisors believe they can procure
required for offering digital assets, including technology and services that are similar to or better
custody services, differs from what is required for than what traditional wealth managers provide.
traditional investment products. Lastly, digital asset
classes are not well understood by many advisors, While this trend presents a challenge for wirehouses
so advising on the products is challenging for them. and broker–dealers, whose advisor force is
expected to shrink by 3 percent over the next
Wealth managers face a choice: they can take a five years, there is a silver lining: RIAs’ reliance
wait-and-see approach and accept the business on third-party products and solutions creates
risks associated with staying out of a rapidly an opportunity for participants in the wealth
growing market, or they can pursue the opportunity management ecosystem to seek a share of this fast-
aggressively by leveraging partnerships with growing revenue and profit pool. Some ecosystem
fintechs while addressing heightened regulatory participants are viewing this segment in terms of
risks. What remains for certain is that over the a single product or service—lead generation, tech
longer term, there is meaningful potential for a far point solutions, custodial offerings, banking-as-
broader class of digital assets to enter the investing a-service for advisors, asset management. Others,
mainstream and for the underlying technologies of including turn key asset management providers
blockchain-based decentralized finance (DeFi) to (TAMPs), established custodians, and traditional
revolutionize the distribution of investment products, wealth managers with attacker mindsets, are
including the T+0 settlement cycle. attempting to build a next-generation, wirehouse-
quality platform for advisors.

New business models position firms Therefore, wealth managers, especially those who
for growth rely on advisor recruiting for growth, need to look
The last of our four contours of the new growth beyond the competitive threat posed by the fast-
narrative is the introduction of new business models. growing RIA channel and explore new business
Two such models are of importance: offering models that would allow them to participate in this
services to registered investment advisors (RIAs) growing revenue and profit pool. Wealth managers
and digitizing the delivery of advice. seeking to serve the RIA segment will need to

58 McKinsey on Investing Number 8, December 2022

manage technology as a core competency, and offering. Bringing more investors on board will
those with large advisor forces will need to manage require matching the advisor-like experience with
the advisor attrition risks associated with opening personalized content and solutions.
up the platform (even partially) to RIAs.

The opportunity for digital advice models. Digital Embracing the new growth narrative:
advice models, including robo-advisor and hybrid A four-part agenda
advisor models, have been around for more than Clearly, wealth management remains an attractive
a decade and have been the fastest-growing industry with strong growth fundamentals and long-
wealth management delivery model, with more term margins. If anything, the disruptions we have
than 20 percent annual revenue growth between discussed in this report expand the industry’s options
2015 and 2020. They still account for only about 1 and will shape the growth narrative for the next decade.
percent of the market, but the growth prospects
are high: the last three years—and last 18 months Given the pace of change, stasis is not a viable
in particular—have marked a step increase in option. We recommend that wealth managers
investor comfort levels with these offerings follow a four-part agenda for action: reposition,
(Exhibit 8). In fact, the share of investors saying redesign, reimagine, and reallocate.
they are comfortable with remote advice grew
from about 38 percent in 2018 to roughly 46 Reposition the firm for what’s next
percent in 2021. Among clients younger than 45, Every wealth manager needs to take a hard look at
the comfortable share grew from 43 percent to the secular growth themes shaping the industry—
59 percent. Similarly, while comfort with digital- fast-growth segments, banking, personalization,
only advice remains modest overall at about 15 new product propositions, and new business
percent, it has more than doubled since 2018 models—and decide, based on the firm’s unique
among investors under 45, to roughly half in 2021. sources of competitive advantage, which of these
updrafts it should ride. Where a firm lacks natural
Unsurprisingly, the growing interest has motivated advantages in capitalizing on particular growth
wealth managers to expand into and innovate themes, M&A is a critical lever for accelerating the
in this channel. However, wealth managers repositioning of individual wealth management
should be aware that achieving a step change in franchises. The last 24 months have seen numerous
adoption of digital advice offerings will require high-profile transactions as firms seek scale and/
going beyond the lower-cost value proposition, or the acquisition of new capabilities to accelerate
privileged acquisition strategies, and brand equity. their strategy. We expect M&A to be a particularly
Among investors who do not express comfort important theme over the next 24 months as
with robo-advisor models, the main reasons they wealth managers reposition themselves for the
give are perceived lack of personalization, privacy postpandemic “next normal,” whenever it arrives.
concerns, and lack of motivation to explore the

2X faster annual revenue growth projected over the next five

years for RIA channel versus industry overall

US wealth management: A growth agenda for the coming decade 59

 Exhibit 8
Comfort with digital advice models has accelerated in the last three years,
Comfort with digital advice models has accelerated in the last three years,
especially for younger segments.
especially for younger segments.
Comfort with using advice model, by age segment, % of investors1
2016 Increase, 2016–18 Increase, 2018–21

Using a remote advisor² Using a robo advisor3

2021 2021
25–34 42 1 15 59 22 1 27 51

35–44 34 9 17 59 14 6 29 49

45–54 32 8 7 48 10 1 10 22

55–64 32 4 10 46 5 14 10

65–75 32 1 7 40 3 1 4
0
Overall 33 5 8 46 7 3 6 15

1
Investors with investable assets of $250K–$5M. In 2016, n = 2,128; in 2018, n = 6,356; in 2021, n = 5,486.
²Respondents who agree or strongly agree with the statement “I would be comfortable working with an investment professional who does not live or work near
me, if I can reach them over the phone and email whenever I need to.”
3Respondents who agree or strongly agree with the statement “I would be comfortable with an automated online advisor (ie, a “robo” advisor) managing my
investments based on my personal characteristics and goals.”
Source: McKinsey Affluent and High-Net-Worth Consumer Insights Survey

Redesign offerings for new needs “How can such a model simultaneously deepen our
Firms also should monitor and try to anticipate relationships and broaden our reach?”
evolving client needs, using this information to
redesign their offerings. Examples could include Reallocate resources to support the strategy
new value propositions (for instance, around tax Finally, successful wealth management firms
efficiency, integration of wealth and banking, or make a bold commitment to putting the money
specific high-growth segments), privileged access where the strategy is, and they make multiyear
to new products (such as digital assets or private resource-reallocation decisions, including where
markets), or completely new business models (for firm’s top talent spends time, in favor of growth.
example, light-guidance digital offerings). Regular reallocation of resources is a critical
but often neglected step that can close the loop
Reimagine client engagement and experience between visionary strategic intent and successful
The third agenda item is to radically reimagine implementation.
client engagement and experience. The pandemic
has reset clients’ assumptions about how they Our research across industries suggests that
want to be served, and the accelerated uptake of fortune favors the bold: the top third of companies,
technology has created unprecedented degrees which have been the most dynamic resource
of freedom for wealth managers. Every wealth reallocators, achieved 1.6 times higher total returns
manager needs to ask, “What is the blueprint for a to shareholders than the bottom third (about 10
client experience model in a digital-first world?” and percent versus 6 percent annualized over 20 years).

60 McKinsey on Investing Number 8, December 2022

60% In the wealth management context, we estimate
that top performers are making strategic resource
increase in share of investors comfortable
with digital-only models since 2018 and
21% increase in those comfortable with
remote models

an agile manner and developing connections

across business units and functions. In addition,
reallocation decisions to the tune of 15 percent or the team needs leaders who are not afraid to
more of operating expenses over five years, whereas experiment and innovate and whose mandates
those simply dabbling with subscale experiments in are aligned with major growth themes that
strategic growth areas will not see results. Simply put, typically cut across business unit lines (for
firms should not aim to be all things to all clients. example, banking and wealth, segments,
sustainability).5

Five questions for wealth management 3. Does your ability to attract sought-after
executives client-facing and technology talent match
Given the significance of the opportunity at hand, your ambition? Over the last 12 to 18 months,
wealth management executives must consider their wealth managers of different sizes and business
firm’s readiness to capitalize on it. To provoke a self- models have publicly announced ambitious
assessment, we offer five questions for executives hiring targets with an emphasis on client-facing
to ponder and discuss with their teams: and technology talent. However, these plans
have been challenged by severe labor shortages
1. What are the three or four priority growth across industries, as a result of what has been
themes you are betting on for the next dubbed the Great Attrition: 40 percent of
five years? While several growth avenues employees say they are at least somewhat likely
and disruptions are reshaping the wealth to leave their current job in the next three to
management landscape, the optimal recipe will six months, and 54 percent of employees say
differ depending on an individual firm’s starting they leave because they do not feel valued by
position and its sources of competitive advantage. their organizations.6 Wealth management is no
Clarifying priority growth themes and aligning exception to this trend.
with your executive team help lay a foundation for
developing a winning growth strategy. While many of the levers for attracting and
retaining talent remain effective, other factors
2. Do you have the right team and operating have gained importance during COVID-19, with
model? To paraphrase Peter Drucker’s famous more than 80 percent of workers saying that a
phrase, “Execution eats strategy for breakfast.” hybrid-office working model is the optimal route
A prerequisite for successful execution is forward. In addition to rethinking their operating
an effective leadership team that is brought models to attract and retain talent, wealth
together around critical behaviors. In the managers need to take bolder and more creative
context of wealth management and the shifts approaches to attracting new-to-industry talent.
the industry is going through, these behaviors These may include flexible working arrangements,
for executive teams must include operating in alternative career paths (including new payout

5
For more, see Natasha Bergeron, Aaron De Smet, and Liesje Meijknecht, “Improve your leadership team’s effectiveness through key
behaviors,” McKinsey, January 2020.
6
A aron De Smet, Bonnie Dowling, Marino Mugayar-Baldocchi, and Bill Schaninger, “‘Great Attrition’ or ‘Great Attraction’? The choice is yours,”
McKinsey Quarterly, September 8, 2021.

US wealth management: A growth agenda for the coming decade 61

 structures for client-facing roles and programs programmatic M&A in the context of business
aimed at creating the next generation of advisor strategy is essential for making accretive deals
talent), and partnerships with various types of that contribute to both top-line growth and
educational institutions. business value.

4. Are you reallocating a significant portion 5. Do you have a partnership strategy rooted
of your resources—spending and capital— in your business strategy? When it comes to
toward priority growth areas, including M&A? digital, data, and technology, it is impossible for
Systematic and dynamic resource allocation any organization to stay ahead of the pack on
is an essential part of a winning business every dimension, so a clear partnership strategy
strategy. Achieving industry-leading levels in is crucial. In fact, many wealth management
this area involves several steps: conducting incumbents already rely on fintechs to gain
a critical review of the firm’s existing cost access to better technology across the value
structure, introducing a culture that continuously chain—client acquisition, client front-end,
reallocates resources from low- to high-value portfolio management, point solutions on
tasks, increasing transparency around returns advisor desktops, cybersecurity, and cloud
of individual projects, and implementing infrastructure, among others. Looking ahead, it
governance processes to enable more dynamic is important for executives and their teams to
resource allocation. be clear-eyed about which capabilities will be
a source of sustainable competitive advantage
Capital reallocation can be a powerful tool for and then to decide how to acquire those
acceleration of growth in high-priority areas, capabilities: build in-house, build in-house in
which requires a clear M&A blueprint consistent partnerships with fintechs,
with the broader enterprise strategy. We expect or outsource.
three major M&A themes to shape wealth
management deal making in the next 18 to 24
months: (a) transactions focused on platform
synergies, mostly in the vibrant RIA market Despite a modest dip in profits, the US wealth
but also among the largest wealth managers; management industry has thus far come through
(b) transactions focused on entering adjacent the pandemic not only unscathed but with tailwinds
revenue pools, such as asset management, from sustained demand for advice, potential upside
banking, retirement, or payments; and (c) of higher interest rates, the rise of new client
transactions to acquire capabilities that will be segments, and the embrace of unprecedented
key for growth—for example, direct indexing, tax levels and speed of innovation. As the industry
solutions, or wealth tech. moves toward the hoped-for postpandemic
new normal, it faces near-term macroeconomic
While not all deals are accretive in value, the top uncertainty but also meaningful opportunity.
25 percent of deals achieve 8.5 percent excess
TRS. Top acquirers are distinguished from the Tomorrow’s successful managers will need to
rest by two characteristics: the ability to embed adapt their models to preempt the disruptions that
M&A in their strategic planning process and lie ahead and adopt a new sense of purpose and
a clear post-acquisition playbook, inclusive innovation as they head into a period of growth.
of an integration capability. Thinking through

Pooneh Baghai is a senior partner in McKinsey’s Toronto office; Alex D’Amico and Jill Zucker are senior partners in the New
York office, where Agostina Salvó is an associate partner; and Vlad Golyk is a partner in the Southern California office.

Copyright © 2022 McKinsey & Company. All rights reserved.

62 McKinsey on Investing Number 8, December 2022

It’s time to become a digital
investing organization
AI and other digital technologies are ushering in the next horizon of performance
differentiation. Here’s how to level up.

by Vincent Bérubé, Ghislain Gagné, Frédéric Jacques, and Marcos Tarnowski

© Anders J/Unsplash

63
 The broad-based adoption of digital technologies enable the analysis of massive amounts of data
has emerged as one of the most powerful and to generate predictive insights at a speed and
disruptive forces in industry over the past decade, scale well beyond what humans alone can achieve.
driving a fourth industrial revolution in which entire Investors already are using analytics and various
sectors are being reshaped and business processes data sources, such as Bloomberg, to support their
transformed. investment decision process, but many are only
starting to leverage more advanced analytics
As often happens with changes of this magnitude, powered by AI. The wide availability of ever-cheaper
those slow to join the fold have been left at a data and computing power means that AI can
competitive disadvantage. We’ve now seen once- enable investors to analyze more data far faster than
dominant incumbent organizations lose ground previously possible.
to their more digitized competitors in nearly every
industry. In the asset-management space, there’s AI-enabled automation can also help investors
little doubt that institutional investors face the same perform repetitive tasks faster and at lower cost.
peril. Banking offers a glimpse of what institutional Many investment processes are repeatable. Tedious,
investors might face as nimble new fintechs offering redundant analyses, for example, can now be
mobile alternatives to services such as payments, carried out by computers, allowing humans to focus
loans, and deposits chip away at incumbents. Other on what they do best: evaluating those machine-
large asset managers, such as pension plans generated insights to challenge their investment
and general accounts for insurance, are likely to theses and factor in idiosyncratic risks that AI will
experience disruptions and performance impacts if not capture.
they remain behind the digital curve.
The cost advantages of digital technologies increase
The good news is that we’re still at the beginning the more they are used. Once the investment in
stages of this new era for large investors. Those technology has been made, organizations can
that embrace digital and analytics as necessary expand the technology’s use with zero marginal
instruments to augment decision making will have increase in costs. Developing the ability to generate
an enormous advantage over those that continue fresh investment insights with greater efficiency will
to rely on personal judgment and incomplete data. prove critical for investors to remain relevant and
Already, the adoption of digital technology at scale is competitive in the years ahead.
creating a new breed of investors who are faster and
better at identifying and evaluating opportunities.
Early returns from the field
In this article, we’ll describe the nature of the While it’s still early days, there is ample evidence
opportunity for investors and explain how to get that digital and analytics can provide investors with
started—while avoiding common pitfalls. a competitive advantage. Early adopters are using
analytics to support portfolio managers across
multiple asset classes. Some firms are using AI to
Digital and analytics: Practically made analyze hundreds of nonconventional data sources
for investors to help them derive a basket of stocks with a higher
Digital technologies profoundly alter how humans likelihood of outperformance. A study by McKinsey
interact with each other, objects, machines, and of more than 1,000 investors found that those
systems and rewrite the division of labor between leveraging analytics had a 5.3 percent gain in return
humans and machines. For investors, tasks on investment capital (ROIC) over those that relied
performed from back to front offices can be on a more traditional approach.
streamlined by using digital applications.
In addition, there’s evidence from adjacent
Artificial intelligence and other advanced analytics sectors. Man Group, a UK-based hedge fund
stand at the forefront of digital. Such technologies with $154 billion in assets under management, is

64 McKinsey on Investing Number 8, December 2022

at the forefront of using AI to generate returns. It Strategy
is continuing to push the frontiers through the While it’s important to be strategic rather
Oxford-Man Institute of Quantitative Finance (OMI), than tactical, that doesn’t mean every part
a research institute it co-founded with Oxford of the organization should be transformed
University in 2007. The OMI brings together experts immediately. To ensure impact is created early
from academia and industry in a wide variety of in the transformation, it is best to start with the
disciplines. They use AI, machine learning, and other transformation of a single business domain before
technologies to generate insights into markets and moving to another part of the organization—a
develop new tools for financial decision making. In full portfolio such as value investing or corporate
real estate, using AI to forecast rent at the street- bonds, for example—where investing teams are
corner level has led to stronger performance in already open to reconsidering their approach
data-rich markets such as the United States. During in order to deliver stronger performance.
the COVID-19 crisis, even port-traffic recovery Although functions such as partner-relationship
emerged as an area where AI was better suited to management, human resources, risk, or finance are
look at all available data to predict where and when also great candidates, demonstrating investment
traffic would resume. impact is more likely to galvanize the organization,
build belief in the benefits of digitization, and create
Despite these successes, some investors shun new the excess returns required to fund future efforts.
technologies because they are wed to the belief
that making investment decisions or enhancing the Strategic pitfalls to avoid
value of a private equity investment is more art than Assuming leadership knows how to direct
science. Still others may fear the threat that AI poses digitization efforts. Make sure decision makers
to their jobs and compensation. get the training and background they need to
lead the digitization effort effectively. Leaders
The reality is more nuanced. Successful use of with only limited technology literacy can have
digital and AI requires a clear understanding of the misconceptions about the power and potential of
limits and strengths of the technologies—as well AI and other digital technologies, which can cause
as the limits and strengths of the humans who must organizations to work on the wrong problems
wield them. Both have essential roles. or adopt solutions that are already outdated.
Executives must recognize that the risks of
disrupting their internal investment processes
Getting started—while avoiding with digitization are far lower than the risks of
common pitfalls not adopting technology at all and losing their
Realizing the full potential of digital and analytics competitive advantage in the long run.
requires a radical change to culture and mindset.
Organizations must shift from a culture that thinks Setting the wrong goal. Many organizations
in terms of individual use cases and achieving misunderstand the real value of digital
immediate returns on technology investments to a technologies and set about using it to replace
culture in which entire investment and operational humans rather than to enhance human decision
processes (such as hiring, performance evaluation, making. On the other hand, sophisticated investors
and general-partner-agreement compliance) are have seen their portfolio performance in equities
reengineered to fully leverage technology. improve by more than 50 basis points by allowing
AI to identify a basket of stocks where portfolio
To reshape the organizational culture as well as the managers should focus their attention. The
actual technology required for full-scale adoption of right goal is most often to pursue digital and AI
digital technologies, successful companies focus on technologies as a means of human augmentation
strategy, capabilities, and execution (exhibit). There rather than replacement.
are pitfalls in each of these areas, and we call them
out here so investment institutions can avoid them.

It’s time to become a digital investing organization 65

 Exhibit
There are six
There are six common
common components
componentsto
tosuccessful
successfuldigital
digitaland
andanalytics
analytics
transformations.
transformations.

Learnings based on McKinsey's experience at hundreds of digital and analytics transformations

across sectors

Strategy

1. Strategy and vision

It takes hundreds of tech solutions to transform a large company; there are rarely silver bullets

Prioritize business domains, not use cases

Develop use-case-level road map for the priority business domains

Be clear on the business problems to be solved

Capabilities

2. Technology 3. Data 4. Talent 5. Agile delivery

Two core tech enablers Successfully managing A superior digital-talent Getting agile right is more
are essential to scale: and leveraging data is: bench gives a competitive than just ping-pong tables
edge. To attract talent:
• cloud-based data • a new discipline in most Successful companies
platform companies • rethink HR practices develop a method they
• automated delivery • a journey or process and the operating can reuse to create new
pipeline (continuous • possibly the only true model solutions
integration and source of competitive • train top management
continuous delivery advantage and develop analytics
[CI/CD]) translators

Execution

6. Solution delivery and operating-model transition

For every $1 invested in technology development, plan another $1 for execution support
Solve for two discrete problems: adoption and operating-model change
Tracking impact can be more complicated because tech solutions cut across the enterprise

Getting too narrow. Some investors focus on Capabilities

addressing smaller, individual issues with software To enable a long-term technology transformation,
that isn’t well-integrated into the overall investing firms will need to set up the right internal capabilities
process. As a result, they often end up launching (see sidebar, “Bringing leadership and practitioners
dozens of small initiatives that, taken together, do into the process”). Scoring some early wins can
not materially move the needle for the organization. inject momentum into the overall transformation, so
Investment decision makers need to take a these early efforts must be well supported. They
holistic, strategic view of the opportunities new should also fit into an overall strategic foundation
technologies present. that can ultimately support scaling of digital and
analytics throughout the organization. Some of
these capabilities include the following:

66 McKinsey on Investing Number 8, December 2022

 Sophisticated investors have seen
their portfolio performance in equities
improve by more than 50 basis points
by allowing AI to identify a basket
of stocks where portfolio managers
should focus their attention.
— Technology: Technology tops the list of key — Talent: The new talent model is much more tech
capabilities. For at-scale digital deployment, heavy, with teams of highly technical specialists
technology should ideally be cloud based to guided by a few seasoned investors who have
enable agility and foster innovation. Firms also the judgment and experience to make the best
need tooling that can enable continuous solution use of the machine-generated insights. This
delivery and post-deployment monitoring (such requires new processes to recruit from a wider
as MLOps). array of backgrounds. The revised HR strategy
must adapt compensation and incentives for
— Data: The approach to data is also critical. Firms the differing needs and aspirations of tech
need a vision and strategy that provide visibility candidates. For instance, as a systematic asset
on the full life cycle of data, from acquisition to manager, Man Group invested in a broad range
insight consumption, and a data architecture and of talent from different scientific backgrounds.
data governance that are supported by IT. These recruits are fully integrated into

Bringing leadership and practitioners into the process

Success with digital and analytics will ultimately depend on whether leadership and practitioners buy into the new solutions
and ways of working. Both groups should be part of the process—and receive specialized training as the first pilot ramps up.

Leaders: The executive team needs a common understanding of digital technology and its related terms. Training should also
focus on helping leaders champion agile development projects, finding the optimal balance between guidance and autonomy
to allow innovative yet practical ideas to flourish.

Core practitioners: For speed and efficiency, multiple core-practitioner cohorts (data scientists, data engineers, translators,
product owners) should be trained in parallel so the organization has the resources to move to new opportunities over time.
Delivering these trainings in mixed cohorts and regrouping the various roles to address real business problems will help the
organization expand its pipeline of projects while building the necessary bench to accomplish the digitization journey.

The broader organization: From the start of the digitization journey, the central team—that is, the group responsible for driving
the AI agenda and setting up the core analytical practices—should roll out an organization-wide digital-literacy program to help
employees at all levels understand the rationale behind the effort and enable them to interact effectively with the central team
to identify goals and end products.

It’s time to become a digital investing organization 67

 investment teams, which means there is no clear the best opportunities and co-developing
distinction between technical (for example, data solutions and adoption processes with the
scientists) and investment (for example, portfolio investment professionals.
managers) talent.
— Define a framework for ongoing monitoring of
— Agile: Finally, to rapidly develop, test, and analytics solutions to enable improvement as
iteratively improve tech solutions, firms will need issues arise.
a new operating model that encourages deep
customer input and collaboration with all key — Align key stakeholders to ensure accountability
business functions. This means empowering for reinforcing adoption and ownership of new
delivery teams with quick decision making, processes lies with the business, not IT.
adaptive learning, and greater autonomy.
Execution pitfall to avoid
Capability-building pitfall to avoid Leaving end users on the sidelines. The practice of
Shiny-object syndrome. In some cases, investors putting frontline users at the center of technology
get caught up in pursuing technology for its own delivery helps organizations seamlessly integrate
sake, rather than leveraging a practical approach insights from data and analytics into the investment
that is fit for purpose. Successful companies keep process. For example, BlackRock’s Systematic
their eyes on the prize. Democratizing access to Active Equity team uses human insights, data,
data, building interfaces for ease of consumption, technology, and mathematics to drive adoption of
embedding analytics, or using automation to focus digital and analytics tools across the core business
high-performing resources on the tasks that add processes and achieve better results for customers.
the most value will serve companies far better than
building out the latest tech without a clear, practical
application. Many investors overinvest in developing
sophisticated AI models, for example, rather than Industries are being fundamentally disrupted
weaving AI into the fabric of their organization by by digitization, and the investment space is no
making code available and easy to use, driving exception. However, basic digital technologies
adoption, and putting in place the capabilities, will eventually erode the scale advantage for
infrastructure, and data foundation needed to scale. investors, making speed the primary differentiator
between competitors—speed that AI can help
Execution provide. There will likely be a dispersion of returns
Adapting the organizational model to maximize that favors players with AI-augmented workforces
adoption of technology by end users in the at the expense of those that continue to invest
organization may be the most challenging part of a with less sophisticated tools. We believe a window
digital transformation, often representing half of the of opportunity exists for investors to build both
total effort and investment. the foundational and advanced technological
capabilities they need to be on the winning side.
Doing so successfully involves three steps: Now is the time to act.

— Establish a robust protocol for rolling out

analytics solutions to the front line by identifying

Vincent Bérubé and Marcos Tarnowski are senior partners in McKinsey’s Montreal office, where Ghislain Gagné and
Frédéric Jacques are partners.

Copyright © 2022 McKinsey & Company. All rights reserved.

68 McKinsey on Investing Number 8, December 2022

 Exploring
investment 70
Highlights from McKinsey’s

themes
2022 sector research

85
Why private equity sees life
and annuities as an enticing
form of permanent capital

93
Digitally native brands:
Born digital, but ready
to take on the world

100
Climate risk and the
opportunity for real estate

108
Innovating to net zero:
An executive’s guide
to climate technology

69
 Highlights from McKinsey’s
2022 sector research
Amid uncertainty, companies across industries are continuing to innovate,
diversify and find new investment opportunities.

71 80
Advanced electronics Healthcare systems
and services
72
Aerospace and defense 81
Life sciences
73
Agriculture 82
Oil and gas
74
Automotive and assembly 83
Retail
75
Capital projects and 84
infrastructure Travel, transportation,
and logistics
76
Chemicals

77
Consumer

78
Engineering, construction,
and building materials

79
Financial services

70 McKinsey on Investing Number 8, December 2022

 Advanced electronics

Tackling inflation with active

price management
by Niels Adler and Nicolas Magnette

Rising inflation is prompting industrial players to pay greater attention to their pricing, cost, and
sales management practices. According to McKinsey’s analysis of 55 European B2B companies in
the industrial sector, active price management techniques have boosted revenues and profitability
over the past year. Among the top-quartile companies that improved their profitability and revenue
the most during this period, more than 50 percent said they used active pricing management
techniques while discussing quarterly results, including the use of determined language, such
as “taking bold pricing action.” For a successful pricing strategy, players should build their plans
across the short-, medium- and long-term.

© Kieran Stone/Getty Images

Companies that increase profitability tend to engage in active price management.

Companies discussing price management in quarterly result presentations,¹ % share (n = 55)

Did not discuss Discussed price Actively

price management management only discussed price Profitability change, Revenue change,
in quarterly reports since last quarter management percentage points percentage points

Top quartile 36 7 57 +10 +27

43 57 +3 +14

29 21 50 +1 +11

Bottom quartile 54 15 31 +0 +25

¹Companies grouped into quartiles based on profitability improvement over past year.

Highlights from McKinsey’s 2022 sector research 71

 Aerospace and defense

Space investment is
diversifying to new orbits
and technologies
by Ryan Brukardt, Jesse Klempner, and Brooke Stokes

Private investors are diversifying their exposure to space-related companies. Historically, a

large portion of both private and government funding has gone toward satellites in medium-
Earth orbit (MEO) or geosynchronous equatorial orbit (GEO) (which operates at a higher
altitude) for purposes including GPS and TV coverage. Investors then expanded their focus to
ventures in low-earth orbit (LEO). Today, there is growing interest in space ventures focused on
orbits around the moon and those even farther from the Earth, with about $1 billion in private
investment going toward these initiatives in 2021. These ventures have varied areas of focus,
from spacecraft components and technologies to mining, infrastructure, and robotics.
© Max Dannenbaum/Getty Images

Private funding is increasing for ventures involving lunar and beyond orbital regimes.
Share of private funding for space-related companies, by orbital-regime focus,1 %

100 Lunar and beyond

Medium-Earth orbit (MEO)
and geosynchronous equatorial
orbit (GEO)
Low-Earth orbit (LEO)
80 Suborbital

60

40

20

0
2005 2010 2015 2020

1
Includes funding from space-related companies founded since 2000. Each company receiving funding was tagged by orbital-regime focus based on review
of company’s website and of public press; funding estimates were split between different orbital regimes where appropriate. Reflects three-year rolling average.
Source: Capital IQ; company websites; Crunchbase; public press; McKinsey analysis

72 McKinsey on Investing Number 8, December 2022

 Agriculture

Global food supply faced

converging risks in 2022; next
year could be even harder
by Daniel Aminetzah, Artem Baroyan, Nicolas Denis, Sarah Dewilde, Nelson Ferreira, Oleksandr
Kravchenko, Julien Revellat, and Ivan Verlan

The global food system depends on a carefully calibrated system in which six main growing regions
supply the majority of the world’s exported grain. The war in Ukraine— combined with early climate
change impacts, trade restrictions, fertilizer shortages, higher energy prices, and other factors—
has thrown the system into a state of high risk. In 2022, much of the deficit in exported grain was
caused by logistical problems that trapped grain in Black Sea ports. Next year, there could be even
greater deficits because grain has not been planted in parts of Ukraine, and suboptimal conditions
may further decrease harvests in this key breadbasket region. Stakeholders should consider ways
© Paul Knightly/Getty Images
to create a more resilient method to feed the world, including by reducing waste and accelerating
efficiency in the food system.

Global grain trade volumes are likely to drop by 5 to 10 percent by Q3 2023, due to both
short- and medium-term factors.
Estimated annual crop export volume drop in relation to expected 2021 export baseline, million metric tons

Short term: Immediate impact: Voluntary trade Increased supply Expected gap
Q2–Q3 2022 constrained restrictions and from regions in 2021–22
sea logistics reduced exports with high harvests crop exports
2022 food
impact based
on 2021 crops
Ukraine

+8 to +11
Russia
Rest of Rest of –15 to –20
–18 to –22 world
world
–6

Medium term: Immediate Impact through Increased supply Expected gap

Q4 2022– impact shortage of from regions in 2022–23
Q3 2023 fertilizers with high harvests crop exports
2023 food
impact based On an already tight
on 2022 crops balance, climatic
events may
Ukraine1 further disrupt
international trade,
and challenge
any positive
outlook on surplus

Ukraine2
+8 to +10
–23 to –40
Rest of
–30 to –44 Rest of world
world
–3 to –6

Note: Analysis based on exports of wheat, corn, barley, and sunflower seeds.
1
Scenario in which conflict is limited in duration and scale, and Black Sea ports are unblocked.
2
Scenario in which conflict is prolonged in duration beyond 2022, and Black Sea ports remain blocked.
Source: Bloomberg; interviews with agricultural companies (> 1 million hectacres under management); Reuters; Ukraine national crop statistics; UN Food and
Agriculture Organization; McKinsey ACRE advanced analytics

Highlights from McKinsey’s 2022 sector research 73

 Automotive and assembly

Unlocking the growth

opportunity in battery
manufacturing equipment
by Jakob Fleischmann, Dorothee Herring, Ruth Heuss, Friederike Liebach, and Martin Linder

Europe’s battery cell–machinery equipment industry is booming on the back of rising global
demand for electric vehicles. By 2025, the annual business opportunity for the industry
is estimated to reach €5 billion to €7 billion. To meet this demand, roughly 30 new battery
manufacturing facilities would need to come online across Europe, requiring up to €100 billion in
capital expenditures. Securing equipment supply and avoiding production delays, however, will be
key success factors in ensuring businesses can make the most of this unprecedented opportunity.

© Monty Rakusen/Getty Images

Ramping up European battery production will create an annual business opportunity

of €5 billion to €7 billion for the equipment industry by 2025.
Total investment in battery cell manufacturing equipment, € billions per year1

7.1
> 30% CAGR
per year Low €100 billion
5.9 1.8
likelihood
€5.3 billion–
1.5 €7.1 billion
4.7 5.3

1.2 4.4
3.5
Total capital- Equipment Business
0.9 3.5 expenditure investment opportunity beyond
High
2.4 likelihood investment expected in 2025, 2025, with > 100
2.6 expected across with total GWh3 annual
0.6
Europe by 2030,2 investment of capacity additions
1.8 with equipment €18 billion–€23 expected to
accounting billion in the next continue
for ~60% 5 years alone

2021 2022 2023 2024 2025

1
Revenues have been harmonized across years to average out fluctuations in annual capacity additions and other factors. Additional capacities beyond 2025
are expected to be announced.
2
If all announced capacities are realized.
3
Gigawatt-hours.
Source: McKinsey battery supply tracker (June 2021); McKinsey analysis

74 McKinsey on Investing Number 8, December 2022

 Capital projects and infrastructure

Is your capital strategy ready

for the 21st century’s first big
investment wave?
by Steffen Fuchs, Homayoun Hatami, Tip Huizenga, and Christoph Schmitz

The magnitude is unprecedented: between 2022 and 2050, roughly $9.2 trillion in annual
average spending will be required to renew, upgrade, and build physical assets to meet the
world’s decarbonization and sustainability goals. In a net-zero 2050 scenario, mobility, power,
and buildings require the most capital spending. Successful implementation of such a colossal
capital management strategy will be challenging. Organizations will need to address supply
chain inefficiencies; outdated project delivery systems; and shortages of labor, equipment,
and raw materials. The solution partly lies in adopting a CEO-led approach that focuses on
deploying advanced analytics for better capital planning.
© Hiroshi Watanabe/Getty Images

Spending on physical assets for energy and land-use systems in the NGFS Net Zero
2050 scenario would rise by about $3.5 trillion annually more than today.
Annual spending on physical assets for energy and land-use systems¹ in a Net Zero 2050 scenario,²
average 2021–50, $ trillion

$9.2 Total annual spending

in a Net Zero scenario
New spending

$3.5 New spending on low-emissions

assets and enabling infrastructure

Current spending

$1.0 Spending reallocated from

high- to low-emissions assets

$2.0 Continued spending on

low-emissions assets and
enabling infrastructure³

$2.7 Continued
spending on high-
emissions assets3

¹We have sized the total spending on physical assets in power, mobility, fossil fuels, biofuels, hydrogen, heat, CCS (not including storage), buildings, industry (steel
and cement), agriculture, and forestry. Estimation includes spend for physical assets across various forms of energy supply (eg, power systems, hydrogen, and biofuel
supply), energy demand (eg, for vehicles, alternate methods of steel and cement production), and various forms of land use (eg, GHG-efficient farming practices).
²Based on the NGFS Net Zero 2050 scenario using REMIND-MAgPIE (phase 2). Based on analysis of systems that account for ~85% of overall CO₂ emissions
today. Spend estimates are higher than others in the literature because we have included spend on high-carbon technologies, agriculture, and other land use, and
taken a more expansive view of the spending required in end-use sectors.
³Our analysis divides high-emissions assets from low-emissions assets. High-emissions assets include assets for fossil fuel extraction and refining, as well as fossil
fuel power production assets without CCS; fossil fuel heat production, gray-hydrogen production; steel BOF; cement fossil fuel kilns; ICE vehicles; fossil fuel
heating and cooking equipment; dairy, monogastric, and ruminant meat production. Low-emissions assets and enabling infrastructure include assets for
blue-hydrogen production with CCS; green-hydrogen production using electricity and biomass; biofuel production; generation of wind, solar, hydro-, geothermal,
biomass, gas with CCS, and nuclear power along with transmission and distribution and storage infrastructure; heat production from low-emissions sources such
as biomass; steel furnaces using EAF, DRI with hydrogen, basic oxygen furnaces with CCS; cement kilns with biomass or fossil fuel kilns with CCS; low-emissions
vehicles and supporting infrastructure; heating equipment for buildings run on electricity or biomass, including heat pumps; district heating connections; cooking
technology not based on fossil fuels; building insulation; GHG-efficient farming practices; food crops, poultry and egg production; and land restoration.
Source: McKinsey Center for Future Mobility Electrification Model (2020); McKinsey Hydrogen Insights; McKinsey Power Solutions; McKinsey–Mission Possible
Partnership collaboration; McKinsey Sustainability Insights; McKinsey Agriculture Practice; McKinsey Nature Analytics; McKinsey Global Institute analysis

Highlights from McKinsey’s 2022 sector research 75

 Chemicals

Cracking the growth code

in chemicals
by Siddhant Gupta and Ryan Paulowsky

Chemical companies need to rethink strategy. Despite high demand from emerging markets,
many diversified and specialty manufacturers are not achieving outsize returns or consistent
revenue growth. Only 16 percent of chemical companies—the growth champions—managed to
grow above global GDP growth rates while delivering an ROIC [return on invested capital] higher
than the chemical industry’s weighted average cost of capital. Slowing market momentum post-
COVID-19 risks tempering growth more. Chemical companies need to ramp up their omnichannel
strategies, invest in digital and analytic capabilities, and reevaluate their contracting strategies to
provide better protection against inflationary pressures.

© artpartner-images/Getty Images

Achieving consistent growth has been a challenge for most chemical companies.
Top specialty and diversified players (n = 151)1

ROIC, median, 2010–19 2 ~3% Average global GDP growth,

CAGR, 2010–19
26 Specialty chemicals
Margin optimizers Growth champions
23% companies 16% companies Diversified chemicals
24
TRS3 = 16% TRS3 = 23%
Size of bubble
22 represents relative
average revenue,
20 2010–19

18

16

14

12

10

8
~7.5%
6 Chemicals industry
weighted average cost
4 of capital

0
Poor performers Growth optimizers
–2 49% companies 17% companies
TRS3 = 10% TRS3 = 16%
–4
–20 –15 –10 –5 0 5 10 15 20 25 30

Revenue, CAGR, 2010–19

Note: Figures may not sum to 100%, because of rounding.

¹Excluding 25 companies who exited the market during 2015–19.
2
ROIC for each year during 2010–19 above average ROIC.
3
Total return to shareholders.
Source: S&P Capital IQ

76 McKinsey on Investing Number 8, December 2022

 Consumer

Three pathways to fast

and profitable growth in
the consumer sector
by Jordan Bar Am, Simon Land, Duncan Miller, René Schmutzler, and Gage Wells

Achieving continuous, profitable growth in the consumer sector amid continuing inflation and
supply chain challenges is not easy. Size matters. Between 2009 and 2019, smaller companies
(with $300 million to $3 billion in annual revenue) grew fastest. On the other hand, companies
with more than $10 billion in annual revenue faced greater challenges and grew at only
2.4 percent. Companies that have outperformed, both in terms of rapid growth and expanded
margins, typically benefited from the following strategies: expanding the company’s core,
entering into new categories and geographies, and launching disruptive businesses.

© PhotoAlto/James Hardy/Getty Images

Rapid growth in the consumer sector is rare, with faster growth typically coming from
smaller and midsize companies that have headroom to grow.
Share of consumer < $3 billion $3 billion–$10 billion > $10 billion
companies, by revenue (195 companies (72 companies (62 companies
CAGR,¹ 2009–19, in 2009) in 2009) in 2009)
% (n = 329)² 2

Growth 11
16 15
> 10% CAGR

Growth 22
16
6–10% CAGR
26

Growth
30
2–6% CAGR 33
27

Growth
12
0–2% CAGR
17

Growth 31
25
< 0% CAGR
17

Weighted average
5.2 4.9 2.4
CAGR, 2009–19, %

¹Revenue growth sales calculated in nominal US dollars. Figures may not sum to 100%, because of rounding.
²Consumer companies based in Europe and the US with 2009 revenues greater than $300 million, but inclusive of global consumer-packaged-goods
companies with large businesses in Europe and the US (ie, Amorepacific, Gruma, Grupo Bimbo, Kikkoman, JBS, Shiseido).
Source: Public financial disclosures

Highlights from McKinsey’s 2022 sector research 77

 Engineering, construction, and building materials

The building products industry

is ripe for innovation
by Matt Bereman, Jose Luis Blanco, Brendan Fitzgerald, Imke Mattik, and Erik Sjödin

The building products industry has been fraught with supply chain disruptions, labor
shortages, and raw-materials price volatility. Our 2022 global survey of more than 500
industry players revealed that many executives view investing in innovation, digital
transformation, and R&D as key differentiators. But change is hard—and harder for some than
others. To stimulate growth and avoid getting left behind due to these trends, leaders should
focus on key value creation drivers. These include setting clear targets for innovative growth,
doing routine interventions on cost programs, implementing marketing and sales initiatives,
and developing a more agile approach to resource allocation.

© Feverpitched/Getty Images

Drivers of value creation can be categorized by routine interventions and more

ambitious moves like M&A and innovation.
Illustrative chart of how value-creation drivers can increase a company’s value, $

Innovation can occur in core

operations and also in the broader
product or business model

Current Align to and invest Determine how to Shape the Innovation 5-year aspiration
performance behind market trends outperform portfolio with applied
(momentum) competitors M&A&D¹ broadly

Drivers of value creation

¹Mergers, acquisitions, and divestitures.

Source: McKinsey analysis

78 McKinsey on Investing Number 8, December 2022

 Financial services

Creating value and finding

focus in the insurance industry
by Pierre-Ignace Bernard, Stephan Binder, Alexander D’Amico, Henri de Combles de Nayves,
Kweilin Ellingrud, Bernhard Kotanko, Philipp Klais, and Kurt Strovink

2021 saw a rebound in the global insurance industry’s premium growth and profits, but the
recovery was not uniform across regions and insurance segments. According to our Global
Insurance Report findings, brokers have emerged as one of the clear winners in the industry,
demonstrating the highest TSR compared to other segments in the insurance value chain
between 2020 and 2021, as well as the preceding ten years. Regionally, North America has
produced the best premium growth, profits, and shareholder returns, with the 2021 performance
attributed to strong vaccine rollouts and the resumption of activities.

© duckycards/Getty Images

Brokers and North American insurers produced the best returns in the past decade.
Annualized TSR by line of business, %

2010–19 2020–21

Global brokers 21.9 53.4

Reinsurers 14.9 –4.4

P&C 12.7 19.8

Multiline 9.8 14.9

Life and health 9.7 7.0

Annualized TSR by geography, %

North America 15.6 25.1

Europe, Middle
8.7 –0.2
East, and Africa

Asia–Pacific 4.9 –3.4

Note: The following sectoral indexes have been considered: Refinitiv Global Reinsurance Index, S&P Global 1200 Insurance Brokers TR Index, S&P Global
1200 Life & Health Insurance TR Index, S&P Global 1200 Multiline Insurance TR Index, S&P Global 1200 Property & Casualty Insurance TR Index, STOXX
Asia/Pacific 600 Insurance Index, STOXX Europe 600 Insurance Index, STOXX North America 600 Insurance Net Return Index.
Source: Bloomberg; Capital IQ; Refinitiv Eikon

Highlights from McKinsey’s 2022 sector research 79

 Healthcare systems and services

Profit pools are shifting in

the US healthcare industry
by Shubham Singhal and Neha Patel

While the growth outlook for the US healthcare industry remains positive, certain segments
are poised to outperform between now and 2025. The overall industry is expected to grow
at 6 percent per year during this period, with payers and providers growing the fastest. For
the payer segment, the profit pool is likely to shift toward government segments due to rapid
growth in the 65-and-up population and increased adoption of Medicare Advantage. Positive
outlook for providers is also driven by the aging population, in addition to the pandemic-
triggered shift in care delivery services and nonacute sites of care.

© ronstik/Getty Images

Healthcare profit pools are expected to show a strong recovery post-COVID-19,

with payer and services segments growing fastest.
Projected healthcare
EBITDA¹ across
segments, 2019–25, +6% 696
$ billion 0% per annum
68 Healthcare services
per annum and technology

561 62 Pharma services

558

45 50 57 Payer
53 55

55 40
183 Manufacturers

155 165

325 Provider
254 249

2019 2021 2025

¹Earnings before interest, taxes, depreciation, and amortization.

Source: McKinsey Profit Pools Model

80 McKinsey on Investing Number 8, December 2022 80

 Life sciences

What are the biotech

investment themes that will
shape the industry?
by Olivier Leclerc, Michelle Suhendra, and Lydia The

Until last year, venture capital (VC) companies were investing substantially in biotech start-ups using
innovative platform technologies to address patients’ unmet needs. This industry segment received
more than two-thirds of the total $52 billion VC biotech funding from 2019 to 2021. Investor interest
also surged in cell therapy 2.0, next-generation cell therapies, precision medicine, and other biotech
platforms. This increased capital allocation has the potential to positively shape long-term drug
development if biotech companies are able to successfully weather ongoing macro challenges,
including slower economic growth, higher inflation, and rising interest rates.

© Who_I_am/Getty Images

Venture capital funding in biotech companies was driven by innovative platform technologies.
Seed to series C1 VC funding in privately held biotech companies, by platform technology, 2019–21, $ billion

7.7 Cell therapy 2.0 7.6 Next-generation gene therapies

Innate immune cells Other T cell therapies RNA-based Other viral-vector

modalities technologies
and editing

1.3
Precision control
of cell therapy
1.7 2.2
Novel Other nucleic acid
1.1 nucleases technologies
In vivo Other
cell therapy 0.4 0.1 0.9
Other Non-nuclease
stem cell editing and
therapies modulation
0.9 4.0 0.7 2.0
Early disease
detection
Target
identification
New small-
molecule
Improved
capsids
0.8
Small
binding sites molecules

3.4
Other
1.8 biologics
1.0
Biomarker 2.1
discovery Biological
Rational 2.0 vehicles
0.3
drug design Novel Protein Enhanced nano-
disease degradation particles 0.2
targets Other
1.5
delivery
Precision population health 0.3 0.5 0.5 methods
Other precision 1.7 Other undruggable
medicines Lead target methods
validation 0.5
1.0 Other ML methods 0.2 0.9 0.9

4.5 4.4 4.0 2.3

Precision Machine learning (ML)– Validated but New delivery
medicine enabled drug discovery ‘undruggable’ targets methods

Note: Figures may not sum, because of rounding.

1
Deals > $10 million in seed to series C in privately held companies during 2019–21; filtered for “biotechnology” industry; excludes contract and research services,
industrial biotechnology, and food/agriculture.
Source: McKinsey analysis based on PitchBook, Inc., data; has not been reviewed by PitchBook analysts

Highlights from McKinsey’s 2022 sector research 81

 Oil and gas

Accelerating the energy

transition requires more
capital allocation
by Tamara Gruenewald, Jesse Noffsinger, Ole Rolser, Namit Sharma, Bram Smeets, Linda
Tiemersma, Christer Tryggestad, Jasper van de Staaij, and Markus Wilthaner

The war in Ukraine has sent energy markets haywire. Amid all the volatility, some long-term
trends—particularly the push for decarbonization—continue to develop. As countries transition
to a low-carbon economy, substantial investments will be needed to support their emission-
reduction goals. According to our Global Energy Perspectives 2022 report, across sectors,
annual investment in energy supply and production is expected to double by 2035 to reach $1.5
trillion to $1.6 trillion. Decarbonization technologies are projected to make up more than a fourth
of these total global investments. Despite their growth potential, however, the business models
© Yaorusheng/Getty Images
and revenue streams in a decarbonized system continue to remain uncertain.

Energy may attract increasing investment, with most growth being in RES and
decarbonization technologies.
Despite decline in underlying fossil-fuel demand, investments in O&G are expected to remain stable

Further Acceleration4

Historical Decarbonization Technologies¹ Power Renewables² Power Conventional³ Gas Oil

Global investments in the energy sector CAGR

Billion $–through cycle perspective average over three-year window 2021–35

1,950
+4% p.a.
1,700
1,550 1,550 12%

1,250
1,150 4%
1,100

850 1%

2%

–1%

2012 15 20 25 30 35 CT AC

Note: This analyses was conducted before the Ukraine invasion in February 2022.
1
Includes sustainable fuels; carbon capture, utilization, and storage; hydrogen; and electric-vehicle charging.
2
Includes solar, onshore wind, offshore wind, hydro, and other.
3
Includes coal, gas, nuclear, and other.
4
For the O&G segments the 2021 Accelerated Transition Scenario is used in combination with Further Acceleration and Achieved Commitments, and the
2021 Reference Case Scenario with Current Trajectory.

82 McKinsey on Investing Number 8, December 2022

 Retail

Playing offense on circularity

can net European consumer
goods companies €500 billion
by Sebastian Gatzer, Stefan Helmcke, and Daniel Roos

The European consumer goods industry is witnessing rapid growth in the demand for circular
products, led by sustainability-conscious shoppers and regulation. Beyond the obvious
environmental benefits, there is also a strong business case for companies—particularly in
the fast-moving consumer goods, fashion and luxury, and electronics segments—to promote
recycled, refurbished, and reused goods. To capitalize on this value creation potential, companies
can develop greener supply chains and operations, calibrate portfolios toward high-demand
circular products, and command appropriate green premiums.

© Andriy Onufriyenko/Getty Images

By 2030, European circular-economy product segments will grow at around 10 to

15 percent annually to reach around €400 billion to €650 billion.
Estimated 2030 European circular-economy market size, by consumer goods category,¹ € billion

Total ~400–650 Total by category

45–110 8– 60–80

~115–200
10
Fashion and luxury

85–140
Fast-moving
consumer goods ~85–140

50–90 ~5 15–30
Other
(eg, entertainment,
outdoor, do it ~70–125
yourself, mobility)

Consumer 0– 40–50 25–30

electronics and 10
home appliances ~65–90
Home and living 30–35 2–4 4–6
~35–45
Sports 10–20 5–10 15–20
~30–50
Recycled and sustainably Refurbished Resold/rented
produced products products products

~220–405 ~60–80 ~120–165

¹Total European consumer goods market in 2030: €1,700 billion (low); €1,800 billion (high).
Source: Euromonitor; Statista; McKinsey analysis

Highlights from McKinsey’s 2022 sector research 83

 Travel, transportation, and logistics

Startup funding in logistics

is the next big investment
opportunity
by Ludwig Hausmann, Maite Pena-Alcaraz, Jaron Stoffels, Max Wiest, and Tobias Wölfel

Investors are exploring new and relatively untapped growth areas within the highly sought-
after logistics industry. Funding for logistics start-ups almost doubled in 2021, with last-mile
delivery businesses, visibility and intelligence providers, and road-freight marketplaces
receiving the largest share of inflows. These areas of the logistics value chain gained global
attention amid the disruption triggered by the COVID-19 pandemic. While only a few startups
have scaled up and achieved profitability so far, more are likely to grow into mature disruptors
over time. For incumbents to stay competitive, digitization will be key.

© imaginima/Getty Images

Funding in logistics startups has increased dramatically and almost doubled from
2020 to 2021.
Total funding and number of funding rounds, 2010–21

Number of funding rounds Funding, $ billion

220 +70% 24.6

annual funding growth

200 –
2014–21

180
+95%
160

140 15.1

120 12.2 12.6

100

80 > 8.5

6.5
60
4.8 2022 off to a
40
flying start with
2.6
20 a $935m funding
0.6 round in Flexport
0.1 0.1 0.1 0.2
0 on Feb 7
2010 11 12 13 14 15 16 17 18 19 20 21 Q1 2022

Source: CB Insights; Crunchbase, Pitchbook, company websites

84 McKinsey on Investing Number 8, December 2022

Why private equity
sees life and annuities
as an enticing form of
permanent capital
Private acquisitions of in-force books are growing. Here’s a
playbook for those considering market entry, those already in,
and insurers wondering how to respond.

by Ramnath Balasubramanian, Alex D’Amico, Rajiv Dattani, and Diego Mattone

© DanielPrudek/Getty Images

85
 Permanent capital—investment funds that do not represent a once-in-a-generation opportunity.
have to be returned to investors on a timetable, or at We’ll also look at the requirements for PE firms on
all—is, according to some, the “holy grail” of private the sidelines that want to enter the market, discuss
investing.1 Permanent capital owes its exalted status some overlooked ways that PE owners can create
to the time and effort that managers can save on value, and highlight some implications for life
fundraising, and the flexibility it provides to invest at insurers as they consider either selling a portion of
times, like a crisis, when other forms of capital can their book of business or emulating and competing
become scarce. with this potent new industry force.

Permanent capital can take many forms, including

long-dated and open-ended fund vehicles. The Why PE investments in life insurance
balance sheet of a life and annuities company is are growing
one form of permanent capital that has drawn much The core attraction is straightforward. The balance
attention. In 2021, private investors announced sheets of life and annuities companies are well
deals to acquire or reinsure more than $200 billion stocked with assets (to match the liabilities of future
of liabilities in the United States. Such investors now payouts and indemnities), but until payout, these
own over $900 billion of life and annuity assets in assets need to be invested to generate returns. And
Western Europe and North America. Assuming the in many cases, the cost of servicing the liabilities
pending deals close successfully, private investors is significantly lower than the potential investment
will own 12 percent of life and annuity assets in the return. The spread represents an attractive margin.
United States, totaling $620 billion, and represent
more than a third of US net written premiums of The most common way for general partners (GPs)
indexed annuities. All five of the largest private to capture the spread is to set up an insurer that
equity (PE) firms by assets have holdings in life they control through an equity investment
insurance, representing 15 to 50 percent of their (sometimes in conjunction with other investors,
total assets under management. By our count, 15 such as sovereign-wealth funds) and then acquire
alternative asset managers have entered the market, or reinsure books from other insurers. To ensure
or stated their intent to do so. Insurance carriers are they earn the required returns on acquired books,
also benefiting from all the attention: many of the these GPs typically influence the strategic asset
largest insurers have sold legacy books to private allocation (SAA) and apply their investment
buyers, typically to improve their return on equity management capabilities to earn alpha on some of
and to free up capital for reinvestment or return the asset classes. The benefits to the GP in this case
to shareholders. For some public carriers, these are threefold:
transactions have generated near-instantaneous
expansion of their price–earnings multiple. — First, in our experience, executing the value-
creation playbook can generate internal rates
The trend is not new: private investing in insurance of return (IRRs) of 10 to 14 percent. Investment
dates back more than 50 years to Berkshire returns have substantially lifted return on equity
Hathaway’s acquisition of National Indemnity (ROE) in recent years. GPs achieve stronger
in 1967. As that example shows, many forms of investment returns largely by rotating the asset
insurance beyond life and annuities can serve allocation into classes that are higher risk and
as permanent capital, including specialty and higher return (while still meeting regulatory and
property and casualty (P&C). In this article, however, rating agency guidelines) and achieving higher
we’ll focus on the reasons why many PE firms alpha within these asset classes. Consider what
have concluded that life insurance and annuities US PE-backed insurers have accomplished:

1
Stephen Foley and Henny Sender, “Permanent capital: Perpetual cash machines,” Financial Times, January 4, 2015.

86 McKinsey on Investing Number 8, December 2022

 one analysis found that they generated 62 — Finally, life insurance offers the potential for
basis points (bps) higher investment yield than scale. Traditional life liabilities in Europe total
the industry average.2 Within three years of €4.5 trillion; in the United States, life and annuity
acquisition, 80 percent of these insurers had insurers carry $4.5 trillion of assets on the
increased their allocation to asset-backed general account, with an additional $1.5 trillion
securities (primarily collateralized loan in separate variable-annuity liabilities, and there
obligations), and over half of their investments are $3 trillion of private-sector defined-benefit
were in private loans (compared with 37 percent liabilities. Even after many large PE acquisitions,
for the industry). Many PE firms have privileged, a huge supply continues to be available, allowing
at-scale capabilities to originate higher risk- PE firms that build insurance capabilities to
return assets and deliver excess returns. What’s scale and take full advantage of this opportunity.
more, the approximately ten times asset-to-
equity ratio typical of insurers amplifies the Another model that some GPs follow is a partnership
impact of strong investment performance. or outsourced chief-investment-officer (OCIO)
model, in which they work with incumbent insurers
A few other factors also contribute to healthy to manage a portion of their assets for the long term
IRRs. For one, disciplined owners are often able and take only a limited equity stake, or none at all.
to operate the business more efficiently and In this case they still receive the benefits of scaling
effectively, as we discuss below. In addition, their credit capabilities, as a high-performing
for some books like variable annuities, public OCIO operation can attract other insurers looking
valuations appear to be lower than private to outsource investment management. This also
valuations. As such, public investors may be wary provides a steady source of fee-related earnings,
of the volatility and opaque risk profile, raising which can drive higher valuations for the GP. And
the issue of whether such books are better as a strategy, this too has potential to be scaled, as
suited to private ownership. other insurers seek higher allocations to these high-
yielding asset classes.
— Second, investing these assets provides a stable
base for GPs to rapidly build their alternative Sellers are willing
credit capabilities. Credit investing is a strategic Put it all together, and it’s clear why life insurance
growth area for many firms at a time when is attractive to PE buyers. Further fueling the
PE markets are becoming more competitive. market is insurers’ willingness to sell: some see
Acquiring a life book immediately provides an opportunity to shift strategy and move into
long-term assets for the firm’s credit arm to more attractive businesses; others think they
invest. It’s a much faster way to reach scale and can deliver greater value by exiting these books
significantly less onerous than raising several and returning the capital to shareholders. One
credit funds. Depending on the structure of the example of the strategic shift is the move by many
vehicle, this can provide a significant source of insurers to a capital-light, fee-based business
fee-related earnings, which are more resilient to model (such as investment management and
market fluctuations and more stable than carried recordkeeping) in structurally advantaged value
interest. In particular, PE-backed insurers pools in their domestic markets (for example, in
typically use structured credit products as core defined-contribution pensions in which assets are
assets in their life insurance books. Origination growing at 6 to 8 percent annually across Europe
of these asset classes is reaching record levels. and the United States). Similar to GPs with strong
For example, collateralized loan obligations, a fee income in their revenue mix, insurers with a high
core asset class for PE-backed insurers, are now proportion of fee earnings will typically trade at
a $760 billion market. higher valuations (often nine to 12 times P/E ratio,

2
Insurance companies remain prime targets for private equity, A.M. Best, July 1, 2021.

Why private equity sees life and annuities as an enticing form of permanent capital 87
 or 1.1 to 1.7 times book value) than those in capital- Market entrants: How to begin
intensive businesses (usually five to eight times, or As so many PE firms have acquired insurance
less than 1.1 times book value). Selling a life back assets, would-be entrants and firms looking to scale
book can provide the needed capital to pivot quickly their nascent operation may find the market more
into a new business, and investors are supportive complicated than it once was.
of such moves. For example, one broad-based US
player divested its closed block of variable annuities As always, the approach starts with strategy. PE
to reduce the volatility of earnings and refocus on firms must first get clear on their strategy for
capital-light businesses. Investors responded well: insurance investments, choosing from a spectrum
over the subsequent three years TSR outperformed that ranges from a one-off opportunistic play to
the life index by ten percentage points. The carrier’s be sold in several years to the foundation for a
price-to-book (PB) ratio rose from 1.2 to 1.6 times, at future platform—and a source of permanent capital.
a time when the broader industry’s PB ratio fell from The choice of strategy has material implications
1.3 to 1.0 times. down the line, on whether or not to insource
IT and operational capabilities; talent strategy;
Even as the capital-light model has gained favor, target geographies (where market dynamics and
the traditional business has become less attractive. regulatory factors are also important); and target
Many insurers’ earnings on in-force blocks have books of business (in annuities, life, or pension risk
come under pressure, as guarantee rates to transfer). Defining the approach up front will save
policyholders are still as high as 150 to 400 bps in costs later. Further, if the deal is large and part of a
some markets, while yields on bonds have declined platform strategy, the investment could change the
by 150 to 300 bps since 2010–11. Naturally, this has DNA of the firm, shifting the focus from PE to private
strained capital as insurers have had to adjust their credit, while also posing future regulatory hurdles.
reserves to reflect future earnings expectations.
An average insurer reinvests about 12 percent of Those firms that are thinking of a platform play, and
its assets annually, so this profitability challenge a long-lasting and growing source of permanent
becomes increasingly acute every year. PE buyers capital, will need three capabilities: proprietary
are subject to the same pressures, of course, but access to potential deals, value-creation skills to
with their different approaches to investment and make the most of the deals they close, and strong
operations, they are better able to overcome the risk-management capabilities given the nature
costs of the capital requirements. of insurance.

In addition, operational and IT issues have continued The most common path for new entrants is to
to challenge profitability and require significant acquire or reinsure a closed block. As competition
investment and management attention to address. increases, some GPs are exploring alternatives,
For example, migrating legacy policy-administration such as scaling organically or through a series of
systems and investing in automation can be smaller transactions. However, these approaches
attractive in the medium term but require careful are proving challenging given the need to reach
management to prevent technical or servicing issues. scale to attain attractive economics. A third
approach seen in two recent examples is a
In short, opportunity abounds. But how to take partnership model. New entrants could consider
advantage? The playbook varies for PE firms partnering with insurers in addition to making
considering an acquisition, those that have owned a outright acquisitions. If the two parties share in the
life book for some time, and insurers. upside (and the risks) and share the capabilities (for

88 McKinsey on Investing Number 8, December 2022

 example, the insurer brings some of the technical Current owners: The value-
capabilities while the GP supplies investment skills), creation playbook
PE firms might be able to secure the benefits of Once they’ve acquired a book, firms can turn their
permanent capital while avoiding the complexity of attention to driving value. Building on our guidelines
operating a life insurer. for closed-book value creation, owners have six
levers that can collectively improve ROE by up to
There are a few risks that PE firms should be aware four to seven percentage points (exhibit):
of and take action to mitigate, starting with the
asset side of the balance sheet, including illiquidity — Investment performance: optimization of the
and credit risk. Rotating the portfolio into higher- SAA and delivery of alpha within the SAA
risk credit assets has advantages but also creates
risk that is important to manage, particularly as — Capital efficiency: optimization of balance-sheet
the portfolio has typically been invested in more exposures—for example, active management of
liquid, stable assets. Managing the credit risk of the duration gaps
underlying assets, maintaining sufficient liquidity as
needed for policyholders, and managing the mark- — Operations/IT improvement: reduction of
to-market volatility on the credit portfolio during a operational costs through simplification
credit downturn to maintain regulatory and rating and modernization
stability are all critical. This risk has been latent,
given the relatively benign credit environment in — Technical excellence: improvement of
the past decade, but a future emergence could put profitability through price adjustments, such as
stress on balance sheets. reduced surplus sharing

A second concern is regulatory uncertainty. — Commercial uplift: cross-selling and upselling

Although regulators are getting used to the idea higher-margin products
of PE ownership of life carriers,3 approval can take
time. As PE firms enter a highly regulated industry — Franchise growth: acquiring new blocks or new
for the first time (and encounter all the risks of distribution channels
shifting regulation), they will need skills to engage
well with the regulator (and ratings agencies, critical Most PE firms view the first lever, investment
stakeholders in reinsurance), to build their trust, performance, as the main way to create value
and, ultimately, to persuade them that the firm is a for the insurer, as well as for themselves. This
responsible owner. lever will grow in importance if yields and spreads
continue to decline. Leading firms typically have
Public opinion can be another obstacle. In two deep skills in core investment-management areas,
recent Western European deals, concerns about such as strategic asset allocation, asset/liability
the impact of a PE owner meant that late-stage management, risk management, and reporting, as
negotiations did not succeed.4 Finally, firms should well as access to leading investment teams that
consider limited partners’ (LPs) reactions to a have delivered alpha.
life acquisition. The potential for sponsor-owned
insurers to invest in other assets and funds raised by Capital efficiency is also well-trod ground, and for
the same sponsor may change the GP/LP dynamic. private insurers it presents a greater opportunity
Such governance challenges are subtle and may given their different treatment under generally
only emerge over time. accepted accounting principles, enabling them to

3
Allison Bell, “Federal crash spotters eye life insurers’ ‘reach for yield,’” ThinkAdvisor, December 20, 2021; “Turning up the magnification:
Regulators have PE-controlled insurers under the microscope (again),” National Law Review, December 9, 2021.
4
Pamela Barbaglia and Carolyn Cohn, “Aviva sets Feb deadlines for $6.6 billion disposals in France, Poland -sources,” Reuters,
January 26, 2021; Kevin Peachey, “LV= leaders criticised over openness in Bain Capital deal,” BBC, November 24, 2021.

Why private equity sees life and annuities as an enticing form of permanent capital 89
 Web <2022>
<Why private equity sees life and annuities as an enticing form of permanent capital>
Exhibit
Exhibit <1> of <1>

The
The value-creation
value-creation playbook can lift
lift return
returnon
onequity
equityby
byfour
fourtotoseven
seven
percentage points.
percentage points.
Potential increase in return on equity by lever,1 percentage points Relevance to book type
Fully Moderately
Life FA/FIA2 VA3
Operations/IT 1.0–1.5
More efficient cost structure
Investments
0.5–1.0
Improve investment return/cost

Capital
0.5–1.0
Greater capital efficiency

Technical
0.5
Pricing adjustments
Commercial uplift
0.5–1.0
Cross/upsell and retention
Franchise growth
New block acquisitions, new distribution 1.0–2.0

Total 4.0–7.0

1
If carrier matches best-in-class benchmark.
2
Fixed annuity/fixed indexed annuity.
3
Variable annuity.

apply a longer-term lens and reduce the cost of a digital-first approach to data and technology,
hedging. However, most firms have yet to explore unencumbered by legacy-system issues. Our
the other levers—operations and IT improvement, preliminary analysis suggests that as PE firms
technical excellence, commercial uplift, and achieve scale in insurance, typically defined as at
franchise growth—at scale. Across all these levers, least $10 billion of assets, costs can be wrestled
advanced analytics can enable innovative, value- lower. In our study of a small sample of US and
creating approaches. European closed-book acquirers, US firms, which
have typically reached scale, enjoy costs 20 to
Operations/IT improvement 40 percent lower than general life insurers in most
Cost cutting is a paradox for private acquirers of major operating-cost categories. But European
insurance books. On one hand, the opportunity is acquirers are burdened with costs 30 to 60 percent
tempting: insurers have generally not cut costs as higher, in part due to the more complex books they
fast as other industries, and the books in question have acquired.
are often high-cost operations. On the other hand,
acquirers sometimes underestimate the complexity Many of the techniques to address operating and
that drives these costs, given the complicated IT costs are well understood: process streamlining,
nature of multiple legacy systems and nuances changes to operating location, and efforts to reduce
across policy vintages—to say nothing of new costs overhead costs are levers most insurers have
for postmerger integration. New entrants have pulled to some degree. Many have also attempted
a particular advantage here, as they can adopt to capture scale benefits. To get to the next level,

90 McKinsey on Investing Number 8, December 2022

insurers can take a comprehensive look at these in a target book, for example, can be 20 to
levers to understand their interdependencies. For 50 percent more accurate than traditional actuarial
example, unlocking scale benefits requires action methodology. Combining actuarial and AI techniques
to reduce complexity of the book, by offloading can unlock significant value as the franchise grows.
legacy products, say, or decommissioning legacy IT For new entrants, identifying innovative ways to
systems. For a GP, this can reduce dividends in the grow the franchise can be particularly attractive.
short term but offer an attractive return given the They might, for example, expand into structured
longer-dated nature of these investments. settlements, flow reinsurance, or coinsurance
(particularly for those without manufacturing
New AI techniques, including machine learning, capabilities). There are at least three prominent
can also help insurers capture more of these examples of players that began with a closed-book
opportunities than was previously possible. focus but now derive significant value from organic
For example, applying these methods to system growth which represents 25 to 50 percent of their
migration and data extraction allows insurers to flows and assets.
bring down part of the costs before executing
an outsourcing contract and therefore retain
more value. Insurers: Fight or flight?
Several leading insurers already exercise the same
Technical excellence value-creation playbook that PE firms are using. In
Conducting a thorough review of contractual many cases, these insurers are better positioned
terms and finding opportunities to adjust where on the operational, technical, and commercial
appropriate (for example, through reduced surplus levers. For example, by running operations and
sharing) can be a material driver of value. New AI IT transformations or using analytics-powered
skills and modernized IT systems can also bolster methods to release capital or improve in-force
the ability of insurers to apply technical and earnings, they are creating value despite the
commercial levers. For example, AI can enhance challenging interest-rate environment.
an insurer’s understanding of customer blocks and
enable it to develop a segmented approach with Insurers are also taking a fresh look at investment
targeted interventions. levers and, in some cases, studying the moves
made by GPs for potential insights. Many insurers
Commercial uplift are building investment skills, reviewing the
AI offers additional benefits, such as avoiding strategic-asset allocation, and finding new ways
lapsing through a better understanding of to secure access to, and generate alpha from,
customers and identifying opportunities to cross- higher-yielding, capital-efficient asset classes,
sell or upsell. For example, one insurer applied AI provided they can effectively manage the risk. In
modeling along with a refreshed strategy for sales more challenging asset classes, some insurers
force optimization. Agents in this program are exploring partnership models. For example, at
delivered between 40 and 250 percent more least two insurers have recently partnered with
cross-sell revenue than a control group that did alternative managers; in these deals, the insurer
not use analytics. brings operations expertise, and the alternative
manager can capture the upside from managing
Franchise growth the credit investments and delivering best-in-
Identifying attractive new blocks and ensuring an class capabilities for investment performance. The
operating model that can successfully scale without arrangement lets the insurer capture a share of
raising costs significantly or damaging policyholder the upside without having to build or buy all of the
service is a critical lever. Advanced analytics can needed specialist capabilities, and can create a
unlock new opportunities here as well: applying structure with which to raise external capital.
machine learning to model policyholder behavior

Why private equity sees life and annuities as an enticing form of permanent capital 91
 For insurers who cannot see a path to building The window is firmly open on this once-in-a-
leading capabilities or have more attractive generation opportunity—momentum is building, and
investment opportunities, sale or reinsurance of more investment is sure to come. But as competition
part or all of a capital-intensive book could free increases and credit spreads remain low, firms will
up significant capital. To gain the best price, they need to evolve their value-creation playbook and
must understand the PE value-creation playbook deploy a broader set of levers to capture the full
sketched above and strike a fair deal. potential from this opportunity.

One final possibility for insurers facing a challenging

value-creation path: a few insurers could pool their
challenged assets and build sufficient scale to offer
a compelling proposition to another insurer, either
as a purchase or a joint venture.

Ramnath Balasubramanian and Alex D’Amico are senior partners in McKinsey’s New York office, Rajiv Dattani is an
associate partner in the London office, and Diego Mattone is a partner in the Zurich office.

The authors wish to thank Pierre-Ignace Bernard, Jay Gelb, Nils Jean-Mairet, Bryce Klempner, Pankaj Kumar, Ju-Hon Kwek,
Nick Milinkovich, Rob Palter, Alex Panas, David Quigley, Andrew Reich, Archie Sinclair, John Spivey, Kurt Strovink, Josue Ulate
Chinchilla, and Ulrike Vogelgesang for their contributions to this article.

Copyright © 2022 McKinsey & Company. All rights reserved.

92 McKinsey on Investing Number 8, December 2022

Digitally native brands:
Born digital, but ready
to take on the world
By applying the right criteria, investors can identify digitally native
brands with the potential to outperform.

by Adam Broitman, Elizabeth Hunter, and Jennifer Schmidt

© Jasmin Merdan/Getty Images

93
 Digitally native brands (DNBs) are attracting attractive their customer file is and how much it will
significant investor attention these days—and for cost to acquire new customers. There are four critical
good reason. DNBs make up an increasing share factors to consider when assessing whether a DNB
of disruptive players in the market, comprising has the potential for outsize performance:
15 percent of the new unicorns funded in 2020, up
from 10 percent in 2019 and 5 percent in 2018.1 They 1. six key metrics
are growing, on average, at triple the rate of overall
2. categories with the most potential
e-commerce,2 while the fastest-growing among
them have scaled from $50 million in revenues to 3. essential capabilities
$1 billion in four to eight years.3 The most successful
4. pitfalls that can derail success
consumer-facing brands, including food-delivery
apps, tech-enabled exercise equipment, and hair-
By applying the criteria outlined in each of these
coloring systems, are innovative category disruptors
sections to the research and diligence underlying a
that enjoy intense customer loyalty.
potential deal, investors have the best shot at
the golden ring of DNB investing: identifying a
DNBs’ online origins give them two important
brand that was born digital but ultimately lives in the
competitive advantages: deep knowledge of their
imagination of the world’s consumers.
customer base and extensive control over the
customer file. Whether a DNB is a product, service,
or a product-service combination, what sets them
apart is the fact that brand owners know exactly
Four critical factors to consider when
who their customers are, what online behavior led assessing a DNB investment
them to their initial contact with the brand, and Step one in finding a DNB with “superstar” potential
what they’re likely to buy next. This insight creates requires developing a baseline understanding of the
opportunities to build deep and lasting relationships core health of the customer file: how well a business
with customers. It’s an advantage that can carry retains and drives spend in its customer cohorts,
over even if, later in their life cycle, DNBs branch into how much it costs to acquire new cohorts, and how
brick-and-mortar. much potential there is to improve in both areas.
These bedrock principles of DNB investing are
Today, low barriers to entry have encouraged an relatively straightforward. Then comes the hard part:
explosion of DNBs, flooding the market with the fruits assessing how well these pieces fit together
of creative entrepreneurship. However, DNBs that and, crucially, how well they underpin a brand with
break through with outsize investor returns are rare. a genuine raison d’être in the DNB landscape.
Over the past two decades, fewer than 0.5 percent
of DNBs have reached $100 million in revenues. Six key metrics
In fact, more than 90 percent of businesses that A brand’s investment attractiveness rests largely on
originated through e-commerce earn less than a handful of key metrics, which include net customer
$1 million in annual revenues (Exhibit 1).4 Investors growth, year-over-year customer cohort value,
face the challenge of sifting through concepts to projected lifetime value (LTV), customer acquisition
determine which are worthy of the capital required cost (CAC), contribution margin, and total
to scale a business or buy into an existing addressable market (TAM). (For definitions of terms
company at high multiples. useful to DNB investors, see sidebar, “A glossary of
terms for DNB investors.”)
There are ways for investors to gauge whether DNBs
are equipped for growth and future profitability, Ultimately, there are a few ratios investors can look
which are primarily grounded in understanding how at based on these metrics that have strong predictive

1
McKinsey analysis of data from CB Insights.
2
ComCap evolution of digital brands report, ComCap, Q1 2020.
3
Tom Huddleston Jr., “How Peloton exercise bikes became a $4 billion fitness start-up with a cult following,” CNBC, February 12, 2019.
4
Revenue Distribution for eCommerce Companies in the Top 10 Countries Database, PipeCandy, accessed October 14, 2021.

94 McKinsey on Investing Number 8, December 2022

 value for future success. One of the most common is the can indicate whether it is gaining any operating
LTV:CAC ratio. This measure is essentially the marginal leverage over time, in particular ensuring that the
return on investment for acquiring every new customer. loss ratio is gradually shrinking.
Cross-industry averages dictate a 3:1 LTV:CAC ratio
as satisfactory5; however, the optimal ratio depends Categories with the most potential
on the category dynamics and business model, with The original generation of DNBs, which began
early-stage players focused on customer recruitment emerging in the 2000s and early 2010s with brands
tolerating levels as low as 1:1.6 such as Warby Parker and Everlane, often focused
on cutting out the middleman to proffer goods at
Another important metric to understand is the overall reduced prices or on selling a unique product, or both.
size of the TAM to the size of the current business. This
figure indicates how much runway the business has Today, to stand out in the marketplace, DNBs
with its existing offering within the target customer must offer even more compelling propositions to
base. Before expanding the TAM into new categories, differentiate themselves from traditional brick-and-
geographies, and customer groups, a good ratio that mortar players or e-commerce offerings. The
indicates further runway is below 5 to 10 percent, most successful brands typically play in categories
though the degree of competition and the size of the with distinct dynamics, such as predictable and
market can make the ideal ratio lower. routine consumption patterns, personal and gift-
buying tendencies, strong gross margin profiles,
In addition, for any business that is still unprofitable, favorable size/weight ratio for shipping, and low
tracking how losses change with revenue scaling likelihood of returns (Exhibit 2).

Exhibit 1

More than
More than 90
90 percent
percent of e-commerce
e-commercecompanies
companiesininthe
theUnited
UnitedStates
Stateshave
have
revenues of
of less
lessthan
than$1
$1million
million per year.

US e-commerce companies’ market share, by revenue band, %

$1 million– < $25 million–

$25 million 98.68% $100 million
8.02% 0.54%

Less than $1 million

90.66%

> $100 million Unknown

0.20% 0.58%

Source: Revenue Distribution for eCommerce Companies in the Top 10 Countries Database, PipeCandy

5
“What is the LTV/CAC ratio?,” Corporate Finance Institute, accessed October 14, 2021.
6
The Startup Finance Blog, “What does your LTV/CAC ratio tell you?,” Lighter Capital, accessed September 15, 2021.

Digitally native brands: Born digital, but ready to take on the world 95
A glossary of terms for DNB investors

Click-through rate (CTR): a ratio that rep- campaigns across multiple channels (for Next-best product (NBP): predictive
resents the percentage of people who click example, online, offline) analytics that help support marketers in
on an ad or product listing identifying the right merchandise to offer a
displayed to them Earned media: publicity or visibility given customer to get them to purchase
gained through efforts other than
Conversion-rate optimization (CRO): ac- paid advertising Projected lifetime value (LTV): the total
tions taken to increase the percentage of contribution margin a company
users who perform a desired action Net customer growth: the number of cus- expects to earn over the lifetime of its rela-
on a given website (for example, making tomers added by the company tionship with a single customer
a purchase) in a given period, minus the number of
customers who churned over the Share of voice (SOV): share of advertising
Cost per acquisition (CPA): total cost of ac- same period compared with competitors
quiring a new customer through a specific
action or channel Next-best offer (NBO): predictive analytics Year-over-year customer cohort value:
that help support marketers in identifying the number of overall sales from
Cross-channel campaign management the right offer (such as promotions, services, a given customer cohort (for example,
(CCCM): technology and tools associated information) to put in front of a given cus- 2017 customers or 2018 customers)
with designing, executing, and measuring tomer to get them to purchase as time goes on

Some of the magic of DNBs is their ability to and ultimately entering brick-and-mortar to
quickly shift direction and fine-tune assortment, gain greater access to cheaper traffic (Exhibit 3).
product variety, pricing, shipping, deals, product
combinations, and marketing messages to A good example of a DNB following this
retain and grow their customer base. Successful playbook is Peloton, which has pulled nearly all the
DNBs monitor tiny shifts in consumer browsing aforementioned growth levers on its path to
and purchasing behaviors (for example, trial $4 billion in revenues in the 2021 fiscal year.7 It
and switch propensity, length of the purchase began by growing across different distribution
cycle, responsiveness to new offers) to be able to channels (for example, brick-and-mortar shops) and
constantly refine their value proposition to optimize categories (such as treadmills and accessories), and
demand and minimize churn. then pursued new customer segments (for example,
app-only customers) and new geographies (such as
Over time, it is essential to move from start-up to Canada and the United Kingdom).8
grown-up and find sufficient scale to leverage
core infrastructure and build on an active customer These actions can expand the TAM for a given
base. The path we typically see begins with brand, allowing them to tap into new pools
expanding beyond the current assortment (for of customers, spending, or both. Successful brands
example, add-on items, adjacent categories, approach expansion strategically, using a test-
or products geared to new customer segments), and-learn approach to experiment with opportunities
which expands customers’ share of wallet while (such as digital pop-up stores or new products
also attracting potential new consumers. The next offered on a limited basis) before committing to full-
step is making a move to new geographies (often scale implementation.
guided by early signs of cross-border purchasing),

7
Peloton Interactive Inc., US Securities and Exchange Commission Form 10-K 2021. New York, NY: Peloton Interactive Inc., 2021.
8
CNBC Disrupter 50, “Peloton launches an app that’s available to anyone—regardless whether they buy a bike or treadmill,” blog entry by
Angelica LaVito, June 20, 2018.

96 McKinsey on Investing Number 8, December 2022

 Exhibit 2

The most
The most attractive
attractive digitally native brands
digitally native brands typically
typicallyplay
playinincategories
categorieswith
with
distinct dynamics.
distinct dynamics.

Category indicators of attractiveness, favorability ranking

LOW FAVORABILITY HIGH FAVORABILITY

Drivers of
consumer 1 Consumer
need state
Doesn’t align with clear consumer need
or can be fulfilled by Amazon or B&M1
Digitally native brand fulfills a need state
that can’t be fulfilled by Amazon or B&M2
demand

2
Predictable Low predictability of consumption Very predictable consumption patterns
consumption (eg, mood-based or occasion-based)

3 Brand
relevance
Lack of brand relevance to drive Effective branding can significantly influence
consumer loyalty and purchasing behavior consumer-purchasing behavior

Drivers of
economic 4 Price or
cube ratio
Low average unit retail (AUR) or high
shipping cost
High AUR and or low shipping cost

success

5 Shelf stability
or perishability
Low tolerance for pile-up or fulfillment
issues
Shelf stability enables room for less
stringent fulfillment timelines and pile-up

6 Complexity of
personalization
Low rewards or high complexity of
personalization
Personalization delights the consumer and
lends itself to high willingness to pay

¹Brick-and-mortar.
2
For example, convenience, access, curation, regular replenishment cadence.

Essential capabilities Brands pursuing a high level of engagement

Successful DNB teams rely on four key capabilities: must provide excellent customer service,
they build great relationships with customers; including rapid resolution of issues (both directly
they offer these customers compelling reasons reported and encountered through “social-
to shop with them; they pursue avenues to reduce media listening”), loyalty programs, and bonus
customer acquisition costs and, ultimately, the content. For example, Gymshark built a large,
payback period; and they use the best and latest engaged, self-reinforcing community online
technology to drive loyalty. DNBs are often and offline through grassroots marketing and
better positioned than traditional brands to do this experimen­tation across new channels, from
because of their origins and infrastructure; those Spotify to Instagram, and adapted its approach
that embrace more of these best practices will have with the rise of newer platforms, such as TikTok.9
the best chance of outperformance.
— Performance marketing: To manage CAC and
— Community engagement: The most successful LTV effectively, high-aspiration DNBs test
players aim for a relationship with consumers and learn to determine optimal channels for
that goes well beyond traditional brand loyalty. acquiring customers. They develop analytics
Instead, they cultivate satisfied customers that enable them to predict and prevent
as influencers who foster brand trust and churn (for example, flagging and reengaging
community participation, driving engagement dormant customers). They use targeted and
online through both company-driven and personalized ads, promotions, and referrals to
user-generated content. increase awareness, traffic, and conversion.

9
Marketing Breakdowns, “How Gymshark bulked up to being a $1+ billion brand,” blog entry by Nikolett Lorincz, September 2, 2021.

Digitally native brands: Born digital, but ready to take on the world 97
 Exhibit 3

Brands over
Brands over time
time must
must move
move from
from start-up
start-up to
togrown-up
grown-up and
and find
find sufficient
sufficient
scale to leverage
scale leverage core
coreinfrastructure
infrastructure and an active
active customer
customerbase.
base.

Growth milestones for digitally native brands

A Clear, compelling brand

Gaining traction Building out Going big
personality, strong PR, and
online engagement drive
A B C D
early growth

B Increasing product mix helps

to drive intermediate growth

C Brick-and-mortar presence
helps brands grow beyond
$50 million, as customer
Revenue acquisition cost becomes
challenging without a physical
retail touch point with the
consumer

D Owned retail and wholesale

expansion, further diversifica-
tion of product mix, new
geographic presence, or new
consumer segments help to
drive further growth

Time

Strong conversion-rate-optimization capability technology solutions for managing site

is another hallmark of a thriving DNB. Successful content. Content-management systems and
performance marketers take a surgical flexible cross-channel campaign-management
approach to optimizing click-through rate, cost platforms automate and personalize customer
per acquisition, paid media (for example, communication as well as content and product
paid search, paid social media, display offers across the customer journey.
advertising, and video advertising), and earned
media (such as organic search results). More sophisticated brands may leverage
predictive analytics to learn how customers use
— Predictive analytics: Winning DNBs capitalize on their websites. This insight helps DNBs identify
opportunities to grow their current customer base the most promising “next-best product” or “next-
by leveraging the deeper data that they can collect best offer” to offer a specific customer, either
relative to their brick-and-mortar peers. Using this to recommend products for their next purchase
data, DNBs can personalize recommendations and or replacements if they are not able to buy
offer bundled products and services that delight the exact item for which they were originally
their customers. Based on extensive testing, searching. This level of customization requires
DNBs can provide incentives (such as free samples, DNBs to create a unified view of each
shipping, and returns) that increase spending. customer, often using a customer data platform
or similar technology solution.
DNBs often begin their operations in a lean,
“scrappy” manner, employing low-cost marketing Pitfalls that can derail success
technology stacks that can easily be modified Investors should be mindful of both conceptual
to promote experimentation and adapted and operational risks that can limit growth
to changing customer or business needs. and profitability.
To do so, DNBs often rely on open-source

98 McKinsey on Investing Number 8, December 2022

 — Constrained total addressable market: DNBs a path to profitability and the potential to
that are positioned in narrow niches may face improve margins as they scale. To this end,
challenges growing beyond early-stage levels. strong DNBs work to optimize the value chain
Investors must look at whether the business by increasing their buying power, economies of
segment is large enough or expected to grow scale, and operational efficiencies.
rapidly enough to make scaling feasible, or
else be willing to bet that the company can — Lack of focus: If DNBs expand their services
expand successfully into new market segments. or products to capture a wide customer base
before first understanding how to win the core,
— Undifferentiated value proposition and they risk building an unsustainable customer
innovation: DNBs that don’t offer customers model with trial but low loyalty.
a compelling reason to take a risk on a novel,
online-only product will struggle to gain traction.
No matter how well-made the product, if it
could just as easily be sold at the corner store, it To be sure, investors must beware the “halo effect,”
is unlikely to become a game-changing DNB. whereby a prospect appears golden because
it checks off a series of boxes. While the factors
Brands stand out from the pack by delivering outlined in this article are indeed associated
products and personality that turn customers into with successful DNB performers, finding a winner
staunch and vocal loyalists.10 This requires a fresh is more complex than simply verifying that
point of view that customers don’t see in staid these steps are followed. The most compelling
brands. For example, Madison Reed turned hair- DNBs started online not because of an
color buying on its head, so to speak, by offering advantageous customer file or a wide customer
custom color kits that arrive on a recurring base but because the product or service itself
basis; consumers can request free online color genuinely belonged there and, by existing online,
consultations designed to imitate sitting in a salon solved problems for customers. Investors
chair. Brands that offer highly novel solutions should remember that this core authenticity must
sometimes need to overinvest in generating an be in place for the specific approaches outlined
initial trial so that customers get used to the idea. in this article to contribute to success.

— Poor unit economics: Few DNBs turn a profit for DNBs represent some of the most intriguing
their first three to five years, and many fail to consumer concepts on the market and provide
turn a profit even after a decade of growth. Over ample opportunity for investors that succeed
the past 20 years, fewer than 0.5 percent in identifying winners. There is significant risk,
of DNBs have reached the $100 million revenue however, of getting stuck funding companies that
level. Even some large, publicly traded DNBs can’t overcome obstacles to growth. Investors
reinvest all earnings into additional marketing can approach DNBs wisely, however, by using the
and capacity expansion and fail to turn a ideas presented in this article to help identify
profit. While DNBs don’t need to be profitable to high-potential concepts. The reward: participating
be an attractive investment, investors must in a brand born of the virtual world that grows up
be wary of DNBs that don’t provide evidence of to make a mark on the real world.

10
Claire Martin, “A rare path: From venture capital to hair-coloring kits,” New York Times, April 22, 2017.

Adam Broitman is an associate partner in McKinsey’s New York office, Elizabeth Hunter is an associate partner in the Toronto
office, and Jennifer Schmidt is a senior partner in the Minneapolis office.

The authors wish to thank Julie Bashkin and Gabriela Hoffmann Pitten for their contributions to this article.

Copyright © 2021 McKinsey & Company. All rights reserved.

Digitally native brands: Born digital, but ready to take on the world 99
 Climate risk and
the opportunity for
real estate
Real-estate leaders should revalue assets, decarbonize, and create
new business opportunities. Here’s how.

by Brodie Boland, Cindy Levy, Rob Palter, and Daniel Stephens

© Curiosity Rover/Getty Images

100 McKinsey on Investing Number 8, December 2022

 Climate change, previously a relatively peripheral tenants that have made similar commitments. They
concern for many real-estate players, has moved will then create new revenue sources related to the
to the top of the agenda. Recently, investors made climate transition.
net-zero commitments, regulators developed
reporting standards, governments passed laws Building climate intelligence is central to value
targeting emissions, employees demanded action, creation and strategic differentiation in the real-
and tenants demanded more sustainable buildings. estate industry. But the reverse is also true: real
At the same time, the accelerating physical estate is central to global climate change mitigation
consequences of a changing climate are becoming efforts. Real estate drives approximately 39 percent
more pronounced as communities face storms, of total global emissions. Approximately 11 percent
floods, fires, extreme heat, and other risks. of these emissions are generated by manufacturing
materials used in buildings (including steel and
These changes have brought a sense of urgency to cement), while the rest is emitted from buildings
the critical role of real-estate leaders in the climate themselves and by generating the energy that
transition, the period until 2050 during which the powers buildings.1
world will feel both the physical effects of climate
change and the economic, social, and regulatory In addition to the scale of its contribution to
changes necessary to decarbonize. The climate total emissions, real estate is critical in global
transition not only creates new responsibilities for decarbonization efforts for reasons likely to be
real-estate players to both revalue and future-proof compelling for investors, tenants, and governments.
their portfolios but also brings opportunities to Significant reductions in emissions associated
create fresh sources of value. with real estate can be achieved with positive
economics through technologies that already exist.
The combination of this economic transition and For example, upgrading to more energy-efficient
the physical risks of climate change has created lighting systems and installing better insulation
a significant risk of mispricing real estate across have positive financial returns. Today, newer
markets and asset classes. For example, a major technologies also make low-carbon heating and
North American bank conducted analysis that found cooling systems, such as heat pumps and energy-
dozens of assets in its real-estate portfolio that efficient air conditioning, more cost competitive in
would likely be exposed to significant devaluations many markets and climates. These cost-effective
within the next ten years due to factors including upgrades can create meaningful change while also
increased rates of flooding and job losses due derisking assets.
to the climate transition. Additionally, a study of
a diversified equity portfolio found that, absent We suggest three actions real-estate players can
mitigating actions, climate risks could reduce annual take to thrive throughout the climate transition:
returns toward the end of the decade by as much as
40 percent. — Incorporate climate change risks into asset and
portfolio valuations. This requires building the
Leading real-estate players will figure out which analytical capabilities to understand both direct
of their assets are mispriced and in what direction and indirect physical and transition risks.
and use this insight to inform their investment,
asset management, and disposition choices. They — Decarbonize real-estate assets and portfolios.
will also decarbonize their assets, attracting
the trillions of dollars of capital that has been — Create new sources of value and revenue
committed to net zero and the thousands of streams for investors, tenants, and communities.

1
2019 global status report for buildings and construction, International Energy Agency, December 2019.

Climate risk and the opportunity for real estate 101

 Fundamental changes brought on by the climate building supplied by a carbon-intensive energy
transition will open new dimensions of competitive grid or a carbon-intensive transportation system
differentiation and value creation for real-estate is exposed to the transition risks of those systems
players. More important, leaders will make a as well. All these changes add up to substantial
valuable contribution to the world’s ability to meet valuation impacts for even diversified portfolios—
the global climate challenge. an increasingly pressing concern for real-estate
companies (see sidebar, “We do mind the gap”).

Incorporate climate change risks into Physical risks, both direct and indirect, have an
asset and portfolio valuations uneven effect on asset performance
Climate change’s physical and transition risks touch Several major real-estate companies have recently
almost every aspect of a building’s operations conducted climate stress tests on their portfolios
and value. Physical risks are hazards caused by and found a significant impact on portfolio value,
a changing climate, including both acute events, with potential losses for some debt portfolios
such as floods, fires, extreme heat, and storms, and doubling over the next several years. Notably, they
chronic conditions, such as steadily rising sea levels found significant variation within the portfolios.
and changing average temperatures. Transition Some assets, because of their carbon footprint,
risks include changes in the economy, regulation, location, or tenant composition, would benefit from
consumer behavior, technology, and other human changes brought on by the climate transition, while
responses to climate change. others would suffer significant drops in value. The
challenge for players is to determine which assets
Physical and transition risks can affect assets, will be affected, in what ways, and how to respond.
such as buildings, directly or indirectly, by having There is also opportunity for investors who can
an impact on the markets with which the assets identify mispriced assets.
interact. A carbon-intensive building obviously
faces regulatory, tenancy, investor, and other risks; Direct physical consequences can be conspicuous:
over the long term, so does a building that exists the value of homes in Florida exposed to changing
in a carbon-intensive ecosystem. For example, a climate-related risks are depressed by roughly

We do mind the gap

As we work with real-estate firms, we of a cluster of our assets due to climate- climate risks “too much” by 67 to 1 (in
notice that investment teams increasingly related factors that just weren’t considered comparison with stock prices, in which
recognize the impact of climate change on in our investment theses.” the ratio was 20 to 1).1 The International
asset values. As one leader of valuations at Renewable Energy Agency has estimated
a major real-estate-services firm recently The industry at large senses how values that $7.5 trillion worth of real estate could
commented to us: “This is the greatest are shifting. A recent survey of finance be “stranded”; these are assets that will
deviation between modeled valuation experts and professionals conducted by experience major write-downs in value
and actual price that I’ve ever seen, and researchers at New York University found given climate risks and the economic
it’s because of climate.” A chief operating that those who think real-estate asset transition, making real estate one of the
officer of a diversified real-estate investor prices reflect climate risks “not enough” hardest-hit sectors.2
told us, “We’ve seen underperformance outnumber those who think they reflect

1
Johannes Stroebel and Jeffrey Wurgler, “What do you think about climate finance?,” Harvard Law School Forum on Corporate Governance, September 3, 2021.
2
Jean Eaglesham and Vipal Monga, “Trillions in assets may be left stranded as companies address climate change,” Wall Street Journal, November 20, 2021.

102 McKinsey on Investing Number 8, December 2022

 $5 billion relative to unexposed homes. According investors and operators are often left with a major
to the Journal of Urban Economics, after Hurricane capital expense or tax that wasn’t considered in the
Sandy, housing prices were reduced by up to investment memo.
8 percent in New York’s flood zones by 2017,
reflecting a greater perception of risk by potential There is also a host of less direct but potentially
buyers.2 In California, there has been a 61 percent more significant transition risks that affect
annual jump in nonrenewals of insurance (due to whole markets. For example, some carbon-
higher prices and refused coverage) in areas of intensive industries are already experiencing
moderate-to-very-high fire risk.3 rapid declines or fluctuations. In Calgary, for
example, the combination of oil price volatility and
The indirect effects of physical risk on assets can market-access issues (driven by climate change–
be harder to perceive, causing some real-estate related opposition to pipelines) has dramatically
players to underestimate them. For example, in depressed revenues from some buildings. Vacancy
2020, the McKinsey Global Institute modeled rates in downtown Calgary reached about
expected changes in flooding due to climate 30 percent, a record high, as of January 2021.
change in Bristol, England. A cluster of major Investors exposed to the Calgary market have
corporate headquarters was not directly affected, seen their asset values drop precipitously and
but the transportation arteries to and from the area are left trying to either hold on and hope for a
were. The water may never enter the lobby of the reversal of fortunes or exit the assets and take a
building, but neither will the tenants. significant loss.

The climate transition will affect both individual Real-estate players should build the capabilities
buildings and entire real-estate markets to understand climate-related impacts on asset
The investments required to avoid or derisk the performance and values
worst physical risks will drive a historic reallocation Real-estate owners and investors will need to
of capital. This will change the structure of our improve their climate intelligence to understand
economy and impact the value of the markets, the potential impact of revenue, operating costs,
companies, and companies’ locations. These capital costs, and capitalization rate on assets. This
momentous changes require real-estate players includes developing the analytical capabilities to
to look ahead for regulatory, economic, and social consistently assess both physical and transition
changes that could impact assets. risks. Analyses should encompass both direct
effects on assets and indirect effects on the
Among the most direct climate-transition impacts markets, systems, and societies with which assets
are regulatory requirements to decarbonize interact (Exhibit 1).
buildings, such as New York City’s Local Law 97.
In June 2019, the Urban Green Council found that Portfolio and asset managers can map, quantify,
retrofitting all 50,000 buildings covered by the law and forecast climate change’s asset value impact
would create retrofit demand of up to $24.3 billion To understand climate change impact on asset
through 2030.4 Standard property valuation values, landlords and investors can develop the
models generally do not account for the capital following capabilities to understand and quantify
costs required for a building to decarbonize, and risks and opportunities:

2
Francesc Ortega and Süleyman Taspinar,
. “Rising sea levels and sinking property values: Hurricane Sandy and New York’s housing market,”
Journal of Urban Economics, July 2018, Volume 106.
3
Elaine Chen and Katherine Chiglinsky, “Many Californians being left without homeowners insurance due to wildfire risk,” Insurance Journal,
December 4, 2020.
4
Justin Gerdes, “After pandemic, New York’s buildings face daunting decarbonization mandate,” Greentech Media, April 23, 2020.

Climate risk and the opportunity for real estate 103

 Exhibit 1
Physicaland
Physical andtransition
transitionrisks
riskshave
havedirect
directand
andindirect
indirectimplications
implicationsfor
forrevenue,
revenue,
operatingand
operating andcapital
capitalcosts,
costs,and
andcapitalization
capitalizationrate.
rate.

Implications of transition and physical risks, by direct and indirect effects

Transition risks Physical risks

Include changes in the economy, regulation, Hazards caused by a changing climate, from
consumer behavior, technology, and other floods, fires, and storms to rising sea levels
human responses to climate change and changing average temperatures

Direct effect Indirect effect Direct effect Indirect effect

Revenue Unattractiveness of a Decline in a sector Disruptions to an Reduced real-estate

carbon-intensive or local economy asset’s operations demand in a local
asset to an occupier resulting in lower from severe or market given
that has made a local real-estate repeated disruptions to
climate commitment demand or occupancy physical-hazard surrounding
events (eg, major transportation or
floods) other infrastructure

Operating Increased utility Carbon charges on an Increased Increased insurance

costs costs given asset given local maintenance costs as costs as insurers
carbon-intensive regulations physical risks recognize physical
building systems increase risks and adjust
underwriting models

Capital Significant capital Increased financing Investment required Increased capital

costs investment required costs as investors to improve the investments (eg,
to meet local energy and lenders price in resilience of building development fees)
efficiency/emissions market-level to increasing physical required to protect
standards or tenant transition risks (eg, in risks (eg, elevating broader communities
demands (eg, early economies lobby, green roofs, from climate risks (eg,
retrofit of dependent upon protecting electric floodwalls, green
heating/cooling carbon-intensive and mechanical infrastructure for heat
systems), increased industries) systems) mitigation)
need to purchase
lower-emissions
building materials (eg,
steel, cement, timber)

Capitalization Changes in capitalization rate due to perceptions of both physical and transition risks by market
rate participants

— Prioritize. Create a detailed assessment of the — Map building exposures. Determine which
asset or portfolio to determine which physical buildings are exposed to risks, either directly (for
and transition risks are most important and example, having to pay a carbon tax on building
which are less important (using criteria such as emissions) or indirectly (for example, exposure
the probability of a risk occurring or the severity to reduction in occupancy as tenants’ industries
of that risk). decline because of a carbon tax), and the degree

104 McKinsey on Investing Number 8, December 2022

 of exposure (for example, how high floodwaters directly inform investment management,
would reach). This could require detailed lease pricing, capital attraction and investor
modeling of physical hazards (for example, relations, asset management, tenant attraction,
projected changes in flood risks as the climate development, and other core businesses. The
changes) or macro- or microeconomic modeling processes within organizations must shift to
(for example, projected GDP impacts based on ensure that climate-related insights can be a
the carbon price impact on a local geography’s source of real competitive advantage.
energy production mix).
A portfolio revaluation informed by climate change
— Quantify portfolio impact. Combine risks can lead to hard choices but will also open the
assessments of the economic risks on individual door to acting on decarbonization and exploring
buildings into an impact map that enables new opportunities.
visualization of the entire portfolio (Exhibit 2). This
requires combining knowledge of the potential
risk or opportunity and an understanding of what Decarbonize buildings and portfolios
drives the economics of a building (including McKinsey research estimates approximately
drivers of net operating income, tenancy mix, $9.2 trillion in annual investment will be required
and areas of cost variability). globally to support the net-zero transition. If
the world successfully decarbonizes, the 2050
— Take action. These capabilities cannot be economy will look fundamentally different from
isolated in a research or environmental, social, the current economy. If it doesn’t successfully
and governance (ESG) function but should decarbonize, the world will experience mounting

Real-estate
Exhibit 2 owners and investors can assess the effects of physical risks
and climateowners
Real-estate transition
andon the equity
investors canvalue ofthe
assess assets in aofdiversified
effects physical risks and
real-estate portfolio.
climate transition on the equity value of assets in a diversified real-estate portfolio.
Illustrative chart and examples of physical and transition risk effects on equity value of assets, %

–20 –15 –10 –5 0 5 10 15 20

Asset class
Office
Office exposed to local economic
growth given concentration of
Multifamily
clean-tech industries results in
Apartment projected to positive impact
experience increases in frequency
Data centers
and severity of flooding results in
negative impact Data center supplied by low-carbon
Retail energy with expected premium
increase results in positive impact

Industrial
Distribution center for oil and gas
extraction for which production is likely to
decrease results in negative impact

Climate risk and the opportunity for real estate 105

 physical risks that will strain the foundations of the This approach can be complemented with
global economy and society. In either case, the market and policy scenarios that change the
places where people live, work, shop, and play will relative costs and benefits of each potential
fundamentally change. abatement lever.

Decarbonizing real estate requires considering — Execute. Set up the mechanisms to effectively
a building’s ecosystem deploy the decarbonization plan. These may
Ultimately, the only way to reduce the risks of involve making changes to financing and
climate change is to decarbonize. Real-estate governance, stakeholder engagement (investors,
players have a wide array of options for how to joint-venture partners, operators, and tenants),
proceed, including low-carbon development and and a range of operational and risk-management
construction; building retrofits to improve energy aspects of the business.
efficiency; upgrades to heating, cooling, and
lighting technology; and technology to manage — Track and improve. As investors, lenders,
demand and consumption. But decarbonization and tenants make their own decarbonization
is not solely a technical challenge. To develop the commitments, they will need to demonstrate
most appropriate path, real-estate players need to that their real estate is indeed decarbonizing.
understand the range of decarbonization options Thus, much of the value of decarbonizing will
and their financial and strategic costs and benefits. come from the ability to demonstrate emissions
reduction to potential stakeholders. Building
Decarbonizing real estate the ability to monitor and progressively reduce
To decarbonize, industry players can take the emissions on the path to net zero will create an
following steps: opportunity for players to differentiate.

— Understand the starting point. Quantify

baseline emissions of each building. This helps Create new sources of value and
real-estate players prioritize where to start (for revenue streams for investors, tenants,
example, individual buildings, asset classes, or and communities
regions) and determine how far there is to go to As the economy decarbonizes, real-estate players
reach zero emissions. can use their locations, connections to utility
systems, local operational footprints, and climate
— Set targets. Decide which type of intelligence to create new revenue streams, improve
decarbonization target to set. There is a range asset values, or launch entirely new businesses.
of potential target-setting standards that take
different approaches (for example, measuring Opportunities include the following:
absolute emissions versus emissions intensity,
or setting targets at the sector level versus — Local energy generation and storage. Real-
asset level). Players should develop a “house estate firms can use their physical presence
view” on targets that achieve business, investor, to generate and store energy. For example,
stakeholder, regulatory, and other objectives. property developers have been outfitting
buildings with solar arrays and batteries, helping
— Identify decarbonization levers. Build an asset- to stabilize energy grids and reduce the costs
or portfolio-level abatement curve. A marginal associated with clean energy.5
abatement cost curve provides a clear view
of the potential cost/return on investment of — Green buildings to attract more tenants.
a given emissions-reduction lever along with Developers and property managers can invest
the impact of that lever on emissions reduction. in developing green buildings or retrofitting

106 McKinsey on Investing Number 8, December 2022

 older buildings to make them green to meet the committed to achieving net zero, firms that are
growing appetite for sustainable workplaces able to decarbonize will have an advantage in
and homes. attracting capital. Real-estate players may, for
example, create specific funds for net-zero
— Green-building materials. Players can explore buildings or investment themes that support
the advantages of green steel, tall timber, community-scale decarbonization.
modular construction, and other emerging
technologies and materials that may have
additional benefits, such as faster and lower-
cost construction. The coming climate transition will create seismic
shifts in the real-estate industry, changing tenants’
— Extra services on-site. Firms can introduce and investors’ demands, the value of individual
new revenue streams, including vehicle assets, and the fundamental approaches to
charging, green-facilities management, and developing and operating real estate. Smart
other on-site services that enable occupants’ players will get ahead of these changes and build
sustainable preferences. climate intelligence early by understanding the
implications for asset values, finding opportunities
— Services for reducing and tracking emissions. to decarbonize, and creating opportunity through
Firms can support occupants by tracking supporting the transition.
emissions and offering solutions to reduce
carbon footprints. These services could Real estate not only will play a critical role in
include smart sensors and tracking energy determining whether the world successfully
consumption through heating, cooling, lighting, decarbonizes but also will continue to reinvent the
and space management. way we live, work, and play through these profound
physical and economic changes.
— Differentiated capital attraction. Given
the volume of capital that has already been

5
“5 ways clean tech is making commercial RE more energy efficient,” Jones Lang LaSalle, April 20, 2021.

Brodie Boland is a partner in McKinsey’s Washington, DC, office, where Daniel Stephens is a senior partner; Cindy Levy is a
senior partner in the London office; and Rob Palter is a senior partner in the Toronto office.

The authors wish to thank Margaret Ewen, Hans Helbekkmo, Yilin Li, Tilman Melzer, and Aditya Sanghvi for their contributions
to this article.

Copyright © 2022 McKinsey & Company. All rights reserved.

Climate risk and the opportunity for real estate 107

 Innovating to net zero:
An executive’s guide
to climate technology
Advanced technologies are critical to stopping climate change—and
the drive to develop and scale them is accelerating. Here are five
themes that could attract $2 trillion of annual investment by 2025.

by Tom Hellstern, Kimberly Henderson, Sean Kane, and Matt Rogers

Illustration by Sinelab

108 McKinsey on Investing Number 8, December 2022

 New technologies represent a critical part of the utility-scale batteries can make them at low cost,
world’s decarbonization tool kit—and the world does power producers will have to keep running fossil
not yet have all the technologies that it would need fleets to cope with the intermittency of renewables.
to solve the net-zero equation by balancing sources Uncertainty about the availability of financing for
and sinks of greenhouse-gas (GHG) emissions. The innovation limits capital formation and slows scale-
good news: McKinsey research on Europe’s net-zero up. Integrating most climate technologies into
pathway suggests that climate technologies that existing infrastructure, hardware, software, and
are already mature could, if deployed widely, deliver operational systems will be complicated, too.
about 60 percent of the emissions abatement that
will be needed to stabilize the climate by 2050. The Yet there are reasons to be optimistic. Recent
challenge is that further abatement must come history suggests that researchers and businesses
from climate technologies that aren’t quite ready, can deliver the necessary advances and cost
including 25 to 30 percent from technologies that reductions (see sidebar, “Charting cost reductions
are demonstrated but not yet mature and another for climate technologies”). Over the past decade,
10 to 15 percent from those still in R&D. the cost of some renewable-energy projects
came down by almost 90 percent, as did the
This need for innovation makes the pace of costs of electric-vehicle (EV) batteries, LED
decarbonization difficult to predict. When, for lighting, and other energy-efficient hardware.
example, will clean hydrogen cost $1 per kilogram: Capital is increasingly plentiful, evidenced by
in 2025 or 2050? The answer will affect the speed the revaluation of cleantech stocks that began
at which industries from aviation to steel can in June 2020, and by the growth in investments
decarbonize. Similarly, unless manufacturers of earmarked for sustainability and environmental,

Charting cost reductions for climate technologies

Absent incentives, climate technologies For example, solar-power generation for the majority of cost reductions, and
must compete with high-emissions achieved cost parity with coal power deployments of solar modules were
technologies based on cost, efficiency, in 2013 and gas power in 20151—after relatively small (about $15 billion). Then,
performance, and other attributes more than 30 years of research and from 2000 to 2014, governments offered
unrelated to their environmental benefits. investment, during which solar-module incentives, via mechanisms such as
Of these, high cost can be a significant costs fell by about 98 percent and feed-in tariffs and renewable portfolio
barrier to widespread uptake—but not a about $270 million worth of panels were standards, that encouraged utilities and
permanent barrier. If demand for climate deployed. Analysis suggests that the other organizations to buy and install solar
technologies is sustained over time, then cost reductions occurred in two phases, systems. Roughly $255 billion of solar
manufacturers can create production each of which saw cost declines of about modules were sold over this time frame,
efficiencies that allow them to reduce 85 percent in the cost of solar modules. with economies of scale and “learning by
costs (exhibit). During the first phase, between 1980 doing” in manufacturing accounting for the
and 2000, R&D investments accounted majority of cost reductions.2

1
Levelized cost of energy, levelized cost of storage, and levelized cost of hydrogen, Lazard, October 19, 2020.
2
Goksin Kavlak, James McNerney, and Jessika E. Trancik, “Evaluating the causes of cost reduction in photovoltaic modules,” Energy Policy, December 2018, Volume 123; Amro
M. Elshurafa, Shahad R. Albardi, Simona Bigerna, and Carlo Andrea Bollino, “Estimating the learning curve of solar PV balance–of–system for over 20 countries: Implications
and policy recommendations,” Journal of Cleaner Production, September 20, 2018, Volume 196; Arvydas Lebedys et al., Renewable energy statistics 2021, International
Renewable Energy Agency, March 2021.

Climate risk and the opportunity for real estate 109

 Charting cost reductions for climate technologies (continued)

Web 2021
Exhibit
NetZeroInnovation
Exhibit 2 of 2

Theunit
The unitcosts
costs of
of some
some renewable-energy
renewable-energytechnologies
technologieshave
havefallen
fallenby
bymore
morethan
than 10 percent
10 percent a year,
a year, as production
as production has scaled
has scaled up. up.
Learning rate (LR) for renewable-energy technologies,¹ logarithmic scales

100 100

1977
LR 24% LR 13–18%
10 10
1984

$ per $ per
watt 1 watt 1
2016
2014
0.1 0.1

Solar Electrolyzers
panels
0.01 0.01
0.1 10 1,000 100,000 0.1 10 1,000 100,000
Megawatts Megawatts
100 100

LR 18% LR 23%
10 10

$ per $ per 2010

watt 1 watt- 1
hour
1984

0.1 0.1 2018

Wind Electric-vehicle
power 2011 lithium-ion batteries
0.01 0.01
0.1 10 1,000 100,000 0.1 10 1,000 100,000

Megawatts Megawatt-hours
¹The learning rate measures the fractional reduction in cost that occurs with a doubling of cumulative installed capacity. Costs include manufacturing costs only.
Source: Avicenne; Benchmark Mineral Intelligence; BloombergNEF; Gunther Glenk et al., “Economics of converting renewable power to hydrogen,” Nature
Energy, 2019, Volume 4; Goksin Kavlak et al., “Evaluating the causes of cost reduction in photovoltaic modules,” Energy Policy, 2018, Volume 123; International
Energy Agency, World Energy Outlook 2019; US Energy Administration; McKinsey Center for Future Mobility

110 McKinsey on Investing Number 8, December 2022

 social, and corporate governance (ESG) objectives. and processes that now run on hydrocarbons and
Governments are lending strong fiscal support converting the electric-power system to renewable
to low-carbon innovation. Pledges from big sources (see next section). Many forms of electric
companies not only to cut emissions but also to gear, from EV batteries to heat pumps to industrial
decarbonize operations and product lines—to furnaces, remain expensive. Further innovation will
buy only renewable fuel or make only EVs—give be needed to reduce costs and increase uptake
confidence to entrepreneurs and their backers. of the electric hardware that will drive a net-zero
Talk of regulatory mandates lends weight to these society.
demand signals.
Better EV batteries. Electrifying transportation
And, again, the need for climate technology is requires cutting the cost of batteries, which can
vast—which creates large potential markets and account for as much as half the cost of an EV.
investment opportunities. Our estimates suggest However, the lithium-ion batteries that are most
that next-generation technologies could attract common in EVs may never fall below the critical
$1.5 trillion to $2 trillion of capital investment per threshold of $100 per kilowatt-hour. To boost
year by 2025.1 To enter these markets and navigate energy density and cut costs, battery chemistry will
them successfully, established companies, start- have to improve. Companies are working on anodes
ups, and investors will need a nuanced and ever- with high silicon content, which represent the next
evolving understanding of technical advances, frontier. Beyond that, innovations in solid-state,
customer demands and commitments, and policy gel, and foam electrolytes would turn ultra-high-
environments. In this article, we lay out five areas capacity lithium metal anodes from a concept
with considerable promise, along with potential into a reality, and one that is safer than today’s
obstacles along the path to scale (Exhibit 1): battery technology.

— electrifying transportation, buildings, Battery-control software. Hardware improvements

and industry aren’t the only route to better batteries. Software
control systems can also help, and even make up for
— launching the next green revolution shortfalls in chemistry. They can shorten charging
in agriculture times: imagine recharging an EV with a 300-mile
range in ten minutes or less, instead of one hour at
— remaking the power grid to supply a supercharger or overnight on most home systems.
clean electricity They can prolong battery lives enough to match the
life of the vehicle. And they could give EVs added
— delivering on the promise of hydrogen pickup or hauling or towing capacity.

— expanding carbon capture, use, and storage

$700 billion–$1 trillion

Electrifying transportation, buildings,
and industry
investment by 2025
Coal, oil, and gas have been the main fuels used to
power buildings, industrial machines, and vehicles
since the early 20th century. Getting to net-zero
5 GtCO2e
emissions will require electrifying most equipment abatement by 2050
1
The estimates of annual capital investment were developed using McKinsey’s suite of decarbonization and energy modeling tools, which
include the Global Energy Perspective (Global energy perspective 2021, McKinsey, January 2021), Hydrogen Insights, Power Solutions, and
our 1.5°C scenario (“Climate math: What a 1.5-degree pathway would take,” McKinsey Quarterly, April 30, 2020). Estimates of emissions-
abatement potential are sized assuming that net-zero emissions are achieved in 2050, based on McKinsey’s 1.5°C scenario. These include only
the abatement that can be directly or indirectly attributed to climate technologies discussed in this article.

Climate risk and the opportunity for real estate 111

 Web 2021
Exhibit 1
NetZeroInnovation
Exhibit 1 of 2

Five groups of technologies could attract $2 trillion of capital per year by 2025
andFive groups
abate of technologies
40 percent could attract
of greenhouse-gas $2 trillion
emissions of capital per year
by 2050.
by 2025 and abate 40 percent of greenhouse-gas emissions by 2050.

Technologies to watch

Electrification Agriculture Power grid Hydrogen Carbon capture

• Electric-vehicle • Zero-emissions • Long-duration • Low-cost • Pre- and postcom-

batteries farm equipment storage production bustion capture
• Battery-control • Meat alternatives • Advanced controls • Road-transport technologies
software • Methane inhibitors • Software and fuel • Direct air capture
• Efficient building • Anaerobic manure communications • Ammonia • Bioenergy with
systems processing • Vehicle-to-grid production carbon capture
• Industrial • Bioengineering integration • Steel production and storage
electrification • Building-to-grid • Aviation fuel • Biochar
integration • CO₂-enriched
• Next-generation concrete
nuclear
• High-efficiency
materials

Annual investment by 2025, $ billion

200–250 100–150 10–50

700–1,000
400–600

Electrification Agriculture Power grid Hydrogen Carbon capture

CO₂ abated per year in 2050, gigaton (1.5°C pathway)

~5.0 ~10.0 ~5.0 ~2.5 ~3.0

Electrification Agriculture Power grid Hydrogen Carbon capture

112 McKinsey on Investing Number 8, December 2022

 Efficient building systems. Buildings account for Launching the next green revolution
about 7 percent of global CO2 emissions. Cutting in agriculture
those emissions would require making buildings Agriculture accounts for about 20 percent of global
more energy efficient with technologies such as LED GHG emissions. The most significant GHG from
lighting, high-efficiency HVAC, and energy controls. agriculture is methane, which has many times
But efficiency alone isn’t enough. Buildings, like the warming power of CO2. Reducing methane
vehicles, have to go electric. Using heat pumps to emissions from agriculture (and other sources)
keep buildings warm, instead of traditional boilers would require major changes to how society farms,
and furnaces, could cut global CO2 emissions by eats, manages supplies and waste, and stewards
three gigatons per year if implemented worldwide. cropland and forests. Many of the changes would
Today’s models are 2.2 to 4.5 times more efficient be enabled by climate technologies, some of
than gas furnaces, and recent advances, such as which are relatively mature while others need
multiple or variable-speed compressors, let heat further development.
pumps work in cold conditions that once caused
problems. Heat pumps do remain expensive, so cost
declines, especially for air-source heat pumps, would
likely have to happen before they are used widely.2
In addition, energy-reactive windows and those
$400 billion–$600 billion
with embedded solar cells could enable buildings to investment by 2025
generate all the power they need.

Industrial electrification. As prices of renewable 10 GtCO2e

electricity and electric equipment drop, industrial
companies could lower costs and emissions by
abatement by 2050
electrifying their operations. The opportunity
appears large. Industrial sectors such as cement,
chemicals, and steel together consume more energy Bringing these technologies to the more than two
than other sectors (such as electric power and billion people who work in agriculture will be one
transportation), and only 20 percent of that energy of the most difficult tasks on any path to 1.5°C of
is electricity. What’s more, electrical equipment is warming, requiring cost reductions, assistance
less costly and more reliable for many industrial programs, and infrastructure (such as distributed
applications, though not all. Electric furnaces, for clean energy). These developments would amount
example, can make heat up to 350°C, but not the to a new green revolution, one with the potential
high heat of up to 1,000°C that many industrial to surpass the gains that were realized as efficient
processes need. Innovation will be needed to farming practices were applied widely in the 1960s.
address these gaps. There is also the question of These are some of the technologies that could
how to finance industrial electrification. Replacing decarbonize agriculture.
long-lived equipment early can mean writing it
off, and industrial products tend to have tight Zero-emissions farm equipment. The largest
profit margins, which can discourage companies amount of on-farm emissions abatement could
from making big capital outlays. New financial be achieved by shifting from traditional fossil-
mechanisms could help companies cover the fuel equipment and machinery—such as tractors,
up-front cost of electric equipment even with the harvesters, and dryers—to their zero-emissions
long payback period. counterparts. The economic potential is significant:

2
Michael Gartman and Amar Shah, “Heat pumps: A practical solution for cold climates,” Rocky Mountain Institute, December 10, 2020.

Climate risk and the opportunity for real estate 113

 deployment of zero-emissions equipment could But companies are partnering with agriculture and
produce cost savings of $229 per ton of carbon landfill sites to produce biogas for various purposes,
dioxide equivalent (tCO2e). Nevertheless, uptake such as making compressed natural gas, which
of zero-emissions farm equipment and machinery counts as a transport fuel under California’s low-
is far behind that of EVs; most varieties are still carbon fuel standard.
in the proof-of-concept or prototype phases.
Cost reductions and supportive financing would Bioengineering. Bioengineering advances
accelerate adoption. agricultural productivity and carbon sequestration
and thereby lowers the sector’s emissions.
Meat alternatives. Between one-quarter and one- Promising technologies include editing of plant
third of global methane emissions are estimated genes to promote disease resistance and manage
to come from the digestive processes of cattle, the soil microbiome.
sheep, and other ruminant animals. Those emissions
will be difficult to abate unless consumers opt to
change their diets. But some of the meat and dairy Remaking the power grid to deliver
that people now eat could be healthfully, and cost- clean electricity
effectively, replaced with protein from crops such Almost everywhere, power grids are old, inefficient,
as legumes and pulses. This may require more land unreliable—and carbon-intensive. They are
and different planting practices but could also nowhere near ready to handle the doubling of
reduce deforestation related to the clearing of land electricity demand that could take place by 2050
for pasture. Lab technology also points toward as electrification happens, let alone prevent a
meat substitutes. Some are plant-based: Beyond commensurate increase in carbon emissions.
Meat and Impossible Foods are two of the leading Modernizing and decarbonizing the grid involves
names in the field. Cultivated meats—those grown three main tasks. One is speeding the installation of
in bioreactors from animal cells—are also advancing. renewable-generation capacity; to achieve a 1.5°C
McKinsey research suggests that this could become pathway, we estimate that the global installation rate
a $25 billion global industry by 2030. would need to increase from three gigawatts per
week to 15 to 18 gigawatts. Another task is adding
Methane inhibitors. Companies are developing feed energy-storage capacity to manage the intermittency
supplements and substitutes that inhibit methane of solar and wind. Last is upgrading the transmission
production by altering an animal’s digestive and distribution network to accommodate more
processes. Trials have shown that these can front-of-the-meter and behind-the-meter assets.
reduce methane production by 30 to 50 percent.
Propionate precursors—a class of free acids or salts, Few utilities are known as risk takers. For the most
such as sodium acrylate or sodium fumarate—have part, they are set up—and required by regulators—
been shown to inhibit methane emissions from to deploy proven, mature technologies. These
cattle without affecting animals’ growth, and one of tendencies present limitations. But if innovators
these has entered the EU approval process.

Anaerobic manure processing. Manure from

cattle and hogs can release significant amounts of
$200 billion–$250 billion
methane. Processing manure in anaerobic digesters
can cut emissions and also generate biogas, a
investment by 2025
renewable form of natural gas that can be used
on farms, sold to the grid, or fed into production 5 GtCO2e
abatement by 2050
of “gold hydrogen.” Such digesters are now used,
though not widely, to control odor and pathogens.

114 McKinsey on Investing Number 8, December 2022

 and grid operators work together (for example, on Software and communications. Traditional
accelerating the scale-up of long-duration storage) electrical grids use idling power plants to maintain
and regulators send helpful signals (for example, grid balance. These so-called spinning reserves
by defining mechanisms to reward providers of are expensive to run but can respond quickly when
battery storage and other services that help deal demand fluctuates. Modern electric grids would
with intermittency), then the following technologies rely on ultrafast communications to maintain grid
could help create a zero-carbon grid. balance by managing every device on the network.
Software-defined inertial substitution (to maintain
Long-duration storage. Even with falling solar grid balance when there are fewer spinning
and wind costs, as well as cheaper lithium-ion reserves), advanced “volt-var” management (to
batteries, the intermittency of renewables makes maintain proper voltage over long transmission
these technologies impractical as the sole source lines or in highly congested urban markets), and
of grid power. A solution is long-duration energy network-wide instrumentation for condition
storage, which can store enough power to supply monitoring and fault isolation would help utilities
a network for two weeks or more (a typical period spot issues and prevent interruptions. Distributed
of limited renewable generation in many markets). energy-management software can coordinate all
In comparison, lithium-ion batteries can provide these elements. Digitized grids will require better
backup power cost-effectively for only four hours. At cybersecurity protection.
a levelized cost3 of less than $20 per kilowatt-hour,
long-duration storage would make 100 percent Vehicle-to-grid integration. As more drivers switch
renewable systems cost-competitive in US states to EVs, the big batteries in their driveways and
with ample wind and solar resources. Storage costs garages could be hooked up to the grid to provide
of $150 per kilowatt-hour would allow very high wind energy-storage capacity. One million typical EVs
and solar penetration, provided that power systems would offer about 75 gigawatts of storage, hundreds
also include strong demand-side management, of times more than today’s single biggest utility-
backup gas turbines, or more integration of scale storage facility provides. Residential backup
regional transmission networks.4 Multiple storage batteries add more. Accomplishing this integration
technologies are emerging, including power-to-gas, requires technologies such as inverters that connect
flow batteries, and compressed or liquefied air. Big rooftop solar, wall batteries, EV batteries, and the
and small companies are active in this market, and grid, as well as fast chargers that buffer the grid
start-ups are pioneering more advanced options such from demand spikes while keeping EV batteries full.
as mechanical systems and modular pumped hydro.
Building-to-grid integration. As buildings’ energy
Advanced controls. Today, grid utilization tends controls improve, the buildings can be dispatched to
to average below 50 percent because the grid is the grid—that is, used to supply power—in ways that
built for times of peak demand and its performance improve system performance. Buildings with energy
worsens in extreme heat or cold. As more storage or cogeneration could feed power onto
renewables and storage systems are deployed at the grid when called for, producing income for their
the grid edge, in homes and commercial sites, they owners. And if a utility could reduce power demand
will make power grids more complicated to operate. slightly in a central business district by signaling
Resilience, flexibility, safety, and efficiency can be buildings to turn down lights, it could cope with
improved with technologies such as solid-state demand spikes less expensively than by turning on a
transformers, advanced flexible AC controllers that gas peaker plant.
allow more controlled grid flow, and high-voltage DC
technologies for data centers.

3
The levelized cost of storage refers to the full cost, per kilowatt-hour, of setting up and running a battery-storage facility.
4
Micah S. Ziegler et al., “Storage requirements and costs of shaping renewable energy toward grid decarbonization,” Joule, September 18, 2019,
Volume 3, Number 9.

Climate risk and the opportunity for real estate 115

 Next-generation nuclear. Nuclear energy has an large-scale hydrogen projects announced between
uneven history: from the 1950s’ promise of “too February and July 2021, bringing the total to more
cheap to meter” energy to construction-cost than 350. Direct investment in these projects, which
overruns in the 1970s to post-Fukushima fears. Now, would produce 11 million tons of hydrogen annually,
the push to decarbonize power has lent new appeal is expected to top $130 billion.5
to nuclear generation, which is emissions-free.
Emerging technologies include the sodium-cooled, Hydrogen has a long way to go to fulfill its potential.
molten salt, and helium-cooled reactors known An entire infrastructure of pipes and storage facilities
as “GenIV”; small, sealed, modular, factory-built would have to be built, at great expense. Europe is
reactors; and fusion energy, an area where new responding with a plan, the EU Hydrogen Backbone,6
start-ups are pushing costs down and timelines to link low-cost supply centers with European
forward to prototype devices in the mid-2020s, demand centers. Other technologies integral to the
ahead of government-backed research programs. hydrogen economy include the following.

High-efficiency materials. Scientific advances Low-cost production. If hydrogen could be made

could produce materials for a wide range of for less than $2 per kilogram in the European
clean-energy applications. Solar cells made Union or $1 per kilogram in parts of the United
with perovskites, a special type of crystal, could States by 2030, major end uses would become
outperform regular silicon solar cells—and cost less economically viable. One production process is the
to make. Graphene, a single-atom-thick sheet of electrolysis of water, whereby electricity is used
carbon, could revolutionize batteries (by enhancing to split water molecules into hydrogen and oxygen
conductivity and storage capacity), solar cells (by atoms. If electrolyzers run on renewable electricity,
offering superior conductivity contacts with lower the resulting “green hydrogen” is carbon-free. (By
light blockage), and high-efficiency transmission comparison, “blue” hydrogen, made from natural
lines to carry power from remote but productive gas, is carbon-intensive.) Estimates suggest that
renewable-generation sites. electrolyzer costs could fall 60 to 80 percent over
the next decade.7

Scaling up the use of hydrogen Road-transport fuel. Hydrogen’s higher energy

Hydrogen could play a significant role in density makes hydrogen fuel-cell electric vehicles
decarbonization, as a clean-energy carrier or fuel (FCEVs) suitable for long-haul or heavy road
ingredient with many applications. High-energy transport. For FCEVs to be adopted widely, they
density and zero-carbon combustion make would need to become less expensive, and fueling
hydrogen well suited to address the 30 percent stations would need to be built.
of GHG emissions—across sectors as diverse as
aviation and shipping, industry, buildings, and
road transport—that would be hard to abate with $100 billion–$150 billion
electricity alone. Hydrogen could ultimately satisfy
15 to 20 percent of energy demand.
investment by 2025
After a push in the early 2000s, innovation in
hydrogen technologies stalled. Now it has new
2.5 GtCO2e
momentum. The Hydrogen Council identified 131 abatement by 2050

5
Hydrogen insights: Executive summary, Hydrogen Council, July 2021.
6
European Hydrogen Backbone: How a dedicated hydrogen infrastructure can be created, Gas for Climate, July 2020.
7
Path to hydrogen competitiveness: A cost perspective, Hydrogen Council, January 20, 2020; Green hydrogen cost reduction: Scaling up
electrolysers to meet the 1.5°C climate goal, International Renewable Energy Agency, 2020.

116 McKinsey on Investing Number 8, December 2022

Ammonia production. This is one of the most Moreover, innovation has been slow. Many existing
promising near-term uses for low-carbon hydrogen. CCUS plants employ 30-year-old solvent-based
Green ammonia, made with green hydrogen, should technologies for postcombustion carbon capture.
be the first variety to match the cost of conventional But new technologies are emerging. Further R&D
ammonia production. Hydrogen is also relatively would be needed to reduce costs, and additional
straightforward to integrate in ammonia production, incentives will likely be required to make CCUS
so less supporting infrastructure is required. And financially viable at commercial scale. But if the full
ammonia can be used as a fuel or as a “vector” for cost of CCUS were to fall below $50/tCO2, it would
transporting hydrogen. make many applications economical. Here are some
CCUS technologies that could help.
Steel production. The steel sector is one of the
largest industrial emitters, producing about 7 to

$10 billion–$50 billion

9 percent of global emissions. The conventional
blast furnace–basic oxygen furnace route for steel
production emits approximately 1.8 tons of carbon
per ton of steel. But using green hydrogen to power
investment by 2025
the direct reduction of iron as a feedstock for
electric arc furnaces (which could also be powered
by renewables) is one route to zero-carbon steel.
3 GtCO2e
Major steel producers in Europe are now piloting abatement by 2050
steel production with hydrogen.

Aviation fuel. As the travel industry recovers from Pre- and postcombustion capture technologies.
the COVID-19 pandemic, air travel is expected to Precombustion technologies such as oxyfuel
produce 3 percent of global carbon emissions. combustion represent promising ways to affordably
These emissions will be hard to abate until planes capture CO2 from point sources since they increase
are made to fly on fuels other than petroleum-based the concentration of CO2 in flue gases. Development
jet fuel. The best near-term alternative, according of new postcombustion technologies, such as
to the Clean Skies for Tomorrow Coalition, may be second-generation solvent formulations, sorbents,
sustainable aviation fuels made from renewable and membranes, is helping bring down the cost of
feedstocks such as agricultural biomass. Within capture. Companies, governments, philanthropy,
the next decade, hydrogen could provide electric venture-capital, and growth-equity firms have all
power for smaller aircraft equipped with fuel cells. helped finance improvements in capture technology.
Eventually, hydrogen could be used for combustion
in larger planes. Direct air capture (DAC). Withdrawing CO2 from
ambient air is difficult because air has, at most,
one one-hundredth of the CO2 concentration
Expanding carbon capture, use, found in flue gases from industrial point sources.
and storage Nevertheless, DAC offers a way of removing CO2
Carbon capture, use, and storage (CCUS) is from the atmosphere—and the world is likely to
necessary to decarbonize hard-to-abate sectors need many different sources of negative emissions
and to remove CO2 from the atmosphere (resulting to achieve a 1.5°C pathway. To that end, several
in “negative emissions”). Presently, use of CCUS is companies are investing in DAC, with the goal of
minimal. Costs remain prohibitively high—typically achieving capture costs of $100/tCO2 to $150/tCO2
$50 to $100 per ton of CO2 (tCO2)—and CCUS by 2030, 60 to 80 percent less than today’s pilot
equipment consumes a lot of energy. Rollout of projects. Low-cost DAC, coupled with low-cost
CCUS has generally stalled at second- or third-of- hydrogen, could enable production of carbon-
a-kind commercial-scale installations at coal or gas neutral e-fuels in the near to medium term.
power plants, steel plants, and refineries.

Climate risk and the opportunity for real estate 117

 Bioenergy with carbon capture and storage its mass. Both have heavy carbon footprints, but
(BECCS). Many fossil-powered plants are nowhere companies are working on solutions that would
near the end of their useful lives. Taking plants sequester CO2 in concrete itself. Technologies for
offline before they are due would burden utilities adding CO2 as an ingredient in cement could reduce
with stranded assets. But the value of these assets emissions by up to 70 percent and make cement
could be preserved by converting them to run on stronger. Emerging processes might combine
biomass, a renewable fuel. Adding CCS equipment captured CO2 with industrial-waste products such as
to a bioenergy plant lets it produce negative fly ash, steel slag, and remediated cement to make
emissions: biomass sequesters CO2 as it grows, and artificial “rocks” for use in place of natural aggregate.
when that biomass is burned, the CCS system keeps
the CO2 from entering the atmosphere.

Biochar. Biochar is a stable, charcoal-like material These climate technologies could contribute to
made by processing waste biomass such as solving the net-zero equation while creating growth
crop residues through pyrolysis or gasification. potential for sectors and geographies. At present,
Adding biochar to soil can improve soil health and the technologies exhibit varying levels of maturity,
agricultural productivity, opening the door for use in performance, market demand, and regulatory
large-scale farming. This practice could sequester support. To bring them to commercial, climate-
nearly 2 gigatons of CO2 per year by 2050. Adoption stabilizing scale would require companies, financial
rates will depend on the results of commercial-scale institutions, and governments to cooperate on
experiments over the next decade. investment and research programs as well as efforts
to integrate technologies with existing industrial
CO2 -enriched concrete. Concrete has two main systems. This challenge is formidable, but the
components: cement, which is the “glue” that holds moment to devote creativity, capital, and conviction
concrete together; and aggregate, such as sand to addressing it is now.
or crushed stone, which gives concrete most of

Tom Hellstern is an associate partner in McKinsey’s Seattle office, Kimberly Henderson is a partner in the Washington, DC,
office, Sean Kane is a partner in the Southern California office, and Matt Rogers is a senior partner emeritus and a senior
adviser in the San Francisco office.

The authors wish to thank Joshua Katz, Alisha Kuzma, Gregory Santoni, and Bram Smeets for their contributions to this article.

Copyright © 2021 McKinsey & Company. All rights reserved.

118 McKinsey on Investing Number 8, December 2022

December 2022
Designed by Leff
Copyright © McKinsey & Company
McKinsey.com