Not so long ago, asset management businesses were considered a ‘must-have’ accessory for any self-respecting bank or insurance company due to the relative lack of capital required. What most of these companies underestimated was the need to manage human capital with the same degree of sophistication and intelligence as financial capital. But the tools are entirely different and few fund managers are equipped with them.
But though there are benefits to being owned by a large parent with deep pockets, it is rare for asset management to be considered a core business area.
The merger fever that gripped the investment industry during the late-1990s bull market created a sharp divide between large organisations and their smaller competitors. Investors came to see brand name firms with global reach as superior to less well-resourced niche firms with fewer products on offer. But this view is changing as large managers continue to suffer an exodus of their top talent to smaller houses, and as specialist mandates grow in popularity.
The stability of an asset manager’s business proposition is an integral part of a successful asset management firm’s future and winning the ‘war for talent’ is key. If a business is well run and has highly skilled investment professionals in an environment that allows talent to flourish, it will be successful whether it is large or small. However, it can be easier for a small, niche firm that is focused on its key area of strength to be successful, so larger firms need to come up with some innovative answers.
In looking at the reasoning behind this conclusion, it helps to start with the basics. What should an investor be looking for in an asset management firm? Clearly, the firm should be able to demonstrate a sustainable competitive advantage. The quality of the personnel is by far the most important factor in achieving this goal. It follows that the firm must have a business structure that can both attract and retain talent.
In our experience, the type of asset management business that is best able to attract investment talent has several key features. These are: a long-term focus on asset management by strong business leaders; a business that has been designed to ensure an alignment of interests with the client; employee interests that are substantially aligned with those of the firm; a stable corporate structure; an effective deployment of resources to support all aspects of the business and management that can successfully manage the growth of the business.
Perhaps all of these are easier to achieve in a niche firm, although size in itself is not the key issue. For example, a large firm can set itself up as a series of boutiques, giving each team ownership of its own product. However, it is fair to say that such an approach requires careful management.
The factors that help a business retain talent are also more frequently found in niche firms. These factors have a lot to do with the strong cultural ‘glue’ of a small firm, where ideally people are treated as individuals and everyone feels they are making a difference. Bureaucracy is noticeably lacking, while there is clear accountability, with decisions being made by small, focused teams. Perhaps most important, the leadership understands asset management.
The main disadvantage of niche firms is that management, while understanding the industry, may not understand how to run a business. In the early years especially, pressing business issues may distract the top people from focusing on managing clients’ portfolios.
For some time now, we have been cautious about asset managers that are owned by larger parents - retail banks, investment banks, insurance companies - where asset management cannot be considered a core business area. Our concerns have grown as many individual portfolio managers, particularly in the equity arena, have left the larger firms to start their own operations in the belief that it is a fairly simple thing to do.
Against this background, ‘big brand name’ clearly does not mean low risk and stability for investors. However, we are also concerned about the rapidly growing ranks of niche players. Good portfolio managers do not necessarily make good business managers, and we are looking carefully at the way some of these smaller firms are being run as businesses. On this basis, it is not difficult to see that some will fall by the wayside.
However, a really well managed asset management business that is part of a large organisation does have many advantages. Among these are synergies with other parts of the business, multiple distribution channels and a diversified revenue stream, which helps if a particular style or product comes under pressure. In theory, a large parent can also provide significant marketing support and administrative backup.
However, in many cases large firms have found it difficult to capitalise on these advantages, while many of the traditional arguments in favour of large firms may not stand up to close inspection. Asset management is not a capital-intensive industry, so being able to dig into a parent’s deep pockets, while beneficial, is not as crucial as is often believed.
Buying in new IT today is much cheaper than trying to update legacy systems, for example. Also, a lot of back office functions can now be outsourced to organisations that specialise in doing this work for niche investment firms.
In an environment where the war for talent is the defining success factor for asset management firms, we need to be selective about both large and small organisations. Over time, as a number of smaller managers inevitably fail, skilled professionals will recognise that there are benefits to being part of a larger firm. However, this will not prevent the larger organisations from losing some of their best people.
And given that asset management is not a capital intensive industry, there is little argument, other than for historical reasons, for firms not to be majority employee-owned. Indeed, portfolio managers by their very nature tend to be believers in capitalism and wish to own their firm.
We see two main reasons why asset management firms either become fully publicly quoted or sell out to other firms - to provide a short-term exit route for senior staff or to raise cash for an acquisition. Neither of these tends to be in the interests of existing clients.
We have identified 10 of the most common types of business model that exist in the asset management world. All have advantages and disadvantages, but clearly some will find it easier to attract and retain staff than others. While not ranked order, it would be fair to say that the structures at the end of the list have a harder task ahead of them, but that is not to say that they cannot be successful with good leadership. They are:
❏ Private company, wholly employee-owned: These companies have a long-term perspective with alignment of interests between staff and clients. However, problems can arise if a small number of individuals own the majority of the firm and they are close to retirement.
❏ Private company, founder-owned: This can be a very good model as long as there are several founders, but these companies are often majority-owned by only one person.
❏ Partnership: These companies have a long-term perspective but there is sometimes a danger that they become too risk-averse given the potential liability and generational issues inherent in a partnership.
❏ Publicly quoted company, majority employee-owned: The listing encourages accountability, but also a shorter-term approach than is taken by private employee-owned companies.
❏ Family ownership: These companies tend to take a long-term perspective but can run into problems if the new generation wants to sell out or the new generation is not of the same calibre as the earlier generation.
❏ Owned by a firm that has bought a number of asset managers:
These firms are usually allowed to be autonomous but the fact that the founders have sold out for cash can be worrying.
❏ Publicly quoted: The focus is asset management, but this model can foster short-termism, including the need to cut costs in times of weakness, and pressure to continue growing, even when the company reaches capacity.
❏ Private company with private equity backing: This model benefits from strong motivation, with alignment of interests, but the private equity firm will want out at some point, leading to a potential short-term focus.
❏ Part of an insurance company: Financial backing is a plus, as is the captive asset base. However, many asset managers with this type of business model have been unable to compete effectively if they have not been able to create a culture different from the parent.
❏ Part of a bank/investment bank: The benefits are deep pockets, a distribution network and a brand name that needs protecting, but asset management is a non-core business that may mean a greater risk of sale to the highest bidder if returns on capital are inadequate. In addition, there is often a short-term business management mentality.
Paul Trickett is European head of investment consulting at Watson Wyatt