By Jon Little
“Our assets go up and down in the lift every day”; “fund management is a people business”, are two of the most over-used, glibbest phrases in fund management, spoken by those who spend little if any, time thinking about what they mean in practice.
We no longer live in a society where most earn a living making or building things. For many workers today, knowledge and skill are their craft; where, amongst the four factors of production, labour is the most highly rewarded and prized. Yet, many fund management businesses are wedded to outdated notions of what constitutes success and how businesses should develop.
Post the industrial revolution, scale and size – growing bigger, producing and selling more – was the recipe for success. Greater scale means lower unit cost, leading to higher revenues and profits. However, this formula doesn’t work for most people businesses, especially fund management. Unfortunately, too many have been infected by the belief that greater size and complexity somehow makes them better.
Consider what it means to actively manage money. Done properly, it’s intellectually challenging and stimulating and requires delving into multiple industries and understanding the dynamics of pricing, competition and strategy.
Fund management is unusual in that success and failure are easily measurable. For those who care little about short term results, there’s the excitement of unearthing something the market has missed, testing the theory, then taking a contrarian position that may, for months, seem to be a losing bet. Then the slow glow of being proven right and, more importantly, visible results in terms of published performance and higher profits for clients.
Satisfaction for talented managers is not, however, directly scaled to the size of their portfolio. Managing $5bn in large cap equities is probably just as satisfying as managing $10bn or even $25bn. What’s in the portfolio is what matters; its size – within reason – is largely irrelevant.
Investment management businesses do not need to grow beyond a certain critical mass to be profitable. The optimum business would comprise an investment team, the largest group within the firm, some support staff and just enough marketing and client service staff to look after clients, with any functions just large enough to be effective.
Unfortunately this is rarely the case. The industry is full of bloated, mediocre businesses with too many funds and products and too many competing priorities.
In these firms the investment team has ceased to be the largest group of employees; herein lies the issue. Sales and marketing people want to sell more product and expand client channels, product development people want to launch more product – this indirectly feed more expansion. More product and sales channels lead to more systems, finance and compliance support. All this leads to business complexity.
The business loses focus because suddenly there are employees whose ‘success’ is judged by criteria that are largely unrelated to investment performance or client outcomes. If the business is not constantly growing, they quickly become expensive and demotivated. At that point even if sensible to restrict growth or close to new business, those running the firm find it impossible to take these decisions.
The tragedy is that these bloated businesses are normally less profitable per employee and per dollar of revenue and find it harder to retain clients and investment staff. Put simply, every investment business should ask itself; would we be better focusing on managing money in one key asset class where we have a real competitive advantage and ditching everything else? My answer is yes.
Jon Little is a partner at Northill Capital.
