Money management firms will have to spend more and search in more places for new assets and clients, according to a new report on the business of investment management.
The study, by the investment consulting firm Investment Counseling Inc., West Conshohocken, Pa., spells out a good news-bad news scenario for the industry.
The good news: Profitability is still good, manager compensation is on the rise and ownership is being spread to more staffers than before. The bad news? Higher compensation and an increased investment in infrastructure will put more pressure on companies' margins and demand more productivity and growth to compete in an increasingly complex market.
The financial markets' rising tide has lifted several boats - including some that will be beached later - according to Investment Counseling's sixth annual Business, Financial and Compensation Analysis. Some firms are getting a free ride thanks to asset growth that can only partly be explained by new business, according to the report, which examined a sample of firms with an average of $16.8 billion in assets and a median asset base of $4.6 billion.
The study covered 71 firms, from boutiques to large firms such as J.P. Morgan Investment Management, PNC Asset Management Co. and Zurich Kemper Investment Management Co. The firms were largely institutionally oriented, but showed a surprising and growing retail bias, noted Chas Burkhart, president of Investment Counseling.
The firms studied increased their assets by an average of 31% between 1994 and '95, with an average compound annualized rate of 25% for the period from 1992 to 1995. (The annualized growth average for the Standard & Poor's 500 Index was 15.3% for the same period, while the Lehman Brothers Government/Corporate Bond Index grew by 8% and U.S. Treasury bills were up 4.1%.) Revenue grew 21% on average from 1994 to 1995, and average expenses grew by 15%, which resulted in a profit margin of 31% in 1995, and average profit growth of 25% from 1994.
But the money management industry seems to have absorbed the good news of this year and concluded the good times won't go on forever. The firms studied projected 11% growth in both assets and revenue for 1996 and 10.5% asset growth and 12% revenue growth in 1997, while they expect to boost staff 5% in both years.
Growth will be imperative for many firms as they begin to fight harder for market share in a maturing market, according to the study. Asset size is not the be-all and end-all of success - continued growth is, according to Investment Counseling's analysis. To keep up with the financial markets, firms will need to grow at a compound annual rate of 10% to 15% for each three-year period and continue that momentum. Those that show flat or negative growth will be in danger.
Size alone is "a generally unworthy determinant of success" unless it is considered in the context of the firm's asset and market orientation, said Mr. Burkhart.
"There are (different) measures of growth and growth expectations for firms at all levels of business," he said. "We don't believe in this paradigm (of) under $5 billion niche boutique, the $150 billion world leaders and everybody in between suffers because of size. . . . The industry has been far too narrow and rigid in determining success measures."
Consolidation of the industry may be overstated, but the growing importance of industry segments such as wrap fee programs and mutual fund supermarkets do require scale, and managers must develop "brand-name recognition" to compete in those markets, according to the study.
Noting a recent Time magazine cover story on Fidelity Investments, the report stated the importance of brand identity will only increase. The report notes even among gatekeepers and prospects in the traditional institutional and private client markets, branding will become a factor.
"Time treats Fidelity as it would any brand, such as IBM or Coca-Cola. Image and branding are becoming paramount in all segments of the money management industry," stated the report.
As the distinctions between institutional and retail segments continue to blur - courtesy of the growing defined contribution market - and new intermediary channels such as financial planners continue to develop, firms are embarking on strategies to bring in assets from multiple distribution channels. The study found 63% of firms gather assets from more than one channel, with the majority of the others concentrating on the institutional market.
Firms will need to concentrate on increasing assets and revenue while maintaining productivity, developing management capability and maintaining overall profitability, according to the report. Success will be determined by a combination of investment performance, marketing and distribution capability, products, the market environment, a capacity to build a brand identity, compensation structures and infrastructure.
"We think it's a fallacy that you need to aspire to a global megamodel or a very small niche boutique. It's more appropriate to think about how you will compete across these determinants," said Mr. Burkhart.
The three key ingredients of future profitability will be brand building, competitive compensation and infrastructure, according to the report. Until recently, branding and infrastructure costs had been minimal, but that trend will not continue, the study concluded. The increased costs associated with marketing and distribution, particularly in new market segments driven by individual investors, will change the profit profile of firms.
Among the study's findings:
-The competition for talent is driving up compensation for investment personnel, which in turn will put pressure on margins when the market turns down. With staff raids and lift-outs on the rise, firms are being forced to spread equity around and hike compensation for the most valuable players.
Compensation is still the managers' main expenditure, making up 63% of expenses, although general and administrative expenses - including distribution costs - are edging up slightly.
The annual total cash compensation averages range from $1.43 million for chief executives and $719,000 for chief investment officers to $220,000 for marketing and sales professionals and $279,000 for marketing and sales managers. Most firms are still basing compensation on industry averages without taking into account the firm's economics and long-term planning, according to the report. Although the scenario is changing slowly, the study concludes many firms set compensation in what it terms a "gun to the head" method where the side with the upper hand makes all the demands, which results in a high level of turnover.
"We're struck by the number of reputable firms that operate on a subjective basis," said Mr. Burkhart. In many firms, talent doesn't know how the management arrives at compensation levels, which creates antagonistic situations that cause people to leave, seeking higher compensation.
The study also found firms are reassessing cash and equity incentives they offer to retain staff, under pressure from the next generation of managers who are requesting ownership and more entrepreneurial pay. Firms must offer ownership to a growing group of key professionals and also are being forced to offer vehicles such as phantom stock to employees earlier in their tenure, according to the report.
-Firms are placing increased emphasis on marketing and distribution activities, although the head count of employees in that area appears to have receded. The average percentage of marketing and sales employees as a portion of the firms' total dropped to 14.4% from 18.2% two years ago, according to the report. However, it appears they are adding personnel in related areas, such as mutual fund shareholder services, marketing support and dedicated client service staff, while boosting investment in brand-building activities such as advertising.
Firms are getting their money's worth from marketing, according to the report. The study found the firms that have the highest profit margins also have the best new asset production ratios per marketer. Firms with profit margins more than 40% had a median of $142 million in new accounts generated per marketing professional in 1995, while firms with margins of less than 10% had a median ratio of $22 million per marketer.
-Technology is having an effect, not only internal operations and distribution but also on brand identity. According to the study, almost 70% of firms said they plan to spend more on technology over the next three years, with 84% of those spending on launching new Internet sites.
"Increasingly, presence on the World Wide Web and Internet connectivity to clients are becoming part of a firm's brand identity and positioning as an enterprise oriented toward the new century," said the report.
It also noted 35% of the firm's studied in this year's report already have web sites.
