Most money management executives are more worried about their own markets contracting than about the cyclical nature of the stock market, consultants say.
Such intense self-examination is driven, at least in part, by ongoing nervousness about the sustained bull market and business prospects once stock market performance returns to historic norms.
In reaction, more institutional money managers are:
* Diversifying and broadening their product offerings.
* Aggressively pursuing new distribution channels -- targeting high-net-worth individuals; participating in wrap fee programs, subadvisory relationships and defined contribution plan management; and selling through third-party financial intermediaries.
* Focusing on and measuring the productivity and profitability of institutional accounts.
* Concentrating on larger clients and accounts with higher margins such as hedge funds, small-capitalization and international equities.
* Deepening client relationships, upping customer service and more aggressively cross-selling multiproduct capabilities to existing clients.
* Adding more dedicated client service staff.
* Adopting narrower, more accurate performance benchmarks to help correct client expectations.
* Moving to variable expense structures from fixed-cost structures to cushion themselves in poor market conditions when management fees drop.
* Offering employees more deferred compensation structures and ownership stakes to spread payouts over time and to tie employees more closely to company performance.
* Using technology to bring operational activities such as trading down to cost levels close to those of passive managers.
* Using technology to provide clients with almost instant portfolio information and access to managers.
* Outsourcing non-core lines of business to best-practice partners.
* Slowing the rate of mergers, although strategic mergers to gain needed product capability continue apace and at high valuations.
AMVESCAP PLC, London, has since the early 1990s diversified by adding new investment strategies by market segments and by country. One effect of the move is to protect AMVESCAP against U.S. market downturns.
"We are in every market, in every distribution channel, use every investment style and handle every kind of account. It has been our No. 2 priority, second only to expanding our global business," said Charles Brady, chairman.
Like AMVESCAP, more money managers are focusing on deepening their relationships with customers and are doing more active cross-selling of their investment capabilities, said David Bullock, a senior consultant in the New York office of Eager Manager Advisory Services.
In general, money managers are not adding extra marketers or support staff in their efforts to consolidate and cement relationships with larger, more strategic clients, he said, meaning the shift often comes at the expense of smaller, marginal clients.
In addition, technology allows a broader information stream between the manager and the client, Mr. Brady said. The Internet makes it easy to "envision a day when a client can know exactly what a portfolio manager is doing second by second. We're seeing relationships evolve to the point that there is almost daily conversation between the manager and the fund, or at least, information is provided daily."
But adding more live bodies might become essential in more challenging markets, said Paul Schaeffer, a partner in the Mill Valley, Calif., office of investment bankers Investment Counseling Inc.
"Many managers have relied on the bull market to deliver client satisfaction in the last few years and are beginning to realize that this might not be good enough in a bad market, when clients need more reassurance," he said.
In addition, managers are adopting more accurate benchmarks and are encouraging plan sponsors to use them for performance comparison, hoping that would help them retain clients in a down market.
"Deteriorating performance is more acceptable if it is judged in the right light," Mr. Bullock said. He would not cite examples of managers that have changed benchmarks.
Investors will place more emphasis on performance if the market slows, said Lee Chertavian, a senior vice president at Affiliated Managers Group, Boston, a holding company for a stable of money management firms.
"We will be going into a period of greater interest in performance. Now clients are quite happy with second quartile returns. They're steady, nothing spectacular and reassuring in a period when market volatility is so high. But I think that may change when market volatility calms or goes away. Clients will be more willing then to hire a manager with more inherent volatility in the investment style, with more chance of outperformance," Mr. Chertavian said.
Barclays Global Investors, San Francisco, has decided to outsource defined contribution record keeping and administration, said Richard Malconian, chief executive officer of BGI's defined contribution plan business. The firm sold its bundled 401(k) plan service in the mid-1990s. "There was a feeling that bundled services were not a core competency -- money management was," he said.
By re-entering the defined contribution plan market on an investment-only basis, Mr. Malconian said, BGI will avoid the problems of "the bundled plan providers who have a lot of infrastructure. Margins are very squeezed, there is a lot more scrutiny on their costs and they are going to have a really hard time justifying the costs of their services. We're outsourcing what others would have built internally."
'Lean, mean machine'
BGI will partner with "best practice" plan administrators, will outsource as much as it can and even as it enters "a major hiring mode, we will maintain a very lean and mean machine. We are going against the grain now, hiring a lot of people, but we're keeping it nimble with a very vertically integrated business model. By outsourcing in a nimble world of e-commerce and new competitors we are staying very flexible," Mr. Malconian said.
Part of that flexibility will be necessary to cope with the much-anticipated stock market correction, Mr. Malconian and others said.
While few managers are taking concrete steps such as closing offices, moving to less fancy digs, canceling client golf junkets or instituting hiring freezes, it's clear that many are concerned.
"There's been three or four years of nervousness as the market edged up further and further. It sneaks into the backs of their minds all the time," said Mr. Bullock.
"It's not complicated. Most managers get paid on a formula based on assets under management. Fees for management go down when the assets go down as a result of stock market changes," said William F. Jarvis, a principal and consultant to money managers at Greenwich Associates, Greenwich, Conn.
The money management business has high fixed costs -- marketing staffs, offices and customer service facilities, analysts and support staff -- that would be hard to cut in the event of a prolonged downturn, Mr. Jarvis said.
About 70% of money managers now use fixed-expense structures, said Glen Davis, a senior consultant at Eager's Louisville, Ky., office, which means that regardless of market conditions, the biggest expense component -- employee compensation -- remains constant. But managers are moving to a variable, incentive-based compensation system that can better reflect manager and marketer performance.
AMVESCAP moved to reduce fixed expenses as early as 1992, when they were 92% of total costs. They now make up 70% of total costs.
After aggressively reducing such expenses across business, 30% of the firm's annual expenses are now variable.
As a result, Mr. Brady said, of the $1 billion in annual expenses projected for 1999, $300 million -- mainly employee commissions and bonuses -- is variable and could be reduced.
Trading cost consideration
In fact, if AMVESCAP were to fall short on projected 1999 earnings of between $500 million and $600 million, that variable expense component could make up as much as 60% of earnings in a poor market.
Trading costs will begin to matter a lot more to money managers if the stock market drops into a more normal range of returns and revenue from management fees drops dramatically, said John R. Casey, president and chief executive officer, RogersCasey & Associates, Darien, Conn.
"In a low return environment, managers will have to manage their businesses a lot more tightly -- more like indexed managers, (who) have been wringing it out for years. When returns are in the range of 10% to 11%, rather than 17% or 18% or higher, but costs are still 2% to 3% of the return, that eats into manager revenue," Mr. Casey said.
But many money managers are already using technology to get their costs down as low as is practical, argued Peter Starr, a consultant at Cerulli Associates Inc., Boston.
"They can't be less than zero. Trades in institutional markets are down now to two or three cents a share as it is. And there is a natural ceiling on how low active managers can go -- they have to be able to pay their talent, their people talent, to stay in place," he said.
Money managers have also shown more restraint in their buying habits, said Bruce McEver, president of Berkshire Capital Corp., New York, an investment bank with a specialized practice in money management mergers.
"The market has had a more cautious tone since July," he said.
Part of that caution has been expressed in a lower level of merger activity, said John H. Temple, a managing director at investment bankers Cambridge International Partners Inc., New York, which also specializes in money management mergers.
The number of money management deals was down 20% in the first six months of 1999, compared with the same period last year, and the prices paid were off 30%, according to Cambridge deal data.