Money managers might need to reduce the number of investment strategies they offer or find savings in their middle- and back-office functions if changing business dynamics reduce their ability to maintain current profit levels.
That's the view of management consultant Boston Consulting Group in a report issued last month that said despite managers' growth in profits, cutting costs has become one of three main drivers of manager profitability, along with the more traditional growth in assets under management and higher margins.
According to the report, “Global Asset Management 2013: Capitalizing on the Recovery,” “cost discipline among money managers continues to be an issue, particularly with managers experiencing outflows. In order to afford investment in new capabilities, it is critical to tightly manage the cost structure.”
The 7% rise in manager profit in 2012 was driven by asset growth, as worldwide money managers' total AUM reached a record $62.4 trillion, surpassing the $57.2 trillion set in 2007 before the financial crisis, according to BCG.
But much of that asset growth came from new strategies — which cost money to implement. And although two-thirds of money managers increased their profits in 2012, BCG said only 33% of managers reduced costs — and 13% did so while also increasing revenue.
Cost concerns create a potential Catch-22 for some managers, said Brent Beardsley, Chicago-based partner and managing director at BCG, and a co-author of the report. “Assets under management are up because product lines are increasing, costing managers more money,” Mr. Beardsley said. “In investing, the rule of thumb would be: If you want to cut costs, you'll need to cut asset classes. We've told some of our (money management) clients that there are some asset classes you shouldn't be in. At some level, the only way to cut costs is to cut products.” He wouldn't say whether any of BCG's clients have or plan to cut back on investment strategies to reduce costs.
Making the choice to avoid adding strategies puts small and midsize firms in a tough spot as well, Mr. Beardsley said. “Larger firms can absorb the costs of expansion more than midsize and smaller firms,” he said. “Few firms are vastly profitable with only a few strategies. Most probably aren't … With traditional strategies, the question (those managers) need to ask is why they're there in the first place.”
“However, those traditional strategies have benefits for those managers over adding other new strategies,” Mr. Beardsley said. Traditional equities and bonds are “efficient, and less expensive than alternatives. Plus, with more specialty classes, sure, they're growing, but lots of people are already there. What can a manager do that hasn't been done? And there's a smaller asset pie with specialty classes.”
James Suglia, U.S. advisory sector leader for KPMG's investment management practice in Boston, said cost reduction — or efficiencies in operations — are a major issue for money managers because of the current dynamics of the industry. “Many managers of various sizes need to be concerned about cost,” he said. “There's the cost of growing a business, adding strategies, but there's also the cost of the regulatory framework, all of which costs a lot to create.”
However, Mr. Suglia said he's not sure it's an either-or between cost savings and strategy reduction. “I don't know if it's one or the other,” he said. “I think managers are saying they need to find out how to be more efficient, more effective, as a means of controlling costs.”
Areas highlighted in the BCG report and by Messrs. Beardsley and Suglia as having potential for cost-cutting include trade execution, risk analysis and fund accounting. Mr. Beardsley said outsourcing of those tasks is one answer, passing those tasks on to custodians like State Street Corp., Bank of New York Mellon Corp. and Northern Trust Corp. “In general, outsourcing the middle office is less complex for the money manager and less expensive than doing in-house. It avoids a lot of technological investments.”
Still, Mr. Suglia said, some future costs in information technology are inevitable as some money managers are using “20- to 30-year-old proprietary systems that need to be upgraded to be efficient. Operating platforms need to have continuous improvements and enhancements.”
One area not targeted as much for cuts, said Mr. Suglia, is company headcount. “When the markets imploded (in 2008-2009), many firms in any sector were laying off people. Some of those more traditional cost-cutting initiatives were done in that 2008-2010 timeframe. Today, cost cutting requires more work.”
Fees also are a focal point in the broader discussion of costs, as pressure to reduce fees means the potential for less revenue. “Every asset manager has a sliding scale of fees,” Mr. Beardsley said. “The more assets you manage for someone, the lesser the price. It's why it's important to have a handle on costs, especially managers with separately managed accounts. The cost control is much better than it used to be, but still small and midsize firms struggle.”