What it means
These firms sit between savers and markets. On one side are retail investors buying funds through pensions and platforms, on the other are institutions such as pension schemes, insurers, charities and endowments awarding mandates worth hundreds of millions.
The business model is straightforward and unusually exposed. Revenue is a percentage of assets under management, so a 20% fall in markets cuts income by roughly 20% while salaries, premises and technology costs stay where they are.
Fee levels have fallen steadily as index tracking has grown. Active equity funds that once charged well over 1% now compete against index funds charging a small fraction of that, which pushes managers either towards scale or towards specialist strategies where fees hold up.
Regulation shapes how these firms operate. Client assets are normally held by a separate custodian rather than the manager, the firm owes a duty to act in clients' interests, and mandates set explicit limits on what may be bought and how much concentration is allowed.
For a client choosing a manager, the questions are practical. What is the total cost including transaction and administration charges, does the manager stick to the stated mandate, and how much of the performance record depends on one individual who could leave.
In practice
Real-world examples.
Example
A local government pension scheme awards a $150,000,000 bond mandate at a fee of 0.35%, paying the manager $525,000 a year. The mandate document specifies credit quality limits and a benchmark the manager is measured against quarterly.
Example
A private investor comparing two funds for a $60,000 holding finds an index fund charging 0.10%, or $60 a year, against an active fund at 0.85%, or $510 a year. Over 20 years the difference compounds into a meaningful share of the final balance.
Example
A boutique manager with $900,000,000 under management loses a single institutional client accounting for 30% of that total. Revenue falls by nearly a third within one quarter, and the firm has to cut two analyst roles to stay profitable.
Formula
Calculation
Management fee revenue = average assets under management x annual fee rate
Performance fee = (return above the hurdle rate) x participation rate x fund assets
A mid-sized manager runs $4,200,000,000 of assets at an average fee of 0.65%. Its management fee revenue is $4,200,000,000 x 0.0065 = $27,300,000 for the year.
One of its funds, holding $200,000,000, charges a performance fee of 20% of any return above a 6% hurdle. The fund returns 14%, so the excess is 8%, worth $200,000,000 x 0.08 = $16,000,000, and the performance fee is $16,000,000 x 0.20 = $3,200,000.
Total revenue is therefore $27,300,000 + $3,200,000 = $30,500,000. Against fixed operating costs of $19,000,000, operating profit is $30,500,000 - $19,000,000 = $11,500,000, a margin of $11,500,000 / $30,500,000 = 37.7%.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Cairnbrook Asset Management, an invented specialist equity manager, ran $1,800,000,000 of client money at an average fee of 0.70%, producing revenue of $12,600,000 against fixed costs of $9,500,000 and an operating profit of $3,100,000.
A severe market fall cut portfolio values by 20%, taking assets to $1,440,000,000. Nervous clients then withdrew 10% of what remained, leaving $1,296,000,000. Fee revenue fell to $1,296,000,000 x 0.007 = $9,072,000, a drop of 28%.
Because costs were almost entirely fixed, the fictional firm swung from a $3,100,000 profit to a loss of $428,000 in a single year without making a single bad investment decision. The episode pushed its partners to add a lower cost index range and a small advisory business, so that not every dollar of revenue depended on the level of the market.
Watch out
Common mistakes.
- Assuming the asset management company holds your money, when client assets normally sit with an independent custodian and the manager only gives instructions.
- Comparing managers on headline fee alone, ignoring transaction costs, platform charges and any performance fee that applies.
- Judging a manager on one strong year, which is far too short a period to separate skill from a favourable market for that particular style.
Questions
People also ask.
What does assets under management mean?
It is the total market value of client money the firm manages, and it is the figure the management fee is charged on.
How does an asset manager differ from a wealth manager?
An asset manager runs investment portfolios and funds, while a wealth manager typically advises individuals on the wider picture including tax, planning and which managers to use.
What is a performance fee hurdle?
It is the minimum return that must be achieved before the manager can charge a share of the gains, so a 6% hurdle means only returns above 6% attract the extra fee.
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