In the first of a two part series, this column will investigate the current state of affairs of the asset management industry. In part two, this column maps out the way forward.
The asset management business in the GCC has followed a puzzling evolutionary path focussed predominantly on listed equities with a smattering of funds investing in private equity (PE) and bonds whilst seeming to ignore other asset classes such as real estate (RE) which not only has exhibited good performance across the region, it also provides for strong cash flow income and appears to have the greatest demand from investors as exhibited by their direct investment demographics.
The asset management business depends on fee income which is split between so called management fees, which are a fixed percentage of client assets under management (AUM) and performance fees which is a payment formula linked to the performance of the fund over a period. The main four drivers for the asset management business therefore are: the level of fees that are being charged, the holding period over which the performance fee is calculated, the performance of the fund and the amount of client assets raised.
The first driver, fees, is driven by market norms and competitive pressure. The lowest fees charged are by listed equity funds, approximately 1.5% per annum in total and bond funds even less, and this reflects competitiveness in the market.
Even though this fee level can be higher for top performing funds, it pales in comparison to, for example PE funds that normally charge a 2% per annum management fee and a 20% per annum performance fee although the latter is only fully realised at the end of the investment period which can be between 5 and 10 years. RE funds would normally charge something in between.
Therefore from a fund business point of view it would seem that the best strategy would be to launch a PE fund, with its higher fees, and possibly a RE fund, with its superior performance, but certainly have little of their business geared towards listed equity funds or bond funds.
The first clue to why there is a clear gap in the market between high margin business and low margin business is the holding period of the fund which is linked to the liquidity of the underlying securities and assets. Asset management firms prefer a short holding periods as they get paid faster and can more easily get paid for short-term bull markets. Furthermore, if the market corrects it is easy to shut down the badly performing fund and launch a new one.
From the point of view of investors high liquidity is preferable to more illiquid assets such as PE and RE. The problem is that this preference for liquidity comes at a price: the non-alignment of the asset manager’s short-term objectives with the long-term objectives of the investor. A way out could be to ask equity managers to get paid over a rolling 5 year period to better align objectives.
The third driver is the performance of the fund. The role of the performance of the fund in the performance of the asset management business is quite often misunderstood and naively believed to be the same thing. Although good fund performance does have a positive impact, this accretive to business performance only if people believe that the performance is attributable to the manager and is repeatable in the future.
The final driver of the asset management business is the biggest by far and that is the client AUM. Without AUM there simply is no business because there is nobody to charge fees to. Other than commercial banks and their massive distribution networks the majority of asset managers, with some exceptions, have had difficulty raising AUM in a timely manner. This helps explain the listed equity culture: if the majority of AUM raised is via commercial banks and their main distribution network is their retail branch network then it stands to reason that the best choice for their retail clients is the least complex choice which would be listed equities.
Where does all this leave the asset management community? The 2003-2008 period saw the launch and initial success of multiple asset management businesses which were decimated in the subsequent global financial crisis. In the following years the asset management industry has been lost in finding a new vision.
In the second part of this series, this column will outline how the asset management might flourish.
You might also be interested in:
- The Future of Asset Management in the GCC (Part 2)
- The Future of Investment Banking in the GCC
- Who Wins, the Trader or the Investor?
This article was originally published in The National.