Cost cuts and margin stability

Thousands of staff have been laid off from asset management companies in recent months (not ours).

We can see this first-hand here in our Edinburgh base. Fees are under intense pressure both as a result of investors losing faith in active management and moving to passive, and within active as institutional clients, in particular, seek to drive harder bargains (though can we please remember cost is not the same thing as value for money?). Volatile markets and rising costs have also contributed to asset management profit margins coming under pressure. How do most firms react to shareholder pressure to protect margins? They cut costs as they lose revenues. But there’s a key question here - how does this serve clients in the long run? The resources required to do a good investment job are pretty much stable. They don’t fall because the markets did. Maybe even the opposite. 

Rather than cut costs to satisfy short-term profitability goals, why don’t asset management firms simply take the hit for a while on the basis that in the long run, this is more likely to generate strong investment outcomes and satisfied clients?

It’s too easy though to say that the answer is to not have external shareholders and that asset managers are simply not suitable to be listed companies. There’s nothing intrinsic in being a listed company that says you can’t take a long-term view (indeed from an investment perspective we strongly favour those that do). I recently had dinner with a friend who runs a large quoted insurance company who was very insightful on the massive importance of listed companies communicating effectively with shareholders. By investing time and effort into explaining what the company’s long-term plan is, management can resist caving into shareholder demands and better make the right long-term investment decisions. Despite the short-termism of most investors, effective communication can persuade shareholders that decisions that may impact short-term profits or cashflows might actually be wise investments with positive long-term payoffs. Possibly companies that communicate well with shareholders also attract more long-term investors, so a virtuous circle ensues. There is some academic evidence (Harford, Kesces and Mansi amongst others) that companies with the most stable shareholder base outperform other companies.

 

This applies as much to asset management companies as it does to everyone else. In general, asset management is a highly profitable business over the cycle. Rather than cut costs to satisfy short-term profitability goals, why don’t asset management firms simply take the hit for a while (and ‘a while’ might mean three years) on the basis that in the long run, this is more likely to generate strong investment outcomes and satisfied clients? Surely that’s not too hard a concept to explain to shareholders? It would almost certainly be better for our industry’s long-suffering clients, and in the long run for our industry too.

Stuart Dunbar

Partner

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