With over $74 trillion in total global wealth, the demand for expert financial advice and asset management is paramount.1 Such analysis aims to provide outsized, uncorrelated returns for a variety of beneficiaries, all with different objectives and return requirements.
These include individuals saving for retirement, universities building new facilities, insurance companies providing life insurance policies, sovereign wealth funds financing public works programs and pension funds providing benefits for thousands of current and former teachers and their families. This is no easy task.
Asset Management Fees
But the challenge is happily met by the asset management industry, considering the typical fee arrangement is typically between 1% and 2% of assets managed, annually. The average amount is actually 1.7%, according to a study by Bain Capital.2 The compensation structure has evolved over the years and has shifted away from a straight, commission-based model to a ‘wrap-fee’ or percentage of assets under management model. Some firms have a combination of both.
The compensation structure has evolved over the years and has shifted away from a straight, commission-based model to a ‘wrap-fee’ or percentage of assets under management model. Some firms have a combination of both.
There are several different positions in the asset management industry. There are the direct investment decision makers which, on the buy-side, are fund managers and portfolio managers. On the sell-side you have the financial advisors. Then there are teams of salespeople, wholesalers, analysts, accountants, order clerks, operations personnel and administrative support staff who all combine to make the money management company operate profitably.
Asset Management Strategies
They deploy a plethora of different investment strategies, all dealing with the inter-play between risk and return. An optimal portfolio is one that provides the highest returns with the lowest risk. This is accomplished by including uncorrelated or negatively correlated investments into a portfolio, which makes a portfolio more diversified, reducing overall risk.
For example, most financial advisors would frown upon a 100% allocation to your favorite internet stock as your retirement portfolio. If the internet company went bankrupt, your account value would be wiped out.
The term uncorrelated refers to asset classes that don’t move in tandem. An example might be gold futures and farmland. Other uncorrelated investments may even be in the same asset class. For example, within equities, combining utility and technology stocks provide some diversification benefits.
This is because utilities are higher-yielding, defensive sector plays while semiconductor stocks tend to have smaller dividends and highly cyclical economic exposure. Learning how to adequately construct such portfolios for clients is part of the Modern Portfolio Theory and is taught in some Masters in Finance programs and the Chartered Financial Analyst (CFA) program.3
Learning how to adequately construct such portfolios for clients is part of the Modern Portfolio Theory and is taught in some Masters in Finance programs and the Chartered Financial Analyst (CFA) program.3
So You Want to Work in Asset Management
But managing assets is no walk in the park. In the quest for uncorrelated returns, fund managers often pursue esoteric, alternative investments that provide higher yielding income at the expense of liquidity. Nowhere is this more evident today than in Britain, where a frightening situation is unfolding with several commercial real estate funds reporting trading halts and frozen redemption requests (withdrawals) citing illiquidity.
Last Monday, a fund run by Standard Life announced it was freezing investor redemptions. Then rumors of more began. The worrisome part of this situation is the swiftness to which the dominos appear to be falling. By the end of the week that number was up to seven (and counting).
“It’s reminiscent of Bear Stearns’ subprime funds before the Lehman debacle”, famed bond manager Bill Gross warned.4
What Goes up Must Come Down
The problems with the commercial property funds arose when investors tried sell their shares in the property funds. The liquidity was adequate at first, but when the redemption requests continued, (spurred on by well-circulated forecasts for a 20% drop in U.K. office prices) the cash and REITs, the buffer that funds keep to meet short-term redemption requests, ran out.
Remember, the funds main holdings are in the direct real estate investments, the actual commercial properties around the U.K. which are of course, difficult to sell in a timely manner. The result is several commercial property funds in the U.K. have halted trading, causing investor’s capital to be stuck in the fund.
But the investors in these funds aren’t just mom and pop. They include major European banks who have actually invested in each other’s funds. These property funds are run by major British financial institutions including M&G Investments and Standard Life. According to a Bloomberg article, Standard Life owns over 2 million shares of a frozen fund run by M&G.5 So the redemption freeze, known as the “gate”, applies to these banks as well, exacerbating an already uncomfortable liquidity situation.
According to a Bloomberg article, Standard Life owns over 2 million shares of a frozen fund run by M&G.5 So the redemption freeze, known as the “gate”, applies to these banks as well, exacerbating an already uncomfortable liquidity situation.
Euro banks are in risk management mode, especially after their share prices have dropped since the Brexit vote. While bank capital is reportedly four times larger than before the financial crisis, if the U.K. property market cracks, the banks collateral will drop and credit could be much harder to access. It is this deflationary credit contraction that could exacerbate the downswing in real estate prices.
The problems with these property funds doesn’t stem from low interest rates, or even Brexit. It’s about the years of foreign capital inflows into safe haven real estate markets, like London, which have propelled real estate values higher. The Bank of England revealed that since 2009, foreign inflows accounted for 45% of value creation in the London property market. Consequently, global investors clamored to participate in London’s real estate gains and many real estate property funds were created, further fueling gains.
Fund flows have come from all over the world, but most notably China. The collapse of the Chinese stock markets last year was a precursor to this week’s events. As a result, capital flew out of China, even with capital controls instated by a nervous government. Money leaked out amidst wires to offshore companies and all the associated tactics that cause a capital control policy to ultimately backfire.
These events underscore the need for risk management procedures and compliance. Capital requirements among banks (especially in Europe) should be raised across the board, not just for real estate investments, in a scramble to prevent another 2008. Its one thing to run a fund that becomes illiquid but another to invest in one.
Other alternative investments may require higher capital buffers, including high yield (junk) bond funds, various structured products and business development companies. These events probably worry institutional investors such as pension funds and insurance companies who have raised their asset allocations over the last few years to traditionally illiquid vehicles such as private equity funds and hedge funds, both of whom can halt investor redemptions through the ‘side pocket’ provision.
Asset Management Compensation
For their efforts in dealing with scenarios described above, asset management professionals are well-compensated. According to CNBC, portfolio manager ranks as one of the best jobs in America, with an average salary of $121,000 and ten-year job growth rate of 32.1%.6 Many portfolio managers were former research analysts or even financial advisors that made the switch from a few million dollar book to running a hundred million dollar portfolio.
For fund managers, the compensation is even more lucrative, often in the hundreds of thousands of dollars. For financial advisors, there is a wide disparity when analyzing compensation. Still, the US News & World Reports claims the median compensation for financial advisors is $81,060.7
Masters in Finance
Jobs in asset management are competitive and candidates are increasingly well-credentialed. Many have obtained, or are pursuing, a Masters in Finance degree or a Finance MBA. Others go on to the rigorous Chartered Financial Analyst (CFA) program. Some enjoy the best of both worlds with a Masters level finance program that prepares students for the CFA program.