Focusing on profitability and management of expenses helps alternative asset managers proactively manage and support their infrastructure more effectively.
The profit and cost information they glean supports their analysis on the impact of growth and changes to the operating model on profitability and performance. But to truly take advantage of this approach, alternative asset managers must develop, implement and maintain a sustainable performance measurement and management framework.
This framework can provide greater insight into drivers of value - both costs and profitability — and encourage higher levels of accountability to help manage expenses, support pricing and manage profitability.
It can also help managers execute and drive profitable growth by enhancing value from new and existing business opportunities (e.g., markets, geographies, investors and products).
The insights gained through this framework will serve as a significant competitive advantage to alternative asset managers as the importance of analytics grows and the grasp of disruption advances.
WHY THIS IS IMPORTANT
Alternative asset managers are reviewing their cost and profit management processes in order to respond to the challenging economic environment and pressures generated from recent market trends. Moving forward, these processes will increasingly affect:
Asset growth: Managers view asset growth as a key strategic priority for their business. Managers with larger portfolios have grown by adding new strategies or increasing penetration with existing strategies and products.
However, as managers add new strategies or expand, they need to consider much more than just revenue. They must also anticipate the associated costs and the impact on operating margins, as well as personnel workload and skill set requirements.
Entering new markets and strategies may require these managers to hire individuals with specialized skills and to implement new and forward-leaning processes, such as accounting for new asset classes or products. A robust profitability strategy will allow managers to model their revenues and costs under various scenarios and help them prioritize their approaches for profitable growth.
Fee pressure from prime brokers: Recent and pending banking regulations such as Basel III and Dodd-Frank have forced prime brokers to reassess how they are managing their balance sheet and capital requirements. As a result, the managers are noticing the impact in the form of rising fees. To date, 29% of managers have seen their prime brokers fees increase, while another 22% expect an increase in fees in the near future, according to EY's 2015 Global Hedge Fund and Investor Survey.
Rising costs and changing relationships with prime brokers also impact talent acquisition and retention. In response to these changes, leading managers have formalized their treasury function and have added personnel such as treasurers to manage the process.
Investor pressure on fees: As a result of these prime broker cost increases, investors have negotiated to reduce the fees they pay alternative asset managers, especially management fees. Managers have seen an erosion of the 2/20 model (2% management fee, 20% performance fee). The typical 2% management fees have been decreasing across the board at alternative asset managers, with the largest managers averaging 1.51%, according to the EY survey. The industry perspective is that this trend will continue before it abates.
Moving forward, managers that want to gain an advantage should assess the profitability considerations of growth — both revenues and cost drivers.
They must also plan for the two-sided pressure from rising prime brokerage fees and shrinking management fees, which has led to a fee squeeze. As the managers face growing and continuous industry challenges and increased fee pressures, an effective expense and profitability framework that is aligned to their operating model can be a competitive advantage.
It is imperative that managers first design an operating model that supports a scalability approach to growth and adapt an expense and profitability model that supports the business.
When successful with the approach, managers will benefit from transparent, relevant, reliable and timely management reporting that can guide more informed decisions and drive profitability for their business moving forward.
With the growing importance of harvesting information, developing an operating and profit model framework facilitates a better understanding of profitability drivers to enhance their business insights.
Alternative asset managers that act today with a strategy that involves optimized resource allocation, effective cost and profit management, and levers of cost will be better positioned for future trends and knowledgeable enough to effectively manage their business.