Despite sustained growth in capital markets, margins across traditional asset management continue to slowly drift ever lower. With fee pressure persisting, a tightening regulatory environment and rising costs of maintaining scalable, technology-driven operations, asset managers must have both the muscle and mindset to manage profitability at a more granular level.
While the concept of profitability is straightforward, applying it to an inter-connected business such as asset management requires a robust profitability methodology which accounts for the noisy nuances of a manager’s product offering, fee structures, distributions channels, and operating model while still providing Executives clear signals of where to focus. Traditional methods and tools, though sufficient for standard financial reporting, often fall short of accurately capturing a manager’s marginal cost of growth. Conventional approaches typically fail to provide senior leadership with the insights needed to accurately identify firms’ highest, and lowest-margin products, distribution channels, and client segments. In an increasingly competitive market, developing profitability capabilities which deliver insights into fund, asset class, desk, distribution channel and client profitability is imperative, particularly as asset managers learn to navigate a lower-margin environment.
Unpacking the key hurdles managers face when defining a methodology
Developing a profitability capability requires input from stakeholders across the business to generate meaningful insights that can be used to drive change. However, this process can be challenging without the right approach.
Typically, we see managers grapple with the following challenges when developing a profitability methodology:
- Allocating Revenue: Managers often find it challenging to measure the value of “building block” funds. “Building block” funds are single-asset class funds sourced from various investment desks and are often used to construct multi-asset strategies for clients. Accurately tracking the contributions of each desk is essential to properly recognizing revenue back to the managing desk and / or fund via internal fee rates or transfers.
- Allocating Direct & Indirect Costs: Determining the appropriate level of granularity to apply to cost allocation can be challenging, and managers often struggle to clearly articulate which costs should be allocated to a fund versus the wider business.
- Allocating Cost Drivers: Managers often struggle to correctly allocate cost drivers across key dimensions of the business, such as asset class, distribution channel and investment desk.
- Forecasting: Many managers can only assess static, point-in-time cost allocation data and are unable to realistically forecast future operating expenses and their cost drivers.
- Achieving Business Buy-In: Developing an accepted, enterprise-wide view of profitability generally requires the endorsement of stakeholders across the business. Failure to secure the appropriate business buy-in on the methodology and cost drivers being used for apportionment is an avoidable, but common, reason we often see managers struggle to effectively harness their profitability insights and analysis.
Building the Muscle: Structuring a methodology to generate effective insights
When embarking upon the design of a profitability methodology, managers must agree which view of profitability is most important to them. There is no “right” way to view profitability, however, a capability is most valuable if it produces outputs which align with how the business measures performance and allows for a repeatable process.
We most commonly see managers view profitability through an investment desk and/or a distribution channel lens. To achieve this, managers must understand the cost of the full value chain, also known as the Fully Loaded Cost of doing business.
To understand the cost of an investment desk, managers must have a view of:
- Attributable Costs: Costs which are directly incurred by the desk in question. Examples include staff costs, variable compensation and market data.
- Allocated Platform Costs: Costs which are incurred by supporting functions. Examples include HR, Finance and IT.
- Allocated Channel Costs: Costs which are incurred through distribution of the desk’s products across distribution channels.
To understand the cost of a distribution channel, managers must have a view of:
- Attributable Costs: Costs which are directly incurred by the channel in question.
- Allocated Platform Costs: Costs which are incurred by supporting functions.
- Allocated Capability Costs: Costs which are incurred through manufacturing and maintaining the products for the channel in question.
By maintaining sight of all three types of costs across the value chain, managers can generate Total Operating Profit for the relevant lens. Attributable profit with respect to either the investment desk or distribution channel is an additional metric managers can derive by having sight of the attributable costs.
Changing the Mindset: Leveraging the new capability to drive change
To effectively apply a profitability methodology, and subsequently extract tangible insights which drive resulting change, managers must have an early idea of the outputs they require at a detailed level – which is often overlooked. Outlining hypotheses early about the drivers and draggers of profitability and the data points that would be required to test these hypotheses is a crucial exercise to generate early results and to avoid becoming lost in granular cost data. Managers who establish a clear view of the desired outputs at the onset are more often able to successfully develop a comprehensive analysis that is repeatable and garner the necessary buy-in from Senior Leadership.
Outputs that we often see our clients use to inform decision-making and drive change include:
Fund & Channel Profitability
The ability to analyze profitability by both fund and channel is crucial to understanding which products and client channels warrant increased attention and distribution efforts. By splitting fund or channel costs across direct and indirect costs, managers can determine how to best focus their cost optimization strategy.
Fully Loaded Profitability
By allocating the cost of manufacturing, the cost of distribution and platform costs to the appropriate funds, managers can see the ‘true’ profitability of a fund. This enables a manager to profile funds accurately and take the necessary strategic action. For example, a manager may apply Fully Loaded Profitability to identify funds with declining growth prospects and margins to determine where divestment may be the optimal path forward.
Fixed vs Variable Cost
The ability to accurately categorize operating costs as ‘Fixed’ or ‘Variable’ enables managers to see which cost pools will scale as the business grows . Similarly, if a firm is considering a carve-out of a business line, the estimated impact on the cost-base can be easily analyzed.
Direct Cost Analysis
When evaluating a product line, identifying which desks are profitable or loss-making is a crucial starting point, but it does not provide the full picture. Breaking down direct costs attributed to a fund allows a manager to distinguish between desks that are simply sub-scale and require further investment to grow and those that have matured and will likely remain unprofitable going forward.
ROI Analysis
Many managers have flagship channels or products which are treated as untouchable. However, by leveraging a profitability tool, managers can highlight where revenue and investment do not necessarily translate into profitability. Furthermore, managers can leverage such outputs to inform which channels or products are objectively profitable and do in fact warrant investment.
Case Study: Establishing a Profitability Methodology to Drive Strategic Decision-Making
