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The Bear Market Has Roiled the Asset Managers

Negative operating leverage will have a big impact on near-term profitability.

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Given the unprecedented decline in the U.S. (and global) equity markets over the last six months, it was not too surprising to see the stocks of asset management firms fall apart during the last half of 2008. With assets under management (AUM) significantly below year-ago levels, we expect to see some significant changes in the industry as revenues decline dramatically, forcing companies to cut costs wherever they can. With investors shell-shocked, it may take some time for the markets to work their way back, leaving the asset managers struggling to improve their sales and profitability in the near term. Given this environment, we expect to see competition for investment dollars heat up, with the advantage going to those firms that have had stronger relative fund performance, can offer a broad array of products to investors, and have fairly diverse distribution channels in place.

Asset Management Is (Usually) an Attractive Business
In most markets, the asset management business is exceedingly attractive. Firms running this type of business collect fees based on the level of assets under management; although in some cases--such as with hedge funds and private-equity investments--performance-based fees can significantly outweigh these investment management fees. The best part of this arrangement, however, is that most investors are either barely cognizant of the fees that are being levied on their investments or don't see the fees (which tend to average less than 1% of assets under management, regardless of the asset type) as being overly cumbersome. As such, revenues continue to flow regardless of how well the firm manages its AUM, with a firm needing only to have a good year (of absolute growth) in the markets and/or increase the flow of funds into its products to realize an increase in revenues. Granted, this is a bit of an oversimplification, because an asset manager that does a terrible job managing money is likely to have investors pull out of its funds, but it does highlight how the asset management firms make their money.

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Greggory Warren, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.