“The industry is full of very bright people who know that the business model around fees is changing but they are simply unable to make the transition,” Lamb told International Adviser.
Innovation dilemmas are more often associated with the technology industry, he said: “Apple came along with an innovate approach of giving its operating system away for free. But the business model at Microsoft was so lucrative that they couldn’t. Ten years down the line they now do.”
Like Microsoft, asset management companies are reading the writing on the wall but are so deeply entrenched in their current, profitable business models that adapting to a new fee model is more difficult and unlikely, Lamb said.
Taking a retail example, he said: “If you were to buy in 2006, you would pay a platform charge, an adviser charge, and a fund management charge that came to 3%. With cash at 6%, fees as a percentage of the risk-free rate was 50%.
“Running a business, you have to look after your shareholders but also make sure you are providing value for money for your end clients, in what is effectively a zero-rate environment."
“If you assume a 2% charge today, with a risk-free rate of 25bps, fees as a percentage of the risk-free rate rises to 800%.
“It’s absolutely right that financial advisers should be questioning what they are paying asset managers.”
Margins are not the problem, Lamb said. “Asset managers running margins of 30% is absolutely fine. The big problem is the absolute number they are charging.”
The cost of talent
Another reason companies are reluctant to innovate is that their top talent is paid as a percentage of the management fees, he said.
For Lamb, the reduction in fees has much greater implications for asset management revenues than people think. “If you see a 10-20% reduction in fees but keep fund manager compensation the same it can be more like a 30-40% revenue reduction.
“Running a business, you have to look after your shareholders but also make sure you are providing value for money for your end clients, in what is effectively a zero-rate environment. But you’ve also got to manage your internal talent to make sure they are not thinking about moving elsewhere.
“Many firms are listed, so there is no prize for the chief executive to turn around and say ‘we are cutting all revenues’.”
Industrialisation
The asset management industry underwent significant consolidation following the global financial crisis in 2008.
It is the larger businesses, comprising several different brands, and the mid-sized active asset managers that have not streamlined their processes and become more cost effective that will be worst hit, Lamb said.
“Active management should be a niche, or ‘craft’, business, it shouldn’t face fee pressure, but by its very nature should be capacity constrained.”
Innovation
One example of innovation by Pacific Asset Management is its approach to retail investors, Lamb said.
“Retails investors tend to get offered two solutions; active, which is sold on performance and value, or passive, which is sold purely on cost. Cheap alone is not enough. As one person said to me ‘you wouldn’t go to a cheap brain surgeon’.”
With half of the world’s assets on track to becoming passively managed, Lamb believes we should be embracing all avenues of industrialisation, whether active, passive, or even direct investing.
“But asset managers aren’t providing that impartial, all-encompassing solution, particularly to retail investors, so that is the first area we want to help financial advisers with.”
