Assessing Advisor Profitability: A Tricky Call For Fund Directors

Transcription

1 Assessing Advisor Profitability: A Tricky Call For Fund Directors April 30, 2014 A Mutual Fund Directors Forum Webinar

2 Today s Speakers Susan Wyderko Meyrick Payne Geoff Bobroff Sara Yerkey President & CEO, Mutual Fund Directors Forum (Moderator) Sr. Partner, Management Practice Principal, Bobroff Consulting Partner, Management Practice 2

3 Topics for today 1. Objectives of profitability analysis 2. Gartenberg principles 3. Benchmarks for assessing reasonableness 4. Cost allocations and fall-out benefits 3

4 Understanding the objectives of analyzing fund profitability Assess fairness of annual contracts Confirm the financial stability of the advisor Highlight any differences in side by side management of other investment vehicles and other management activities Limited guidance, few quantitative guidelines or benchmarks other than a 1982 Gartenberg case 4

5 Legal precedents: the Gartenberg line of cases (circa 1982) A fee must not be so disproportionately large that it bears no reasonable relationship to the services provided Securing the lowest possible fee is not the goal of the board, especially through negotiations which might damage the capacity to serve the shareholders interest High profits earned by the advisor are not necessarily indicative of an excessive fee The advisor is entitled to recoup their costs and make a fair profit The fees must not be so excessive that they could not reflect the results of arm s length bargaining A cost-plus type of contract is not intended Establishes the only existing numerical benchmarks 5

6 Following the Gartenberg process Process is king; but process is not substance Requires fund by fund analysis of profitability of the advisory fee and fall-out benefits Marketing and distribution costs should not be considered when evaluating the profitability of the advisory fee Shareholder servicing may be included Gives the board authority to ask for appropriate profitability data 6

7 Advisory fees historically make up 71% of all fund fees Typical Cost Structure of Mutual Funds Advisory 71% TA 13% Custody 3% Accounting 3% Admin. 4% Other 6% 7

8 8 Summary of Pre-tax Profit from Advisory Activities (excluding distribution) of Selected Publicly-held Companies Significantly Engaged in Mutual Fund Management

9 Fund-by-Fund Advisory Profitability Illustrative Advisor Profitability by Product and Total Advisory Profitability Benchmark Equity 71% Alternative 50% Fixed Income 45% Money Market 2% Total Complex Advisory Profitability Current Industry Ave. Advisory Profitability 49% 52% 0% 10% 20% 30% 40% 50% 60% 70% 9

10 10 Summary of Pre-tax Profit on all Investment Activities (including distribution) of Publicly-held Companies Significantly Engaged in Mutual Fund Management

11 Fund families typically earn higher margins on advisory functions, less on shareholder servicing and lose on distribution Illustrative Fund Channel Profitability and Comparative Benchmark Advisory 58% Shareholder Services 10% Distribution -30% Total Investment Profitability 41% Current Industry Avg Investment Profitability Benchmark 30% 11-40% -20% 0% 20% 40% 60%

12 Potential Influences on Profitability Asset size Product mix (equity, fixed income, mmkt) and fee levels Compensation structure (fixed, variable, performance) Distribution method (direct, platform) Client channels (institutional, retail, high net worth) Active vs. passive managed products Sub-advisory agreements Sub-administration agreements Number and size of accounts Average Assets ($ millions) $5,000 $4,000 $3,000 $2, Average Assets and Pre-Tax Operating Margins of Sample Firms Avg AUM 50% 40% 30% 20% $1,000 Operating Margin 10% Operating Margin 12 $0 0%

13 Product Mix Trend % Average AUM Product Split of Sample Firms, % 60% 40% 20% 0% 55% 58% 58% 57% 50% 52% 51% 48% 50% 12% 12% 18% 14% 13% 12% 13% 14% 16% 27% 23% 21% 20% 25% 28% 29% 32% 29% 6% 7% 7% 7% 7% 6% 7% 8% 9% Equity Money Market Fixed Income Alternative 13

14 Determining fund-level allocations: Possible Methodologies: Directly charged (fund specific) Average assets Revenue (assets * management fees) Effort (implies time tracking) Square footage (occupancy) Fund flows Trade execution Number of people Procedure Emphasis: Documentation Year-over-year consistency 14

15 Typical fall-out benefits or losses Profit on affiliated transactions such as: Shareholder servicing Custodial services Cross-selling opportunities Brokerage services Overhead absorption for other businesses Direction of trades Other benefits and costs 15

16 Final Considerations Managers often see funds as one of many financial products Director s responsibility is only the oversight of the funds Profitability is ONE of many measures to observe during the complete assessment of the fund Fee trends 16

17 216 West Hill Road, Suite 200 Stamford, CT Phone: (203) Fax: (866) Meyrick Payne Sara Yerkey Bobroff Consulting, Inc. 40 Woodbridge Drive East Greenwich, RI Phone: (401) Fax: (401) Geoff Bobroff 17