Industry Business Model
The primary source of revenue for asset management companies are the fees they charge their clients for the services rendered. These fees are generally linked to the performance of the funds and the size of the assets, popularly known as an asset under management or simply AUM. On the expense side, the primary cost to an asset management company is compensation expense. The following section explains each of these concepts in detail.
REVENUE
A major source of revenue for an asset management company is fees and commissions income, mainly management fees and performance fees.
The management fee rate is an agreed-upon rate applied to the assets under management (AUM). Management fees, a major source of revenue for an asset management company, are computed by multiplying the agreed-upon fee rate with the average AUM. This fee rate can vary depending on factors such as the asset class strategy and geography. When analyzing the management fees earned by an AMC on the total assets managed, analysts look at the ratio of fees to AUM (the management fee rate ratio). Additionally, when analyzing the total revenue generated by an AMC on the total assets managed, analysts look at the revenue margin on the average AUM for companies where the revenue is generated from other sources as well.
Performance fees or incentive fee rates are fees charged by an asset management company for generating returns exceeding a predetermined benchmark on the assets managed, unlike the management fee, which is charged without any regard to the return generated.
NON-INTEREST EXPENSES
The largest category of non-interest expenses for an asset management company are compensation expenses and employee benefits. In addition to these employee costs, asset management companies incur expenses related to professional services and fees.
When evaluating the operating efficiency of asset management companies, analysts use the ratio of non-interest expenses to total revenue. This ratio is commonly known as the efficiency ratio in the U.S. and the cost-to-income ratio in other countries. When evaluating the expenses of an asset management company, analysts look at both the level of the efficiency ratio, its trend (a downward trend is generally preferred), and how it compares to its peers.
PROFITABILITY AND DISTRIBUTIONS
Profitability
Analysts rely on return ratios to compare the profitability of asset management companies. The most popular return ratios or indicators are return on assets and return of equity. These ratios are measured as:
Return on average assets – Net income applicable to common shareholders as a percentage of average assets.
Return on average equity – Net income applicable to common shareholders as a percentage of average common shareholders’ equity.
Distributions
When companies are profitable, they distribute capital to shareholders by paying dividends and/or by repurchasing shares. An asset management company’s distributions are analyzed using payout ratios, which are dividends and/or repurchases relative to earnings.
Asset Management Business Model
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AUM Roll-forward
Assets under management (AUM) is the key driver of fee revenue for an asset management company and is influenced by net new flows, net market performance, FX, and acquisitions. The schematic diagram below models the change in AUMs by contribution along with the key measures of efficiency tracked by analysts.
Assets Under Management (AUM)
Assets under management (AUM) are categorized by product type, client type, and investment style, which is useful when understanding the business. AUMs are organized as follows:
