Industry Profitability Returns as Average Assets Rise in 2010
Written by Meyrick Payne and Sara Yerkey of Management Practice Inc. (MPI)   

     The most important function performed by mutual fund trustees is the annual review of investment management arrangements.  One of the factors in this review is the analysis of the investment manager’s profitability. The Jones vs. Harris case has reinforced the contract renewal process that has been conducted for the past 30 years, and has emphasized that the assessment of the advisor’s profitability remains a necessary step.

     The procedure trustees follow to review profitability is critical and should have some benchmark against which to evaluate profitability. MPI has tracked the pre-tax profit margins of publicly traded companies significantly engaged in mutual fund management. The range of individual margins varied, however the average return after all costs, before taxes and excluding extraordinary items, was generally about 30% of revenue.  In contrast, the advisory margin averaged closer to 50%. These trends are shown in the chart below.

 

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     MPI’s analysis concluded that average annual assets had returned in 2010 from the dramatic decline in 2008. In addition to greater assets, higher revenues and resulting margins were also the result of an increase in advisory fees due to an asset mix shift away from more risk-averse products, such as money market funds and ultra-short bond funds, to more adventurous fixed income and equity products. Furthermore, the asset mix returned to a greater percentage of retail clients, which often show a higher advisory profit, but not necessarily operating margins.


     In 2010, there were several factors which kept margins lower than might have been expected. First, firms that had the majority of their assets in money market products experienced a large outflow of assets and often had to implement voluntary fee waivers in order to maintain positive yields. Second, higher bonuses and investment in technology and infrastructure after a two-year freeze eroded potential increases. Lastly, the 2010 margins would have had a more significant increase compared to 2009, but in 2009 many firms recognized one-time extraordinary items, reducing the expense component of their margins. Including these items, the 2009 margins would have been significantly lower.

     Measuring and monitoring profitability on a fund by fund basis is also important because the trustees represent shareholders of each individual fund and because the Gartenberg ruling emphasizes the importance of individual fund review.   Fund profitability is typically based upon the advisory fees and the corresponding expenses alone, whereas the complex-wide operating margin is measured on the basis of all investment management activities, including marketing and shareholder services.

     MPI’s analysis of advisory margins shown above corresponds to those referred to in the Gartenberg line of cases, where a “guideline” margin of 77% was established. In our 2010 analysis of 18 public companies where we could obtain roughly equivalent information, we found that the average profitability on the advisory contracts had increased to 54% and the operating margin for those companies was 31%.

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The complete analysis including ten years of operating and advisory margins, underlying participant detail, product and asset trends and profitability drivers are available by contacting Management Practice.