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March 04, 2007 Going With The Flow
In the business of asset management services, the name of the game is flows. That is of course, the amount of money coming in the door and conversely the amount going out. This is important because, asset management firms generate revenues primarily through fees on assets currently under management and to a lesser extent, fees on gains earned by the company's investments.
It isn't surprising then, that firms with a successful track record, strong reputation, solid investment strategy, tight corporate governance and talented personnel attract large amounts of capital. Of course, consistent gains in excess of benchmarks every year has yet to be realized by any participant in an efficient market. Given that nobody hits a homerun every year, asset redemptions are inevitable, and as an industry have been in excess of 15% of total assets under management annually.
An interesting strategy beginning to emerge in the hedge fund space is the restructuring of performance fees. For example, breakingviews.com recently reported on Orbis Investment Management, a Bermuda based money management firm that has recently adopted the practice of refunding performance fees during years where investments have produced losses. The effects of the performance fee refund are potentially far reaching. Fee refund policies reduce client losses and provide incentive for customers to maintain relationships with investment management firms. Another important benefit is the alignment of interests of the investor and the management firm, as both benefit from good performance. The end result could lead to increased loyalty of clients and the resulting reduction in redemptions and smoothed losses during hard financial times.
Refunding fees seems to be a wining strategy for investment managers, potentially reducing redemption rates and bolstering flows. It will be interesting to see the value-add to early adopters and the effects on the industry as a whole.
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