April 03, 2015

Of Asset Managers and Asset Gatherers

There are at least two fund houses in India that take pains to point out that they are ‘Asset Managers,’ and not ‘Asset Gatherers.’  To many, this seems an exercise in semantics.  Someone I was speaking to, had this to say: “How can you manage assets if you don’t gather any?”  Someone else had this view to offer: “Gathering and managing go hand in hand.” 

I am not a spokesperson for these fund houses, and I am sure these fund houses can explain their statements to anyone who questions them.  But, to me, it is the spirit behind these terms that makes this an important distinction.  In this post, I would like to share what I personally think it means for a fund house to be an Asset Manager in spirit, as opposed to being an Asset Gatherer.  While doing so, I would like to offer food for thought to fund houses about what stance they should be adopting.

To borrow a citation by John Bogle, for a fund house to regard itself as an Asset Manager it should believe that “its principal function is the management of investment portfolios. Everything else is incidental to the performance of this function.”  It would stand to reason that such a fund house would regard the performance of its fund(s) as a key measure of success.

To understand how being an Asset Gatherer differs from being an Asset Manager, it may help to look at what financial journalist Jason Zweig had to say in a 1997 speech, where he asked an audience of mutual fund executives to consider: “Are you primarily a marketing firm (read: Asset Gatherer), or are you primarily an investment firm (read: Asset Manager)?” 

According to him: “You can be mostly one, or you can be mostly the other, but you cannot be both in equal measure.”

He went on to list ten points of difference.  Here are a couple that are easy to understand in the Indian context.

“The marketing firm has a mad scientists’ lab to ‘incubate’ new funds and kill them if they don’t work. The investment firm does not.”

“The marketing firm creates new funds because they will sell, rather than because they are good investments. The investment firm does not.”

While I agree with most of what he said, from the point of view of the Indian mutual fund industry, there was one crucial point of difference which he did not mention (or, at least did not mention clearly enough) i.e. the importance that a firm gives to distributor/ advisor incentives. 

As far as I can recall, till fifteen years ago or so, this issue didn’t exist.  At that time, other than fund performance, there was very little to reasonably differentiate one fund house from another.  For that reason, most fund houses, as I remember, had a clear focus on delivering good fund performance.  This is not to say that they all managed to do so, but almost unanimously they recognized that this was probably the most critical point of difference, to attract investors.  Put differently, nearly all fund houses aimed at being better Asset Managers.

However, over the years, this has changed.  The key parameter of success for most fund houses today has become the AUM.  Most advisors, and many investors measure the stature of a fund house by its AUM. Even the influence that a fund house exerts on AMFI or the impression that it makes on SEBI is arguably linked to its AUM.  In the words of the CEO of a fund house, “Having a large AUM makes it difficult for one to ignore our point of view.”  In effect, as an industry, over the last fifteen years, we have encouraged a culture of asset gathering.  This has obviously come with its share of consequences.

The foremost impact has been that a number of fund houses have developed an overreliance on the distributor/ advisor community to reach out to investors.  While there are good reasons to engage advisors given the complexity of mutual funds as a product, overall there has been a high price to pay for the benefits that have come the way of the industry and the investors.  The distributor/ advisor community (particularly, the banks) has come to wield formidable clout which, in turn, has led to the emergence of distributor incentives as a necessary weapon in the armory of most fund houses to retain and grow their AUM. 

So, as I see things today, fund houses appear spread across three camps, so to say.  In the first are those that regard distributor incentives as the single-most important factor in building their AUM. In fact, some within this camp believe in pushing the envelope to make distributor incentives the overly dominant factor in boosting their AUM.  Or to put it in the words of John Bogle, for such fund houses, “the art of persuasion has crowded out the art of performance.”  These are the fund houses that I would classify as Asset Gatherers.

In the second camp are those fund houses that aspire to be Asset Managers but recognizing the clout which distributors carry, attempt to increase their AUM through a mix of moderate distributor incentives, good fund performance and customer service, and value-added services to distributors. 

Finally, in the third camp are a tiny group of fund houses that are primarily focused on delivering good fund performance and customer service, from which they expect the growth in their AUM to be a logical outcome. In their engagement, if any, with distributors, incentives play a much lesser role compared to these factors.  These fund houses, in my opinion, are the only ones that can claim to be Asset Managers.

So, is there a business case to be an Asset Manager?

According to Zweig, there is.  In his aforementioned speech, this is how he put it:

“The fund industry is a fiduciary business; I recognize that that’s a two-part term. Yes, you are fiduciaries; and yes, you also are businesses that seek to make and maximize profits. And that’s as it should be. In the long run, however, you cannot survive as a business unless you are a fiduciary emphatically first.

In the short term, it pays off to be primarily a marketing firm, not an investment firm. But in the long term, that’s no way to build a great business.

More importantly, there is a moral case for being an Asset Manager.  In the 2010 edition of his book, Commonsense on Mutual Funds, John Bogle said, “What we need in the mutual fund industry is far more focus on the management of shareholder assets and far less on the marketing of fund shares. We need to reorient our thinking about what a fund is, and whom it is designed to serve.”   While his comments were directed at the US mutual fund industry, the Indian fund houses, AMFI and SEBI would do well to pay heed to his advice.

To be fair, SEBI has been using a mix of force and persuasion, directly, and through AMFI, to get the Indian fund houses, and advisors, to think about their fiduciary responsibilities.  But the battle, if I may call it that, is far from over. 

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