Why a Firm’s Large AUM Isn’t Everything

Having a large AUM looks good on the outside, but for some firms, total assets managed could be covering up organizational risk and inefficiencies that need to be addressed.

When given the choice between more assets under management or less, the more the merrier, right? 

What’s more, an investment firm has a bit of “street cred” with a higher amount of assets to showcase. 

To the competitors, a large AUM sends a message that the organization is a force to be reckoned with, and therefore, “be afraid.” 

To the retail and institutional investors, as well as the media, it means “be in awe.”  

“So many assets under management, that firm must be doing things really well!” 

…or is it? 

No Department Operates in a Bubble

A CEO or CFO should know this better than anyone else. At the top, they see how everything is connected, and there is a bottom line that the whole organization is held accountable to. 

Every department has its own expectations, and for some of those departments, total AUM is the benchmark by which to be judged. However, AUM, no matter how beautiful it might look, can be deceiving. 

Even for teams that aren’t judged by AUM, their work performance can also affect the firm’s profitability that is derived from the revenue of assets managed. 

In short, beneath the surface of AUM lurks a lot of risk. 

Why a Firm’s Large AUM Isn’t Enough

A Few Investors Hold a (Disproportionately) Large Amount of Assets

Setting market performance aside, AUM can be highly volatile. 

An investment organization that prides itself on having a high AUM could have the rug pulled out from under its feet when one or a few high-net-worth investors take their assets elsewhere. 

Some financial institutions rely on a handful of large investors for cash flow. Let’s say there is a fund supported by 5 investors each with $100 million, and then one backs out. AUM now drops 20%, and revenue falls similarly. Are these firms prepared for such risk? 

Some funds are exclusive, and they perform extremely well. If one investor leaves, someone else can easily fill that coveted spot. Other funds aren’t so fortunate, and the loss of a major investor can be financially painful. 

The same situation holds true for advisory firms that have several clients, but a minority of those accounts for a (dangerously) disproportionate share of the firm’s total assets under management. If one or a few of those key clients leave, a financial hole needs to be filled.  

To fill those holes or preventing holes from forming in the first place, investment companies need a plan to attract clients/investors, as well as well as take measures to ensure they remain clients. 

Attracting New Assets Is Not the Same as Generating Returns on Investment

Bringing in new assets is great, especially considering the issue we mentioned in the above section. What’s more, attracting new assets can be the result of how well a hedge fund or RIA performs in managing others’ assets.  

However, underperformance remains an issue, take actively managed funds for example. 

For some organizations, it’s easier and faster to build AUM by attracting new assets, whereas generating returns on investment is much more challenging. 

Investment firms must differentiate between the two forms of AUM growth and judge team performance accordingly. 

For example, fund managers may find it easier to grow AUM by merely attracting new investors. For these managers, it’s more lucrative and less labor-intensive to charge a management fee of 2% (or less) of total assets than it is to work extra hard to earn 20% of the capital gains. 

Of course, that is a very short-sighted approach, and it’s not to say fund managers aren’t interested in generating returns, but if the incentives favor new asset acquisition, they need to reassess their priorities. 

At some point, investors will no longer tolerate prolonged underperformance, and they will leave. 

Make sure the performance is there to support and justify that attraction of new investor assets. 

AUM Is Not an Indicator of Higher Profits and Margins

With more assets to manage, that means more management fees to collect, and therefore a growth in revenue. 

But with an increase in assets to manage, so there is an increase in expenses.  

Ramping up may require hiring new staff, or it means creating new workloads that are non-revenue generating, like middle- and back-office work. 

And when it comes to separately managed accounts, the amount of customization and attention demanded by each client could stretch resources thin. 

Investment firms can be doing everything right in terms of attracting new assets and growing those them through solid performance, but that revenue-generating activity can be offset by inefficient organizational practices. 

Routine, mundane tasks can be automated or outsourced. New technology can be implemented to improve processes, and tasks can be better performed with turnkey platforms for investment managers.  

Revenue and profits are not the same, and it doesn’t take an accounting or finance expert to say that.  

But remember that a rise in AUM doesn’t always correlate to a rise in profits, unless inefficiencies are addressed and resolved. 

AUM Does Not Represent the Client Experience

Just as the total assets under management is not a guaranteed indicator of higher profits and margins, so does AUM not reflect the quality of service a client receives… not as a rule, at least.

AUM can be a reflection of quality service, as clients trust the firm in managing their assets and as seen through testimonials.

However, a large AUM firm with a large client base doesn’t always mean the client experience is better.

The large organization may benefit from brand recognition, attracting clients who may not notice the alternatives. That’s certainly a marketing success, but the organization could be a victim of its own success when client and asset growth outpace the level of support needed to manage the growth, eroding the quality of service.

What’s more, a large company may take its large client base for granted, prioritizing the needs of some clients over others. Even if we give the benefit of the doubt that these organizations are stretched thin, it’s still not fair to the clients who were promised and expected a certain standard of service.

In any areas where service is lacking, be it the availability to speak with clients or the ability to provide up-to-date portfolio details at the clients’ request, investment companies regardless of AUM size should look at how to leverage technology better.

Striking a balance between human and machine assistance for the client can provide organizations the ability to scale, making rapid client growth no longer the concern it once was.

Technology exists that can generate reports with accurate, up-to-date and readily available information, requiring minimal human effort. And by providing a digital, mobile-friendly platform for the client to access all their details, it may lessen the need for the clients to call their advisors over things that technology can already provide for the client.

In turn, this allows more time for the firm to focus on areas where human activity is more valued.

For firms that already have such platforms for clients, at a minimum they should see where there is room to optimize and evaluate whether a new system would better serve the clients.

AUM Can Be Everything, Under the Right Conditions

For those outside the organization, AUM is a shorthand reference to gauge how successful an organization appears.

In some ways, it’s like a house that appears clean when it really isn’t; everything was shoved into a closet or room off-limits to visitors.

And just like in The Wizard of Oz, “Pay no attention to that man behind the curtain,” some firms might say, “Pay no attention to that risk and inefficiency behind the AUM.”

Threats of high-net-worth client and investor departures can undermine total AUM. AUM growth through new assets has to be weighed against how well those assets perform. Higher AUM may translate to higher revenue, but not higher profits and margins. Also, a high AUM does not automatically equate to a better client experience.

That said, investment firms can tout their total assets under management with pride when everything behind the scenes is running effectively and efficiently.

From sales and marketing to investments, and from operations to technology, no one area of an investment firm operates in a bubble.

As leaders of a hedge fund, RIA, or a large institution, it is their job to remind everyone how every department is accountable to every other, and weaknesses in some areas can not be tolerated just because stronger areas can pick up the slack.

At end of the day, the financial bottom line has the final say, so firms must address their weaknesses.

And by changing their ways, they‘ll have a large AUM that is truly deserving of herald and praise.