Asset Management: Investing Essentials

Here's how the asset management business works.

Aug 4, 2014 at 2:43PM

The asset management industry thrives on the concept of "other people's money," generating billions of dollars in fees for managing trillions of dollars in worldwide wealth.

As an investor, you have likely used the services of an asset manager before, whether it's through investing in a mutual fund or relying on a pension for future retirement spending.

What is the asset management industry?

Put simply, asset managers invest money on behalf of their clients.

Asset managers range in their investment strategies. Some invest only in stocks. Some invest only in bonds. A few invest in anything from real estate to precious metals. The strategy depends entirely on the company's expertise, its fund choices, and its clients' needs.

The industry thrives on the fees for managing other people's money. In general, asset managers are not in the business of making money by making investments with their own money.

How big is the asset management industry?

Around the world, asset managers managed $62.4 trillion in wealth in 2012. In North America alone, asset managers reported $30.3 trillion in managed wealth, or roughly half of the world's assets under management.

The size and scope of the asset management industry has grown on the back of growing world wealth. From 2002 to 2012, managed assets nearly doubled, from $32.6 trillion to $62.4 trillion.

Asset Management

Growth is expected to continue. PricewaterhouseCoopers estimates that global assets under management could swell to as much as $102 trillion by 2020.

How does the asset management industry work?

The business model for a traditional asset management company is relatively simple. Asset managers pool capital from thousands of investors, then do the work of investing in different opportunities. For this service, the managers charge a variety of fees.

Mutual fund asset managers often manage billion-dollar funds that invest largely in stocks and bonds. For this service, a mutual fund asset manager will debit a management fee from their customers' accounts, often ranging from 0.5%-2% of assets each year. 

Private equity and hedge fund asset managers, however, charge two sets of fees. The first is a management fee, similar to a mutual fund. The second is a performance fee, which rewards the asset manager for success. A typical structure in this niche is called 2-and-20, or 2% of assets under management each year, plus 20% of the returns of the fund.

What are the drivers of the asset management industry?

There are three big drivers in the asset management industry. The biggest, and most important, is the amount of client money a firm manages. The more money a firm manages, the more revenue it can generate by way of fees.

Conveniently, the positive return expected from investing provides a natural way for the industry to grow. As stock and bond prices have only gone up over long periods of time, the amount of managed assets has also risen.

Keep in mind, though, that subpar returns will ultimately break any asset management business. This is considered a "winner-take-all" industry in which the best-performing firms attract more client money and top talent. Poor performers slowly lose assets under management to the best-performing companies.

The second key driver is the average fee an asset manager can collect from its clients. In very competitive markets such as passive funds or exchange-traded funds, asset managers cannot charge much more than a fraction of 1% of assets under management. An index fund might charge only 0.10% of investor money in fees each year.

In less competitive markets, or where specialized knowledge is more important, fees grow larger. Distressed debt funds, for instance, can charge 2-and-20 fee levels that can tally up to 4% of invested funds annually.

This leads perfectly to the last driver: costs. The biggest expense is the people -- portfolio managers, analysts, and lawyers -- who expect big paydays for a good track record. Million-dollar salaries necessary to retain top-performing portfolio managers can put a big dent in a firm's earnings.

The takeaway on asset managers

The top asset managers have provided incredible returns to investors. In many cases, the asset manager's stock has performed better than its own line of funds!

Over time, the industry will assuredly grow with rising wealth. But that doesn't mean investing in an asset manager is an obviously good investment. A combination of elements -- fee levels, employee compensation, and the performance of asset prices (the stock market included) -- ultimately determine the returns investors can expect.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers