First World Problems in Fund Management

Tadas Viskanta from Abnormal Returns posed an interesting question on social media this morning. “How”, he asked, “has a company as big as Fidelity managed to stay private for as long as it has?”

A number of decent and partial answers popped up, but surprisingly (to me, anyway), none of them got to the core of the matter.

It’s the Johnsons. Period.

As others pointed out, a traditional asset management business of any meaningful scale is a simple operation. You take in management fees, and in most cases you or a third party deduct fees directly from whatever vehicle or client account is being charged, so there is rarely even a meaningful consideration of receivables. Fidelity’s business has other fee sources, of course, but take this as a general observation. Most industry expense structures are convention-driven and reasonably well-established. You will pay 25-40% of top-line to portfolio management teams, all considered. Sales people and executives will pretend that sales costs and commissions are variable, but by and large they are not. Not really. Depending a little bit on account aging, and a little bit on institutional/retail mix, sales teams will usually take 10-25% of top-line, all-in. Yes, of course there are exceptions to both.

Unless you operate stat arb, high frequency or certain types of CTA or quant strategies, capital expenditures are not really a thing unless you’re doing it wrong. Ultimately, you are left with three obvious and not-at-all-unique-to-asset-management overhead levers to determine whether you run with EBITDA margins of 25% or 45%:

• Breadth of Business (i.e. both channel and product, to the extent product breadth increases operations/investment staffing)
• Scale of Products
• Ratio of Seed or Volume Businesses (e.g. new funds, sub-scale low fee products)

The asset manager generating the highest margins is the $10 billion manager with one or two similar products run by a single investment team, where the CIO is also the CEO, and which only sells to institutional clients. I have visited with many privately held managers of this variety. Nearly all comfortably generate 50% EBITDA margins. Some will claim even higher levels, but in practice, the operation of an asset management business at higher margins tends to cause compensation pressure from either the investment or sales side of the house.

The bad side of profitability? It’s a $800 million shop trying to get a full, thematically consistent series of twelve ETFs off the ground. These firms are usually scraping by with promises to employees of a swoop-in acquisition from a growth-starved bigger player.

Even with all the fee pressures, rebellions against active management and rapidly accelerating costs of doing business in retail channels, any asset manager of any meaningful scale must work very hard not to make a reasonable profit. Yes, what “scale” means is rising, and yes, that goes double if you have any designs on selling through intermediaries (i.e. IBDs and wires), but by and large, this is true.

But the fact that Fidelity – or any other asset manager – throws off a ton of cash and has limited capital needs doesn’t explain why they haven’t sold or gone public.

There are plenty of companies with the same traits – because they are traits common to asset management companies operating at scale – that have made very different decisions. They have sold or gone public. In most of those cases, they did it for a simple reason:

Because of a big, concentrated founder position.

Nearly every asset management company that sells itself out of private company status does so because a big founder or concentrated group of founders wanted liquidity. A dominant share of private asset managers, even at significant scale, have big founders or a concentrated group of founders on their cap table. It is worth remembering that concentration of ownership is the other almost inevitable side effect of operating entrepreneurial non-capital-intensive people businesses.

So say what you will about Fidelity, but the reason they’ve managed to stay private is because the Johnsons – and today that means Abby – value something else more than instant liquidity for their immensely valuable stake. Maybe it’s independence, maybe it’s control, maybe it’s avoiding even more regulatory headaches than they already have to deal with, and maybe it’s a belief that continuity matters to investment results. And yes, maybe it’s a belief that now’s just not the right time, that the even bigger liquidity event is still down the line.

But as a rule of thumb, no matter why an asset manager tells you they are selling, you can usually find-and-replace their explanation with “Big founder wants liquidity.” If an asset manager tells you why they are not selling, you can usually find-and-replace their explanation with “Big founder doesn’t want liquidity.”