The Big Leap
Face the Challenges of “THE BIG LEAP.”
The money management industry is now ending its fifth year since the historic plunge in 2008 equity markets and the strong economic aftershock is dissipating. From the rubble, some firms have joined a “new wave” of growing asset managers emerging on the money management landscape. Some of these firms were grown from scratch but others simply transformed their original business model to fill the market vacuum for new investment products responsive to both shifted realities and different asset class emphasis. At the same time many firms have not transformed and have chosen to simply let market action return them back to the same approximate pre-crisis levels. While its helps to be in “new wave” growth areas like managed ETF, liquid alternatives or dividend growth, there are firms managing stronger growth in even highly competitive areas like fixed income. What are the keys to joining the firms starting to leap to larger size and greater profitability?
The more successful diverse upstarts and reengineered platforms are separating in terms of growth and profitability from those that simply stood pat, but a separation is also evident within those aspirational firms that want growth to a higher scale. Firms ultimately face the challenges of what Dan Kreuter of DAK Associates has termed, “The Big Leap.” The “Big Leap” challenge comes as firms extend beyond the small cadre of the original partners of their entrepreneurial phase and extend past singular distribution that put them on an initially stellar growth path. Re-envisioning the next key outcomes for the firm is the essential management task for successfully evolving these promising enterprises into highly profitable mid-sized firms. DAK Associates, a search firm specializing in asset managers, and Gladstone, its sister transaction advisory firm have seen their own growth accelerate by targeting firms as they reach key transition points or commit to become faster growers.
This paper examines observations from a database of firms at the threshold of the “Big Leap.” It explores characteristics of the recent winners and losers while tracking the firms’ actions in managing key elements of the enterprise. The research of 500 firms that may have potentially achieved high growth rates entering 2013 reveals more than 150 notable “pre-leap” firms nationwide. Assets under management for these firms range from $150 million to $1.5 Billion in AUM. The study further identified fifty of these for further study as these firms confront identifiable ‘Big Leap challenges.”
Many of the 50 firms targeted for sharp focus have relied on their own “hands on” work and expertise in their initial formative stages. Firm leadership is now recognizing that strong linear growth compounds exponential challenges in hiring, distribution, infrastructure and compliance. Many are not eager to put additional capital at risk to accomplish the Big Leap to a more diverse and sound organization and are turning to partnering through acquisitions, mergers and joint ventures. Most difficult but equally essential is a hard look at the mix of leadership and executive talent which often is the single biggest block to rapid expansion. Therefore, for the first time for many, these firms turn to executive search, an industry itself in transition. Transactions of various forms or retooling through restructuring of the management team are prominent catalysts accomplished by firms now showing stronger organic expansion.
The key drivers of these fast growing potential Big Leap firms often seem to involve one or more of the following investment and economic trends;
1-Tightly banded results as stocks and asset classes correlate.
Though the situation has gotten somewhat better through 2013, the difference in the valuations and multiples of sector equity leaders and laggards became quite compressed until recent increases in the gaps between winners and losers. This set the stage for Managed ETF and index allocators aimed at both wealthy individual investors and institutions. Asset classes have been a focus ever since Brinson’s widely studied papers of the 1980’s that asserted asset classes would drive 90% of investment results. But this reality was highlighted sharply in the turbulent 2008 and 2009 turbulence. REITS, alternative assets including commodities and managed futures, and BDC’s are among the offspring of these trends.
2-Cost pressures from lower fee levels.
Compressed overall returns in many asset classes have prompted high fee sensitivity. New firms, particularly those with quantitative investment processes have developed and grown by producing outcomes at a lower cost. Smart Beta indexes and Factor Based (or “Rules Based”) security selection are new exploding growers benefitting from this new reality. The Big Leap challenge emerges because the firm’s efficiency often does not help with the needs for building fund and other product wrappers while extending into new distribution channels. Expansion steps into new distribution are the most daunting shortcomings of the “Big Leap.” Distribution costs, organizational structure and key talent acquisition are the most frequent areas of misunderstanding and need of assistance for the new growing firms.
3-Evolution of robust wealth manager platforms.
The dramatic enhancement of brokerage platforms has been driven not only by larger Independent Brokerage firms like LPL, Ameriprise Financial, AIG, Cetera and the like; major Custodial Platforms (Schwab, Fidelity and T.D. Ameritrade), but also specialized platforms and TAMP programs engineered by Pershing, Envestnet, Brinker and others. Tiburon Research has assets managed by TAMPs growing from approximately $16 billion to $250 billion over the last ten years. The services of these firms spans from trade execution to assistance with marketing along with outsourced back offices. The efficiency of these offerings has spurred “up from the roots” managers that grew out of managing wealth advisory assets. The trend is for most new firms to arise from this environment as opposed to the institutional breeding ground of the previous decades.
4-The Booming End of a Thirty Year Bull Market in Fixed Income.
It was 1957 and the massive stimulus by the post war Federal Reserve had created long awaited growth in housing and autos. The economy began to grow and the climb of interest rates and inflation began slowly. By 1980, double digit interest rates were the norm and it would take the painful topping of rates by Paul Volcker to mark the beginning of the retreat of rates and a long sustained bull market for bonds as rates fell finally to near zero from 1982 into 2013. The startling implication is that today’s investment managers have never experienced the road just ahead which should be one of steadily rising rates with increased inflation. Many of the businesses started or accelerated in 2008 have flourished in the massive stimulus of falling rate markets. These firms must not rely on a repeat of these favorable factors. A sharp examination of unfamiliar and difficult environments of the 60’s and 70’s may be in order for asset allocators. Builders of portfolios of mixed assets have a distinct challenge in determining how to replace using bonds for the core diversifier during stock market corrections.
5- The worldwide scarceness of yield at a time of enormous demand.
Supply and demand are at work as the world’s population ages into a need for recurring steady retirement income just as rates hit historical lows not seen since World War II. REITS and alternative income products should continue to enjoy robust demand that has already boosted numerous firms to lofty asset levels. The absence of naturally high yielding instruments will spur wide-ranging creativity through synthetic products that address the need for higher yield with acceptable risks. In general these drivers of opportunity are not yet done and offer the promise of ongoing though evolving portals of growth.
There are some revealing observations in studying the prosperous firms of the past six years that have exploited these drivers of opportunity. For example, employee ownership or incentives has sparked higher levels of performance for revamped management teams. By contrast, for “non-leapers” (more than half), the equity of the firm is still fairly concentrated in no more than two of the founders’ hands. This makes it hard to retain or attract the needed expansion talent. The owner of such a business has a personal wealth built on a far too concentrated asset that can be volatile regardless of the firm type. Many such firms have not restructured to determine the financials of the firm with earnings after owner compensation. Simple restructuring can make it clear what the firm makes for its owners as an operating enterprise. One simple two-step to the Big Leap is clarifying financial structures and spreading ownership through fair valuation.
Another common characteristic of these recent growers is an increasing reluctance to invest in new product structures like a mutual fund wrapper. A smaller but related shortcoming is the certification of performance through GIPS certification. Paul Lally, a founder and President at Gladstone, a specialized Transaction Advisory firm, notes,” Firms entering into a merger or related transactions are often surprised that their value is unduly impacted by unaudited track records or the missing mutual fund or other wrappers needed to expand into new distribution channels. Firms experience success but then become hesitant as the size of expense items like these is larger than those they have previously encountered.”
The harsh reality for the successful team arriving at an inflection point of size and growth is the changing leadership need. The skills of even the founding entrepreneur may not match the particular challenges facing the “Big Leap” stage of development. It’s essential to hire the right key talent to elevate the growing firm in areas like distribution, operations and compliance. It is equally important to structure compensation and retention to solidify and retain the firm’s talent. The frequency of “bad hires” is very high for these inexperienced management teams. The single biggest obstacle sure to slow growth at this important stage is a belief that the success of the initial management team is a precursor to extended success.The consistent reality is that such teams have never expanded into new distribution, altered product packaging or revamped the back offices for larger size. Not only do effective search firms find the talent that is needed, preeminent firms meticulously define roles and job descriptions that are a key part of building the path to success for the entire team.
Related to the restructuring of the leadership team generally needed to re-accelerate the firm as it grows is the reality that many of these newer firms are led by veteran leadership that may now face succession issues. The entire financial services landscape is besieged by a wave of baby boomer retirements and finding the natural succession candidate or approach is almost always more difficult than anticipated. If the leadership team is within ten years of retirement or slowing down, there is a challenging succession phase ahead. Within three years there will be an even more pronounced recognition of the daunting talent availability gap at senior levels of emerging asset management firms. As one goes through profiles of successful but slow growing firms, there is a large population of firms led by a 30 year veteran. The firm is too dependent on the leader and not broad enough in terms of younger executive talent to grow. When the skill requirements demand facility with rapidly changing technology, and other specialized attributes are added to the mix, the firm may slow down simply because key hires take months and months to accomplish.
The positive side of this set of challenges is the recognition that firms are successfully accelerating past $2 Billion and then $3 Billion in assets. They are characterized by a diverse management team, a vetting of partnering and transaction opportunities and a financial structure built to highlight profit and growth drivers. These characteristics alongside the many important execution steps like completing product restructuring, audits, performance certification and new distribution channel penetration are the common characteristics of those firms that have already passed through the “Big Leap” phase into a renewed growth posture. There are even more firms that could potentially take “The Big Leap” but are instead like the frog comfortably and passively facing death by scalding in slowly boiling water. They are not yet recognizing that the temporary lull in their expansion is more than a passing issue. For these, the study of their peers is a clarion of needed actions to move through this crucial growth stage.
Valuation is another common challenge for “would be” growers in asset management, and wealth managers as well. As previously mentioned, simple steps like properly structured and stated financials are a starting point. But firms fail to benefit from the learning that comes with a simple valuation exercise. There a several firms specializing in financial services that have become recognized for the complex art of valuation of a money manager or wealth manager. The characteristics of a firm’s client bases are an obvious driver for wealth managers and many executives understand the importance of fee levels and client concentration. But savvy valuation experts bring another level of precision and benchmarks that is very difficult for generalist firms to replicate. These metrics are crucial information for a firm considering whether it is worth it to invest, hire and push for a Big Leap in growth.
The other notable characteristic of successful firms leaping ahead of competitors, is a willingness to partner. This can be as formal as a merger or as creative as a fund adoption. Matching a need for product with an owner of a potentially explosive track record is one of the most successful transactions found repeatedly in the new wave of faster growing firms. Many firms reach out to a dozen of their known industry associates to try to find these opportunities by “word of mouth.” The truth is that a professional firm will reach out to 100-150 such target firms before finally finding that right partner to exploit the opportunity for mutual growth. In short, “you don’t know what you don’t know.”
Human Capital Considerations – Emerging firms anticipating and desiring rapid growth need to think differently. Wearing multiple hats can be fun and stimulating, but smart CEO’s who are in growth mode need to think about on-boarding a Distribution Head, a COO, a cutting-edge Marketer, or a Portfolio Manager / Chief Investment Officer to divide and conquer.
Distribution – DAK has the deepest rolodex and knowledge set in the industry when it comes to raising assets. Decisions around your sales strategy require thoughtful considerations:
Our search process is strategic and comprehensive, ensuring success by design, not chancing success by serendipity.
The full set of relevant questions for aspiring asset managers revolve around questioning the status quo that might have been successful only at a small size. Is the team appropriate for tackling the multi-dimensional problem of diversifying distribution, creating new product structures and restructuring financial systems for valuation clarity? Is the ownership structure holding back the creation or retention of the right team? Those that answer some or all of these challenging questions affirmatively have begun to grow to higher levels of scale and are finding growth compounding. Those in the path of investment growth drivers are poised to miss a remarkable new window of opportunity if these issues are left unaddressed.
Queries can be forwarded to DKreuter@DAKassociates.com, 800-669-9DAK