Risk Management for Asset-Management Companies

Bernd Scherer

“For an asset manager the greatest risk is operational risk” (Hull 2007, p. 372). In 2008, however, asset-management companies came under severe profitability pressure from market rather than operational risks. What has been seen as an annuity stream that was thought to expose firms to little or no earnings risk materialised as directional stock market exposure combined with high operational leverage (high ratio of fixed to variable costs). While operational leverage led to what has been praised as a scalable business (low costs of taking on additional business) in good times, it was always clear that this would lead to massive losses in bad times. In short, asset managers partially share a client’s benchmark risks. As client benchmarks went down, so did asset-based fees (percentage fee applied on average assets under management (AUM) within a year), which still represent the bulk of fee agreements in the asset-management industry.

At the same time, operational leverage increased the downturn in profits. A small example should make the mechanics clear. Suppose we have an asset manager with US$100 billion AUM, 50bp fees and 35bp total costs and an operational leverage of 90% (31