How Asset Management Companies Make Money

What is an Asset Management Company and How Do They Make Money?

Asset management companies are investment firms that offer a range of solutions to their clients. Generally, they sell products such as mutual funds or exchange-traded funds and manage private accounts for other companies. In exchange for these services, they charge fees that most often represent a percentage of the assets under management.

Due to economies of scale, clients of larger firms may be able to benefit from lower fees. Fees also depend on other factors such as the asset class, the sector being invested in, or the transaction’s complexity. For example, clients are charged higher fees when their investment strategy involves sophisticated tools such as trading derivatives or taking short positions.

Asset management companies provide investment solutions to a range of clients such as retail, institutional (pension or sovereign wealth funds), insurers, banks, private clients, and wealth managers. Asset management products are pooled investments, often mutual funds or exchange-traded funds, where the company’s involvement can be active or passive.

What Do Asset Management Companies Invest In?

Investors’ demand drives the creation and design of products. Usually, asset managers focus on a specific asset class, market segment, or are generalists. For example, smaller firms may concentrate only on equities and specialize in emerging markets or a distinctive investing style, such as value or growth. Usually, the larger the company, the broader the range of products it offers across the active and passive space. For example, the world’s largest asset manager, BlackRock, has assets under management totaling over $1tn and offers products across multiple asset classes – fixed income, equities, alternatives, etc.

Expenses and Fees

Clients pay fees to cover the costs incurred by the asset management company. Trading fees (also referred to as transaction costs), administrative expenses, and salaries for staff (for example, a mutual fund would need the support of research analysts) are all examples of possible costs. To cover these costs and make a profit, asset managers apply various fees to their products. First, the ongoing charge fee (OCF) takes a percentage of the total assets. For example, a fund of $100m with an OCF of 0.8% would charge $800,000 in fees. Sometimes this can be a tiered structure, and fees may decrease when the size grows.

Performance fees are another way of generating income. These align the asset manager’s interests with their clients’. Generally, performance fees are a percentage that is charged in addition to the ongoing management fee, but only when the fund outperforms its target. For example, if a fund has an objective to outperform the FTSE 100 index by 2% annually, any return above this 2% target can be subject to a performance fee of 20%. So,  should the strategy outperform the FTSE 100 by 6% (which exceeds the target by 4%), the asset manager will charge a 20% performance fee on the additional returns of 4%.

Some funds may also apply initial and exit charges when investors invest in the fund or withdraw from the fund. They are usually a percentage of the sum that the investor invests or withdraws.

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