Why Portfolio Managers rarely set up their own Fund Management Co.?
Many dream of becoming the next Benjamin Graham, Warren Buffett, Peter Lynch, Sir John Templeton or Bill Miller. Ferociously learning, reading, honing their investment acumen and analysis, and taking the CFA, CAIA, CMT. All these to be the next hotshot Fund Manager, the darling of investment trends. Starting from analysts, product specialists, traders and as time wears on, their dreams fell apart and into oblivion. Reality sets in.
In Singapore, there are only a few hundred fund management co. (236 registered fund management co. in 2015) despite Singapore managing $2.42 Trillion of assets. Globally, the largest stock markets have listed stocks totalling $67 Trillions in 2015.
- 2015 Overview of the Financial Industry in Singapore
- List of Stock Exchange Market Capitalization 2015
Why is it so hard to set up a fund management co.? Why analysts, star traders and portfolio managers rarely get to set up their own fund?
No. 1 It starts with Regulations
Being good in portfolio management and investment is one thing, knowing how to fulfil regulatory requirements is another. Fund Management is a serious business. It manages large financial assets, money that belongs to people. These involves trust, safeguards and sustainability.
Fund management, like banking & insurance are highly regulated activities. Most analysts, traders, product specialists & portfolio managers in financial institutions had rarely crossed swords with authorities from around the world, often only with local authorities. This means many do not have the adequate understanding to navigate through a complex regulatory framework.
- China’s Top $1.57 Billion Fund Manager Arrested
- Warren Buffett in anti-trust probe for using Moody’s Investors Service
No. 2 And Administration & Operations
Fund Management is an incredibly tedious & administrative business. Tracking financial markets and data, funds tracking and reporting, custodian liaison and reconciliation, clients reporting and updates, cashflow of fund and business and many more.
The good news is there are many service providers of fund administration, custodian & reporting. The bad news is they have their strengths and weaknesses. Some providers have inadequate reporting techniques on trading activities or some do not have reporting for some financial markets. This means the Fund Manager has to adjust his strategies according to what is administrative and operationally plausible, forgoing what could be lucrative investment opportunities. And since most Portfolio Managers passion is in finance, economics and trends, why deal with operations & administration?
No. 3 High Running Cost
Fund Management is an expensive business. The cost of operation can be $1 Million to $2 Million for a new small setup managing $50 Million of funds. For a large fund of $1 Billion, the annual operating expenses could be around $20 Million.
The high cost of running a Fund Management Co. deters many from setting up one. It can take between 6 months to 18 months to set up a fund and to raise capital. During this period, they could forgot a potential income of $250,000 to $2 Million from their existing role as Portfolio Managers.
No. 4 Acquiring Client Base
And since many Portfolio Managers focus their time on economics trends, financial markets analysis, they do not spend time with clients. Mostly, they rely on marketing channels to do the fund raising and subscription.
In other words, they don’t have a client base. They are not able to pick up a few phone calls to raise $50 Million for investments. And since Fund Management is a competitive business, being new means there is little incentive for clients to trust their funds. The preferred option is to set up an institutional fund, though the minimum fund size is usually $300 Million or $1 Billion, depending on targeted institutions’ market. The screening criteria is also more stringent.
No. 5 Building a Marketing Team
A strong marketing team is extremely important for a Fund Management Co. to sustain and grow its business. Unfortunately, it is hard to attract good marketing teams to join new set-ups from established firms. The longevity and quality of structure in an established fund means the marketing team would not want to risk their credibility and reputation to raise funds for a new and inexperienced independent Fund Manager.
No. 6 Earning Trust
Fund Management is not only about returns. Economic cycles goes up and down. There could be years of negative returns. It takes time to build up the reputation.
It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently
~ Warren Buffett
- The Demise of Long-Term Capital Management
- Bernie Madoff: Scamming of America – The $50 Billion Ponzi Scheme
- Rogue Trader: Nick Lesson and the Collapse of Barings Bank
No. 7 Showcasing Core expertise
Being part of a big brand name such as Blackrock, Fidelity, PIMCO, JP Morgan and UBS makes selling expertise much easier. Plus, the Portfolio Manager has access to the expertise in various fields of economic developments and trends within the organisation.
To be independent and setting up their own Fund Management firm would put their individual ability under severe test and scrutiny. Alphas and benchmarks become major considerations in their daily investment and risks management decisions. The lure of an outperformance could be as destructive as a wait-and-see approach.
Plus, all clients and staffs would place an extra eye on the new Fund Manager who was ultra-confident of his/her philosophy before set-up.
No. 8 Reputation Risk
Portfolio Managers had built up their skills and reputation over many years of hard work. Starting from analysts, traders, product specialists to assistant portfolio managers and becoming full-pledged Portfolio Managers. With so many new analysts every year, they are the rare few who manage to rise up to become Portfolio Managers.
With a strong reputation, unsurpassed knowledge and an illustrious future, they put their lifelong achievements at risk by venturing to set up a new Fund Management Co. Their reputation is now at risk. Just like when Warren Buffett or any star Fund Manager makes a bad mistake, thousands of analysis pour in on what’s going on with that bad decision? Why would he make such an amateur decision?
A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.
~ Warren Buffett
Read More: 20 Traders who lost more than a Billion
No. 9 Sustainable Performance
Having a good run in performance means nothing in Fund Management. Due to reporting standards, the performance are scrutinised in periods of 1 year, 3 years, 5 years and 10 years – depending on the domiciled regulatory framework. Fund Analysts use advanced analytics to track funds’ performance.
There are also fund trackers such as Morningstar, Lipper Awards and Citywire. New Fund Managers have a hard time trying to balance between outperformance and sustainable performance.
No. 10 Sustainable and Growing Fund Size
It is not only about performance. The fund size has to grow organically (performance) and through new subscriptions (attract new investors). The larger the fund, the more cost-effective it is to run the fund.
The benefits of a growing fund are it attracts attention and also retains existing investors and staffs. Although a fast-growing fund may impede its original strategy because of its bigger investment amount (eg. becoming market makers, requirement to use expensive services because of liquidity risks, clearing risks, trade privacy). A slow growing fund may point to a poorly set-up fund.
No. 11 When Crisis Hits
Imagine the $500 Million fund was set up in September 2008. Be it in bonds or equities, the portfolio value would decline by as much as 80% in 6 months.
No hedging would had helped as systemic risks increased then, where the prices of options, swaps, forwards became secondary to the risks of the counterpart. Read: Germany’s stupidest bank as €300 Million was transferred to Lehman Brothers after it’s collapse
You will also be hit by withdrawals that severely cost the fund overheads to be increasingly expensive against the fund size.
No. 12 Supreme Courage
Needless to say, it takes a lot of courage to set up a Fund Management Co. to rival many of the leading Fund Management Co. around.
Many had preferred to set up a Hedge Fund to take on short-term market opportunities against creating a Fund Management Co. that traditionally carry a business focus to last for decades. A Hedge Fund is also more lucrative to run as it allows taking higher risks alongside profit-sharing opportunities (Hurdle Rate & High Watermark).
In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand
~ Benjamin Graham
No. 13 Peer Pressure
Continue to manage a $10 Billion portfolio in the worlds’ leading financial institutions or build everything from scratch with an unsecured target portfolio of $200 Million to $500 Million.
It is no easy feat to count the opportunity cost of the income. The peer pressure is daunting, as days pass. How do you make up for lost time? How do you create the outperformance?
No. 14 Key-Man Risk
As the Fund Manager and very likely the leading Fund Manager who makes all the investment decisions, you are the key-man to the fund. Without you, everything collapse.
This is the reason why some funds start off with a strong team. Though a strong team means the fund’s strategy is likely a team-based decision. This is a complex risk, a tradeoff and for Portfolio Managers who ponder over risks and returns considerably, this often becomes a stumbling block. Read More: 2015 Singapore Fund Mangement Co. at a glance
Tip: Speak to your Private Banker or Wealth Manager about Key-Man Insurance. An often-overlooked Wealth Management solution.
These are the 14 reasons why most Portfolio Managers rarely set up their own Fund Management Co. Which firm would be the next Fund Management Co. to be included in the list?
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