Nine months later!

Well actually it’s more like 12-18 months to get a FAIS licence according to my lawyer friend John, who deals with these matters. My point is – it takes less time to make a human being than starting an asset manager!

If you have no idea what I’m talking about, make sure you read part 1 of this series.

Some may say this is a good thing. It should not be made too easy to become a custodian for the management of other people’s money. Others bemoan the slowness and complexity of the regulatory process. Notwithstanding this, it is clearly possible to become regulated to manage money if you meet the criteria. I say this because I see a few new businesses popping up on a relatively regular basis.

My friend Warren now has his license and has set up the other necessary and not insignificant requirements, namely company registration; tax registration etc, to start his business.

It makes sense that Warren’s first product will be an equity fund, as this is where his experience lies. The negative is that this is the most contested of all product categories and asset classes. The majority of start-up asset managers begin life as equity managers, and some have ambitions to start multi-asset funds in the future. It is naturally easier to start with a focus on one asset class. Whether it is a good idea to compete in the equity space, from a business perspective, is debatable!

There are over 150 different equity unit trusts that have more than a 3-year track-record created by nearly 100 different asset management businesses in South Africa. I use the word “different” but many will be quite similar. By this I mean that they’ll hold roughly the same shares listed on the JSE (our relatively small and concentrated stock market) but in marginally differing weights. Some will be called “benchmark huggers” – a bit of a derogatory term for an active fund with holdings very similar to the index, generally making it more difficult to materially beat the index but charging much more in the way of fees.

On the other side of the spectrum are the funds which are very different from the typical market index. These funds are often called “contrarian.” This term is typically used to describe a fund or approach resulting in a portfolio which behaves differently from the index.  I use this word different, but actually I should say “better”, as why be different but worse than the market?

Sadly, performing worse than the market is the case from time to time – even with skilled active managers. What then happens is that investors lose faith in the fund and withdraw. Ironically this often happens just before the turning point. This is called “performance-chasing” – looking for a better performing fund than the one you’ve invested in.

It is a recipe for disaster in investing.

“Buy low – sell high” is a logical concept to most. However, when it comes to fund performance this is often an impossible task. Behaviourally us humans are hard-wired to do the opposite. It’s our natural instinct and it’s hard to fight against.

Once Warren has developed a track-record of good performance – meaning he has demonstrated he can out-perform the market – he’ll use this track-record to market his portfolio and hopefully attract some investors. Fund consultants and advisors usually require a minimum of 3 years.  By the way 3 years is probably the worst period you can choose. Problem is, most often a period of good performance is followed by a period of bad performance. This often happens within a 3-7 year cycle.

Even if you are a skilled active manager like Warren, your investors will find it hard to match your track-record when investing in your fund. This is, unless they invest from early on and stick with you for an extended period of time – typically much longer than 3 years. The key problem here is defined by a great term called the “Bahaviour Gap” – which I learned about from Carl Richards.

There are very many reasons why investing, and active management in particular, is so hard. Even if you can demonstrate that you have skill and can translate it into a product worthy of being paid for by investors it is likely that at some point, the journey that your investment results take, will diverge from your clients expectations or perceptions and this will severely test the relationship.

Being an asset manager is not just about beating markets (delivering alpha). Importantly, it’s also about good communication with clients. This includes continuously articulating, in a cogent manner, what you do; how you do it and when you do it. Managing their expectations and making sure you delight your clients with your services, aside from good investment results, is critical. And all of this needs to be off a foundation of solid governance.

So, if you want to start your own investment business make sure that you understand the many and complex facets over and above the element of having the skill required to be an active manager, and the time required to spend on non-investment related, ie. business issues.

Are you considering starting an asset management business?

Leave your questions in the comments!

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