Most Likely to Succeed: Leadership in the Fund Industry

The authors’ review of mutual fund industry rankings over the past two decades suggests critical factors for success in the business. Surprisingly, the critical factors are not fund performance or marketing. Instead, the firms that are most likely to succeed are dedicated to the asset management business and are structured as partnership-like organizations controlled by their investment professionals. View a webinar based on this article. We review mutual fund industry rankings over the past two decades to determine critical factors for success in the business. We conclude that the critical factors are not fund performance or marketing. Instead, in our view, the firms that are most likely to succeed are dedicated to the asset management business and are structured as partnership-like organizations controlled by their investment professionals. Fourteen of the top 25 mutual fund sponsors in 2010 were dedicated to asset management, and the market share of these sponsors has increased dramatically from 1990 to 2010.Diversified financial firms lost share in the fund business over the past 20 years despite their attempts to expand in it. We review those attempts, which relied principally on mergers and acquisitions, during three time periods: 1993–2001, when diversified financial firms acquired fund sponsors; 2002–2006, when dedicated asset managers became buyers; and 2007–2010, when the credit crisis forced diversified firms to divest fund management subsidiaries.We conclude that little support is left for the theory of the financial supermarket that drove diversified firms into the asset management industry in the first of the three periods. Expected revenue synergies failed to materialize because of high-net-worth investors’ preference for open architecture over proprietary products, intense regulatory scrutiny of potential conflicts of interest, the ease of comparison shopping on the internet, and the difficulty of cross-selling financial products. Many diversified firms also had trouble retaining investment professionals and living with the volatility of investment performance.We examine the reasons for the success of the dedicated asset managers, focusing on the three largest firms in the U.S. fund industry: Fidelity, Vanguard, and Capital Group. These firms are focused on asset management, have nonhierarchical organizational structures that appeal to investment professionals, and have developed compensation programs that help retain those professionals. Also, these firms are privately held.Although private ownership insulates firms from the pressures of the public market, it also creates challenges. Specifically, privately held firms have difficulty in valuing their equity interests and transferring them from one generation to another. And they must grow organically because the absence of shares as a noncash currency makes acquisitions harder.Most other dedicated asset managers that ranked among the 25 largest mutual fund managers have publicly traded stock but are controlled by their own investment professionals, using a variety of ownership structures. This public–private hybrid approach makes it easier to transfer ownership from one generation of owners to the next, as part of a management succession, and allows these firms to grow through acquisitions. But these firms must cope with the disadvantages of public ownership.We believe the advantages of public ownership outweigh its costs. We conclude that the fastest-growing firms in the mutual fund industry in the future will be dedicated managers that have a public float but that are controlled by their own financial professionals.Authors’ Note: This article is based on research for The Fund Industry: How Your Money Is Managed (John Wiley & Sons, 2011).