Margin-of-Safety

The Institutional Performance Derby: The Client Is the Loser 50
The Money Management Business
If the behavior of institutional investors weren't so horrifying, it might actually be humorous.
Hundreds of billions of other peoples hard-earned dollars are routinely whipped from investment
to investment based on little or no in-depth research or analysis. The prevalent mentality is
consensus, groupthink. Acting with the crowd ensures an acceptable mediocrity; acting
independently runs the risk of unacceptable underperformance. Indeed, the short-term, relativeperformance
orientation of many money managers has made "institutional investor" a
contradiction in terms.
Institutional investors are presumably motivated both by the ongoing challenge of
achieving good investment results and by the personal financial success that accrues to
participants in a profitable money management business. Unfortunately for investment clients
these objectives frequently are at odds. Most money managers are compensated, not according to
the results they achieve, but as a percentage of the total assets under management. The incentive is
to expand managed assets in order to generate more fees. Yet while a money management
business typically becomes more profitable as assets under management increase, good
investment performance becomes increasingly difficult. This conflict between the best interests of
the money manager and that of the clients is typically resolved in the manager's favor.
The business of money management can be highly lucrative, It requires very little capital
investment, while offering high compensation and the rapid development of what is effectively an
annuity. Once an investment management business becomes highly profitable, it is likely to
remain that way so long as clients do not depart in large numbers. In the money management
business management fees paid by new clients constitute almost pure profit. Similarly, lost fees
resulting from client departures affect profitability nearly dollar for dollar, since there are few
variable costs to be cut in order to offset lost revenues.