For decades, those of us in the investment industry have been able to give thanks for a business model that has produced high margins in a consistent fashion.  Assets are generally sticky and markets have mostly gone up, bringing those paid based on fees charged on assets under management a plentiful harvest year after year.  It has accrued most noticeably for the owners of the firms and their top money managers (sometimes one in the same), but the table has been spread for lots of others too, including those in the trenches at the firms, dealers who sell them securities, research firms that give them ideas, vendors that provide them with tools, and others throughout the food chain, like me.

We now face a different situation entirely.  The knife cuts both ways — although we have been used to seeing it work in only one direction — and the drop in asset values of late has reduced fees, which no longer can support the expense structures that had been built.  The papers are full of stories about firms that have already announced staff reductions.

A recent report by Casey Quirk and McLaganCasey Quirk | Published this week, this piece (“Crisis in Asset Management:  Profitability Under Siege”) details some of the issues that asset management firms face by summarizing the operating models of just under fifty firms. explores some of the choices that firms are facing.  I think it’s most interesting to look at it in conjunction with another document from Casey Quirk, slides from a presentationZephyr Associates | The talk (“Managing the Complete Firm in a Brave New World:  Liberation and Alignment in Investment Management”) was given by John Casey at the Zephyr Client Conference. given in September 2007.  While the new paper is focused on the economic imperatives of the moment, the older slides show important context for the choices that have to be made.  As is inevitable, some of the ideas presented then look out of date now, given that changes in the environment have exposed weaknesses in some of the elements (securitization, certain alpha strategies, etc.) that were thought to be building blocks for the future.  Nonetheless, it represents one map of what might be, and it reminds us of the need to contemplate the big picture and put strategy in front of tactics.

That is precisely what asset managers need to do now; to be successful going forward they must avoid the temptation to cut costs in ways that are the quickest and easiest.  The best time to redo the business model is when things are going well, but it is also the toughest, since few understand the need for it at the time.  At least now it’s clear to everyone that something must be done.  As I indicated in my recent posting on the changes at Putnam,the research puzzle | The rant was titled “more of the same,” since I thought their moves broke no new ground whatsoever. I hope that some firms will take the challenges that are presented as opportunities to break some new ground.  Who will be the pioneers?

As pointed out by Casey Quirk and McLagan, the ownership structure of a particular firm is an important factor in determining how likely it is to be able to do something other than simply chopping costs.  In addition, as always, the secret ingredient will be the nature of the leadership approach of those running the firm.  Will they be able to think outside not only the economic box they feel trapped in, but the proverbial box that restricts innovation?  Can they imagine that some of today’s expenses that might seem frivolous will drive the revenues of years to come?  Do they have a vision of how the industry will be changing and where they will fit in?

In the future, looking back on this difficult year, some firms will be thankful that they headed out for the frontier.