We are at that point in the quarterly cycle were the largest asset managers, and our industry watchdogs, are once again reporting AUM changes for the previous quarter and last 12 months.  So what! The question that we should be asking and that which should be reported is: “How does this growth or decline in AUM impact the strategy(ies) being managed by the aforementioned firms?”

In my humble opinion, assets are being concentrated among too few firms, and as a result of this asset growth, the products managed by these firms are far exceeding the natural capacity of these strategies.  Subsequently, clients end up paying active fees for, at best, index-like performance.  If that is going to be the result, buy cheap and not expensive beta – index!

Initially, significant asset growth has the potential of driving performance forward, as managers have to buy the same stocks that are in their portfolios.  However, watch out when asset growth levels off or worse, begins to decline, and managers are forced to sell a percentage of their holdings in stocks that remain in their portfolio(s).

Hiring an active manager is never easy, especially given the plethora of options.  However, just evaluating a firm based on its performance, people, philosophy and process is not enough. One needs to understand how the additional assets being received will impact that managers ability to maneuver / trade, especially if that manager is in a less liquid area of the capital markets, such as small cap value.  Every product has a natural capacity, and investment managers should manage to these levels and be transparent with their clients, especially as they near their target AUM.

As markets grow, so does the natural capacity.  But managing through capacity places the client’s interests behind those of the manager, and sets the managers business up for future failure when it becomes nothing more than another underperforming shop.