One recurring question we hear from clients is what business model builds the most value for an investment management firm. It’s a reasonable question to ask these days, given the irony of simultaneously strong financial markets and the degree of negativity surrounding the RIA community. In the past month alone, Focus Financial dropped plans for a public offering, Morningstar reported that passive mutual funds pulled in over $500 billion in 2016 while active funds lost nearly $350 billion, and the parent of AllianceBernstein fired most of AB’s senior leadership. All of this happened at the same time that the Nasdaq hit new all-time highs.
Looked at from this perspective, building value in an investment management firm appears to be fairly challenging, but from our perspective the challenges are uneven. Further, we don’t know that the secret to building value in an investment management firm is so much about choice of model as it is developing and executing a strategy which no one else can match. We like to refer to this as finding a firm’s “unfair advantage.”
Unfair Advantage
We didn’t coin the term “unfair advantage”, but we get it from the title of a book about racecar driving by Mark Donohue. In the late 1960s and early 1970s there were many great race car drivers, but few were as highly regarded at the time as Donohue. He was important not just because of his success across a variety of racing platforms – everything from sports car racing to Indy cars to NASCAR to Can-Am – but because he approached auto racing more as an engineer than a daredevil.
Mark Donohue studied mechanical engineering at Brown and was known on racecar circuits for his skill at reading the handling and performance characteristics of his cars. Donohue’s most noteworthy success was taming the Porsche 917K. Porsche had spent so much time developing a twelve cylinder boxer motor that developed over 1,000 horsepower that they neglected attention to the aerodynamics and suspension work that would actually keep the car on the road. The 917 was ferociously powerful, but it was also nearly uncontrollable. Donohue took the body off of the car and drove it to check out the drivetrain and suspension first, and then started working on the aerodynamics. Once he was done, the car was unbeatable, and Donohue’s legend was cast.
After several successful seasons in the Porsche, Donohue retired from racing to write Unfair Advantage. The advantage he sought in a race was not his own talent – Donohue did not think he was a particularly skilled driver – but to have the very best car in the race. In truth, the unfair advantage that Donohue’s team, Penske, enjoyed during this time was to have an Ivy-League educated driver who could fine tune a car to fit a particular race on a particular track under particular conditions. Donohue returned to racing in 1974, and died in a crash on a practice lap in 1975. Were it not for his book, he might have been forgotten.
Finding Your Firm’s Unfair Advantage
After years of working with investment management firms of all shapes and sizes, it is our opinion that building the most value in an RIA comes down to the same thing: developing and capitalizing on some unfair advantage. That may sound unnecessarily mysterious or metaphorical, but it really boils down to examining the basic building blocks of firm architecture and finding out where your firm can excel like none other. We’ll break this down for you over the next few weeks.
