Investment management firms are celebrating record assets under management after an increase in 2017 of 16.1 percent – from $18.2 trillion to $21.1 trillion. According to Thomson Reuters Lipper, equity managers fared the best with an increase of 21.6 percent. This is obviously great news for investment managers as it translates into nice-sized bonuses. However, beneath the surface, there are signs that the foundation may be cracking in many firms, exposing the vulnerabilities of investment managers as they enter a new period of market volatility.

AUM Growth You Can Count On?

The same Thomson Reuters Lipper report concluded that stock market performance was the chief contributor to asset growth in 2017. It certainly didn’t come from new inflows. During the period Sept. 2016 to Oct. 2017, of the nearly $700 billion of assets that flowed into mutual funds, $686 billion flowed into passively managed funds. In fact, active equity funds have experienced net outflows in each of the last two years. Were it not for the surging stock market of the last several years, many investment management firms would be experiencing net AUM declines. Given the current state of asset flows, investment management firms should be asking themselves where their asset growth is going to come from without the assistance of a stock market that appears to be tiring after a nine-year bull run. Larger firms, with their massive resources and manpower will continue to capture market share. However, smaller firms need to commit to a strategy that focuses on real organic growth just to keep from sliding backwards. The two areas firms need to look to for organic growth in these challenging times is in their investment strategies and their client base.

Keeping Alpha Alive

The last decade has proven to be very challenging for active managers who need to generate consistent alpha to achieve organic growth. Some investment managers have resorted to lowering their fees to attract or retain assets, while others have looked to their investment strategies for ways to squeeze more alpha from them. An increasing number of investment managers are augmenting their investment strategies with creative approaches utilizing new quantitative and analytical techniques, such as artificial intelligence, and alternative data sources for providing investment insight.

Some investment managers are discovering the limitations of having just one investment strategy. Being a one trick pony in a volatile market environment can create too much risk exposure, where as having a second strategy allows one to zig as the other one zags. Diversifying investment strategies can help keep a strategy in favor more of the time.

For Real Organic Growth, Focus on the Vital Issues

Addressing the alpha conundrum is typically job one for most investment management firms but, while it is of critical importance, it can’t come at the expense of addressing the loss of assets due to client attrition. Firms that rely heavily on institutional assets are especially vulnerable to asset declines when one or two major institutions decides to defect. However, gradual advisor attrition is a major problem for most firms. They just don’t know it because they have been focused on AUM, which, thanks to the stock market, is at record highs. Many firms don’t realize they have reached a critical juncture where future asset growth may be solely reliant on their ability to retain existing advisor clients and find new advisor clients.

Shares Outstanding is Key to Asset Growth (or Decline)

Firms that focus primarily on AUM are likely to neglect the more critical measure of organic growth, which is shares outstanding. In the recent market environment, AUM has been able to increase even as shares outstanding decrease. However, it’s like a crumbling foundation. In a declining market, AUM will decline faster because there are fewer outstanding shares holding it up.

When investment management firms experience net outflows, it means they are losing an increasing portion of their share base, which consists in large part of the financial advisors who are taking their clients’ assets elsewhere. Unless there are new financial advisors in the sales pipeline, there is nothing except the hope of continued stock market gains to stem the outflows. But then hope is not a strategy.

Time to Shift Your Thinking

When we have conversations with investment management firms about their goals, it invariably centers around AUM as the primary target (i.e., We want to reach $2 billion of AUM). However, the goal needs to be broken down, so the critical measures can be understood and incorporated into a strategy. For example, what portion of the AUM growth can be expected to come from market appreciation? What will be generated from new flows resulting from your sales and marketing efforts? It requires real strategic thinking to differentiate between market performance and the kind of organic growth that comes from ongoing marketing and sales efforts.

Achieving real organic growth has never been easy. It takes time and resources. And, it must start by focusing on the things that you can control and that really matter. You can’t control the next 40 percent increase or decrease in the stock market. Yet, short of a proactive plan to grow assets, stock market performance will be the dominant contributing factor in where you will be a year from now. That’s no way to run a business.

It’s already April and you have been implementing your strategic plan for 2018. Either you are on track or you’re behind. If your focus has been on AUM as your primary goal, now may be the time to switch your thinking to what really matters.

Dan Sondhelm is CEO of Sondhelm Partners, a firm that helps asset managers, mutual funds and ETF’s grow. He can be reached at 703-597-3863. Or check out his recent Insight article Rethink Your 2018 Growth Strategy Now for specific growth strategies.