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Financial Markets and Portfolio Management

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04-04-2017

A note on the valuation of asset management firms

Authors: Juha Joenväärä, Bernd Scherer

Published in: Financial Markets and Portfolio Management | Issue 2/2017

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Abstract

Market capitalization relative to assets under management is often used to value asset management firms. Huberman’s (2004) dividend discount model implies that cross-sectional variations in this metric are explained by cross-sectional differences in operating margins, and yet we find no evidence of this in our data set. We show that a superior model—inspired by the work of Berk and Green (2004)—includes also the level of fees as an explanatory variable. This approach dramatically increases the fit of our valuation model and casts doubt on the relevance of the so-called Huberman puzzle.

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More general valuation frameworks are available, yet despite their technical feasibility for modeling purposes, from a practical standpoint they cannot be implemented without deep insider knowledge (all internal and external contract terms) of the particular asset management firm being modeled.

We also use GICS (Global Industry Classification System) codes to ensure that the matched manager is a pure asset manager.

These data are given in Columns 5, 7, 9, 11, and 13 of Table 1.

Influential data points are discovered by calculating Cooks distance for each regression. BX (Blackrock) and KKR (Kohlberg/Kravies/Roberts) are identified as influential (Cooks distance exceeding 1).

Optionality in fee income would render the dividend discount model as a theoretical tool close to useless. Empirically, our approach might still work if income from performance-based fees is reasonably steady, i.e., if the optionality does not materialize. Asset management firms with performance-based fees have an even stronger incentive to monitor capacity and limit assets under management as eroding alpha cuts directly into their revenue stream.

See Scherer (2010, 2011) concerning real-world frictions and their effect on optimal risk management by asset management firms.

Suppose the CAPM is used as our asset pricing model. Then the risk-adjusted discount rate for fees on a US small cap portfolio would be the expected returns on those stocks, or \(R=R_{\mathrm {US}\_\mathrm{small}\_\mathrm{cap}} =r_f +\hat{b} _{\mathrm {US}\_\mathrm{small}\_\mathrm{cap}} \left( {R_{\mathrm {US}\_\mathrm{market}\_\mathrm{portfolio}}} -r_f \right) \).

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Title: A note on the valuation of asset management firms
Authors: Juha Joenväärä
Bernd Scherer
Publication date: 04-04-2017
Publisher: Springer US
Published in: Financial Markets and Portfolio Management / Issue 2/2017
Print ISSN: 1934-4554
Electronic ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-017-0287-y

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