COST MANAGEMENT / P&L DISLOCATION

Implications of the COVID-19 Crisis

March 27, 2020

An issue that affects everyone in the investment management ecosystem—whether managers, intermediaries, or allocators, etc.—is the effect of revenue declines on cost structures. A number of articles have touched on the viability of boutiques through the crisis (for example, “Restaurants Are Being Destroyed. Money Managers Should be Scared” and “The RIA Profit Margin to Weather a Pandemic’s Recession“). Cost cutting/restructuring—whether at smaller boutiques or larger enterprises—has material implications.

  • Q1 revenue impact is a bit of a wildcard, though first-quarter billings are only days away for most. Even more unclear is Q2. Managements are trying to scenario-model what the top line might look like to understand bottom line impact and thus the implications for forward spending, reinvestment, bonus pools, etc.
  • Firms with 40-50%-plus cash flow margins can obviously tolerate revenue declines much better than their poorer margined peers. However, the owners’ perspective on where that impact will be felt most ranges from incredibly self-centered to company-first attitudes. At least they have the flexibility to take margin hit and protect the status quo. Firms with narrower margins and more revenue sensitivity are being forced to act, and it’s going to be hectic and divisive for many. Net inflows or outflows will mitigate or exacerbate this problem.
  • Specific cost-cutting measures are varying. Travel spending has obviously evaporated, but this is typically only a fractional % of costs. Other discretionary line items may be tweaked, but comp—as the biggest line item, by far, for every single manager—is a likely area of action. This will play out in four ways…(1) reduced profit distributions, (2) comp cuts for senior execs, (3) comp cuts across the board (bonuses, even salaries), or (4) layoffs.
  • We’ve heard a range of responses thus far, from full speed ahead to indefinite termination of all hiring activity, and layoffs. Anecdotally, public managers have been the most aggressive thus far, with a spate of hiring freezes (e.g., BlackRock and JPM, in contrast with privately held Capital Group). Many companies will use the downturn as cover for contemplated personnel changes. And if the downturn extends and margin impact worsens, we will see far more layoffs. A few large companies have, for now, offered assurances there will be no short-term layoffs (e.g., Morgan Stanley, Citigroup, Deutsche Bank).
  • Distribution is often an early target for layoffs, as new business activity slows, less productive members can be trimmed, and these aren’t seen as harmful to clients. Does not apply to client service/relationship management, which is more important than ever. Trimming investment talent is tricky, as the most “expendable” tend to be the least expensive.
  • Implications for future operating structures abound. Remote working is likely to be seen in a better light going forward; certainly many are getting more comfortable with video conferencing. This may translate into reduced physical footprints, more hoteling, etc. Also, firms may reconsider their commitment to (or adoption of) open office space as workspace proximity and lack of barriers elevate contagion risk.
  • Parented managers are perhaps most in the crosshairs. Revenue contribution, allocated expense, and relevance are coming under the microscope. Look for shuttered/merged units, spinouts, and more battle lines drawn between management units and their parent company owners.

Despite the massive volatility and shockwaves of the last few weeks, we need to remember it’s early in this saga. Many chapters are still to be written, just as the effects of 2008 manifested themselves over many years after the sub-prime crisis. Duration is in some ways more important than magnitude. Allocators and gatekeepers are watching closely to see how managers respond… how responsibly they manage their businesses, what they prioritize, etc. Some allocators will use this as a catalyst to make change, others will form deeper loyalties. This crisis is going to be very revealing.

Respectfully,

Brad & Chas

About Rosemont

Rosemont Investment Group is a private investor in asset and wealth management companies, backed by permanent capital. Over the past 20 years we have been minority equity partners in dozens of firms, in all cases majority-held by employees. We serve in a non-controlling advisory role, providing solicited guidance on issues ranging from high-level strategy to functional decisions and assist in business and corporate development. www.rosemontinv.com