To Retainer, or Not To Retainer

To Retainer, or Not To Retainer

Successful International Distribution – Part 4

By Daniel T. Allen, CEO, Aliier

There is perhaps no topic quite so contentious among asset managers and distributors as the topic of so-called retainer payments. There are a lot of different attitudes on this topic, ranging from managers who refuse to pay for even the most basic expenses, all the way to managers who pay for everything but, in return, demand excessive levels of control. One of our functions as an international platform is to hire distributors to support our managers, and we have seen many different variations surrounding how this topic is handled. We take no absolute position as to what the best way is to handle this key component, as asset managers can have various levels of success with them all. However, in our view, the critical decision factors regarding what approach to take include:

  1. Understanding what you are doing and why;
  2. Determining how it helps you to achieve your goals in the new international venue, and;
  3. Making sure those choices are a good fit for everyone.

Active vs. Passive Distribution

The first decision you need to make is whether you want to be passive or active in your distribution efforts. The passive approach to distribution typically involves hiring as many distributors, on pure commission, as possible. No one distributor has exclusivity, except perhaps to a named lead where the manager only pays a commission which is typically around 20%-25%. Active distribution, on the other hand, represents an aggressive and targeted approach to distribution with a dedicated focus on long-term growth in a specific market.

Passive Distribution

Essentially, using the passive distribution approach means the manager is throwing everything against the wall to see what sticks. Distributors who are willing to take a manager’s strategy for a commission-only structure, who do not get anything to compensate them for their time and costs, will typically run down their contact lists to see if there is any interest, then put your factsheet into a briefcase loaded with a stack of others and offer it only if asked. Occasionally, inexperienced distributors who are unrealistic about what it takes for active distribution will accept such a deal, but they will rapidly give up on your firm. Also, this approach generally doesn’t work well in more sophisticated institutional spaces and it can create conflicts; however, it has the advantage of not requiring much investment. For the manager who doesn’t want to fully engage a new market but wants to operate opportunistically, this can be a way to pick up the occasional allocation. Just remember, you really do get what you pay for.

Active Distribution

For the asset manager who prefers to fully engage a new market and develop a long-term professional presence as well as relationships that grow over time, active distribution makes more sense. In an active distribution arrangement, the distribution team will have a significant geographical or market segment exclusivity. The team will report on its efforts either directly, or indirectly through a responsible entity or platform, to the asset manager. The asset manager should be fully engaged in the distribution process and commit to travelling into the new market at least 3-4 times a year. The asset manager who takes an active approach should look at this style of distribution effort as part of building long-term enterprise value.

Active distribution is a journey.

Active Distribution Expectations

Active distribution is a long-term effort and goes way beyond just running through a contact list. Done right, there will be significant market engagement which involves expenses such as airline tickets, rental cars, hotel bills, coffees, breakfasts, lunches, dinners and, in addition, somebody must spend a whole lot of time on phone calls, e-mails and in meetings. Any expectation that assets will start accumulating significantly in less than six months to a year is unrealistic. Do not expect it. Someone must make an investment of time and money before there is any significant return, but it can be well worth it. A manager opening a new market to steady AUM growth enjoys significant economies of scale. Revenues are incremental – you already have your operations and portfolio management in place – so after your cost of sales most new revenues drop right to the firm’s margin.

Nobody Works For Free

Some asset managers want distributors to spend a lot of time, effort and their own money promoting the asset manager’s firm, all on the come. Distributors, on the other hand, must weigh the cost of aggressively supporting a manager against the chances of success and the upside that results. Regardless, nobody works for free. This mental tug-of-war goes something like this:

Distributor:It is probably going to take at least 12-18 months to start raising significant assets and it will take 2 years before assets climb considerably. My costs are heavily weighted up front. I would be crazy to pay for the airline tickets, rental cars, hotels, lunches, dinners, etc., and not be compensated for the enormous amount of time that the calls, the e-mails, and the meetings will take to get this done unless there is significant upside. And, if this asset manager screws up, I will lose everything I have invested and not be able to raise any assets. That’s not fair.

Asset Manager:I developed this strategy. I have been working on it for years and it is a terrific strategy. When this distributor tells somebody about it, they would be crazy not to put a ton of money into it. Why should I have to pay the distributor a retainer for his time, T&E to cover his costs, plus a percentage of my management fee on top of that, just for talking to people? And, if I do exceptionally well, this distributor will get huge allocations and could make a fortune. That’s not fair.

Every Asset Manager Charges Every Client A Retainer

This paragraph doesn’t apply to everyone but for those it does, remember that fair is fair. Unless you are offering to make the distributor a partner in your firm, there needs to be some reasonable compensation for your distributor’s effort. I have always been fascinated by the resistance that some (not all) asset managers have towards paying for what they get. Every asset manager charges every client a retainer (a/k/a management fee). Think about it. An investor comes to an asset manager with a pool of existing money seeking the help of that asset manager to increase the size of their investment. The asset manager immediately starts charging that client a management fee on the assets, that the investor already has, in order to compensate for all the effort that the asset manager is making in order to increase the size of the investor’s pool of money. In fact, even when the market goes down, asset managers continue to charge a management fee. Yet, some asset managers routinely ask distributors to spend their own money and massive quantities of time to work to increase the size of the manager’s asset pool but do it solely on a minimum performance fee basis.

It Is All About Balance

As a global platform, we have worked with various distributors and we have tried a lot of different approaches. Each of them can work and each of them can fail depending on the circumstances and parties involved, but there are some factors that are inherent in each arrangement. First, there are significant costs to international distribution. That is a fact. It will either be the manager or the distributor, or some combination of the two, but somebody will pay those expenses, or you will not succeed. If you are an asset manager, do yourself a favor and be honest with yourself. Decide if your fears surround being more downside adverse or more upside adverse.

If your fear is primarily that the process will not work, then you will likely be asking your distribution partner to cover more of the upfront expenses. In this case, your distributor is not just a vendor, you are asking them to be your business partner. If you have a distributor who agrees to cover your distribution expenses, you should accept that you will pay more in commissions. If you expect the distributor to pay for everything, then the commission should probably be 50%. There should also be a longer term to the contract of perhaps 3-5 years. You will also need to accept that since you are not covering the costs you will have little influence over the distribution team.

If your fear is that you will give up too much on the upside, then you need to be prepared to pay a retainer or, as I prefer, a minimum payment. Depending on the structure you can, if you wish, limit the agreement to 2 years with a lower set fee of approximately 25%. You may also choose to set a declining fee structure, starting higher at lower AUM levels and dropping with higher AUM levels. Regardless, if you are paying for the distribution costs, you have a right to set reasonable expectations and reporting procedures.

Most of the time, it is some blend . Personally, rather than the traditional retainer plus T&E plus commissions, I prefer a minimum monthly payment that is essentially what would be the retainer plus reasonable T&E. I believe that the distributor’s T&E expenses should be always be paid by the distributor out of the minimum payment so that isn’t a point of friction. I have seen too many demoralizing arguments over small differences in the cost of a flight or hotel. I also prefer a declining commission structure starting generously and then declining with growing AUM. With a generous commission on the first assets, the distributor is rapidly weaned from any minimum early on but with a declining commission level for larger levels of assets, the manager’s concerns about a windfall are addressed.

This approach tends to fire up the distributor in the beginning when it is most needed but avoids the risk of the distributor becoming complacent about the manager. The declining minimum puts pressure on the distributor to keeping moving after the initial newness of the relationship begins to wear off. We believe that this approach gives the manager the best chance at success, creates strong economies of scale, and even mitigates the long-term costs to the manager should lightning strike.

Whatever approach you choose, like most things, if you want to be successful, the final equation requires that there be a fair balance.

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