In an industry badly scarred by the crisis, asset managers need to return to the role of prudent fiduciaries, responsible for the financial health and security of their clients.

A year after the collapse of Lehman Brothers, the asset management industry struggles to adapt to a changed world.

The global credit crunch had catastrophic effects on every segment of the asset management industry. The industry saw 40% of its entire value plunge, client portfolios decimated and revenue streams savaged in just a few horrendous months.

In the wake of this disaster, smart asset management companies have set five priorities:

• 1. Boost liquidity
  One of the key lessons of the downturn was the importance of liquidity. Many institutions did not fail just because their investments were bad. The subprime mortgage securitizations that precipitated the crisis, for instance, represented only a tiny percentage of the mortgage-backed securities held by most investors.
  
  They failed because client withdrawals and redemptions forced them to liquidate their assets and unwind trades at an inopportune time. Since then, many asset managers have seen building lines of credit and ready cash as their first order of business, for their client portfolios as well as for themselves.
  
  
• 2. Improve risk management practices
  Risk management was a second area in which most asset managers were found wanting last year. Investments rated AAA one week were reclassified as junk the next. Portfolios of derivatives contracts, once seen as sure things, turned out to have potential liabilities so vast they could not even be calculated.
  
  Even some of the best-laid plans for asset diversification turned out to be little more than wishful thinking. Investment risk cannot simply be measured from an index, and operational and business risk cannot be completely divorced from it.
  
  
• 3. Reduce fixed costs
  As long as the markets were going up, the industry’s bloated cost structure was of little concern. Clients were happy, shareholders were happy and few worried about how much cash leaked out through an inefficient supply chain.
  
  Many firms were caught by surprise when revenues plummeted, leaving them struggling to maintain vast workforces, enormous offices and costly vendor relationships. This experience has taught the survivors just how important it is to maintain liquidity and put as many costs as possible on a variable basis, despite the furor about bonuses.
  
  
• 4. Reinvent the pricing model
  One issue many Ernst & Young leaders have heard is that the pricing model for asset management is badly out of sync with client expectations. Clients are tired of incentives in which managers are feted as magicians in the years the markets are rising and then excused from responsibility in the wake of a general decline.
  
  In the future, more money will have to be made by demonstrating resilience in down and up markets.
  
  
• 5. Rebuild customer trust
  These days, the public is keeping a much closer and more skeptical eye on the financial services industry as a whole, and more particularly, on asset managers. Institutional investors are watching much more warily than was once the case.
  
  Not surprisingly, regulators – who in many cases are now also shareholders – see the collapse as prima facia evidence that self-regulated markets don’t work. They are taking a tough and politically popular line with the industry.
  
  It may take years, but asset managers have no choice but to work hard to win back the trust lost in the debacle. And it will be no small feat to achieve this, particularly in a still-fragile market environment.
  
  It requires the asset management industry to return to its roots culturally, as a fiduciary responsible for the financial security of millions of people. Asset managers need to return to a place of prudence, while still taking advantage of the opportunities new communications and information technology offer. They also need to find new ways to serve clients more closely, find rewards and understand risks in a faster and more global nature.
  
  In short, clients are demanding nothing less than the reinvention of the entire industry.
  
  “How do you educate customers to make more intelligent buying decisions when it is in your best short-term interests not to? The industry is in need of some reflection and soul searching.” — Ratan Engineer, Ernst & Young Global Asset Management Leader.
  

A need to take action

Now that the markets have come roaring back, the temptation to forget the lessons of the past year is already beginning to grow. Asset management firms must not be lulled into complacency.

The economy is getting better, and it seems to be growing stronger every day. But crucial parts are still on a respirator – a machine controlled by governments who face massive financial pressures of their own. And then there is the pressure from the constituents, who have no love for an industry many perceive as responsible for lost homes, lost jobs and lost savings.