Barrier to Entry (Part 1)

GIPS compliance and verification leads me to perceive a high barrier for entry into the asset management (AM) industry.

The first barrier is significant expense unless one has ample AUM awaiting management. GIPS compliance and verification may not cost $40,000 but it could cost half that. In addition would be expenses of setting up the IA, getting licensed, legal documentation, accounting, hiring a compliance firm, and perhaps contracting with a prime broker. Many of these are recurring expenses, too. I could easily see $40,000 per year total. If I charge a 1% management fee then I’m in the red until I build to $40M AUM* (taxes not included).

The second barrier is solid investment performance–probably necessary to attract institutional money. Developing a strategy with an impressive long-term Sharpe ratio is difficult. Most people in the financial industry have limited or no trading experience. The best trading minds with whom I have associated come from outside the industry and while some are capable of generating good (time-limited?) performance, the vast majority retains full-time jobs. Alternatively, they may be of retirement age. The former cannot afford the expenses mentioned above. Neither the former nor the latter have enough knowledge [or desire] about what it takes to enter the industry.**

Given the prohibitive cost and the performance requirement, some cheaper companies provide third-party verification of model returns that I doubt institutions would find credible. These are priced for individuals who, like me, are probably associated with limited AUM potential. One inexpensive service with which I have communicated has a simple “one account/one model” requirement. One could open multiple accounts with a brokerage, trade different strategies, and then just have the most profitable account verified to come out smelling like a rose. I doubt the big institutions would risk their reputations by outsourcing to TPAMs who have used inexpensive verification services like this. Sometimes you get what you pay for.

For all these reasons, I perceive the barrier for entry into AM to be quite high. Those with access to high-net-worth individuals (e.g. financial advisers in the business of raising assets) do not have the expertise to generate solid performance (hence the demand for TPAMs). Those able to generate solid performance don’t have enough knowledge about and/or desire to enter the industry or access to enough assets to make the expense worthwhile.


* It would cost less to sell my services to existing IAs as a TPAM or sub-adviser.
** I feel like I’ve done more research into wealth management than most retail traders.