What is Assets Under Management (AUM)?
Assets under management (AUM), also called funds under management, is the total market value of the securities a financial institution (such as a bank, mutual fund, or hedge fund) owns or manages on behalf of its clients.
Example of AUM for a Mutual Fund
Let’s take the example of a mutual fund with a diversified portfolio of stocks and bonds and a significant cash position. Let’s suppose that the mutual fund’s portfolio consists of $1.5B in stocks, $2B in government bonds, $1.5B in corporate bonds, and $1B in cash.
The total value of the fund’s assets under management will be $6B.
Why Assets Under Management are Calculated
The total value of AUM is a measure of the size of a financial institution and a key performance indicator of success, as a larger AUM generally translates into larger revenue in the form of management fees. That’s why financial institutions look at the value of AUM and compare it to competitors and to their own history to assess business trends.
Moreover, in some jurisdictions, the value of assets under management may determine whether an institution must comply with specific regulations.
The way institutions or investors calculate assets under management can differ slightly. Some banks may include deposits and cash, mutual funds, and their calculations. Other institutions consider only the funds under discretionary management, which the institution can use to trade on behalf of the clients.
How AUM Changes Over Time
The amount of assets under management changes due to:
- Inflows and outflows of funds. For example, investors in a mutual fund may increase or reduce the size of their investment by buying additional shares in the fund or by selling the ones they already own, which will change the total size of the fund’s AUM.
- The value of the securities in which AUM is invested. For example, a mutual fund will experience an increase (decrease) in AUM when the market value of its securities increases (declines).
- The number of dividends paid by the companies in the institution’s portfolio, if reinvested and not distributed.
As a result of the factors above, the value of the assets under management changes constantly.
The factors mentioned above also determine how fast AUM changes. For example, other conditions held equal are:
- A fund with frequent inflows and outflows will demonstrate higher volatility in its AUM than a fund with a very committed and stable investors’ base.
- A fund that invests in volatile securities will experience wider fluctuations in AUM than a fund that invests in stable, low-volatility securities.
However, the volatility in AUM may also depend on whether the securities owned are liquid or how often they are marked-to-market.
- For example, an extremely illiquid security may not trade so often, and the impact on AUM may not be as frequent as it is with liquid assets.
- A private security may not be marked-to-market very often, which means the value of AUM will not change as frequently as it does with a traded security.
Investor Money and the Volatility of AUM
A fund with frequent and/or big inflows and outflows will experience more volatility in AUM, which will be an obstacle to the effective management of investing strategies, especially when the investments targeted are illiquid.
To avoid the potential damage of frequent inflows and outflows, institutions, such as mutual funds or hedge funds, can rely on some partial solutions:
- Lock-up periods, generally between a few months and a few years, during which withdrawing funds is not possible.
- Closing the fund to investors, either permanently or temporarily, so that additional money can’t flow in.
The abovementioned measures are particularly helpful because:
- They help the institution avoid phenomena such as the forced selling or buying of securities, which will be particularly problematic in the case of illiquid markets.
- They help avoid an excessive growth of AUM that would lead to problems of allocation, as it is often difficult to invest large amounts of money effectively, especially if the fund involved is targeting outperformance vs. benchmarks.
If the volatility of AUM is under control, the fund is able to pursue its investment strategy without having to increase or decrease its positions because of inflows and outflows.
Assets Under Management as a Measure of Success
Whether we are dealing with banks, asset managers, insurance companies, or other financial institutions, the size of AUM is a measure of the company’s success. That’s because it is generally correlated with other KPIs.
- A larger AUM is generally correlated with higher revenue if ROA is constant or doesn’t change significantly.
- The size of AUM is also a measure of prestige for the institution and its management, as asset managers and banks will usually be ranked based on this metric.
- Moreover, the management’s compensation and bonus packages often depend on the size of AUM.
Assets Under Management and Fund Performance
Excessive growth in AUM can be a negative factor, especially for asset managers who invest with an active style and target outperformance vs. benchmarks.
- Very large amounts of money are difficult to allocate in a timely manner and without impacting the price of the securities bought and sold.
- As a result of larger amounts of money flowing in, asset managers usually need to increase diversification, which can work against the goal of achieving a significant outperformance vs. benchmarks.
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