Evaluating Cost Efficiencies in Asset Management and Custody Banks Using Data Envelopment Analysis

Abstract

As the aging Baby Boomer generation saves for retirement and demands suitable retirement savings vehicles, the role of asset and custody management banks is growing and the assets under their management are rising. The authors used a data envelopment analysis (DEA) model to evaluate the economies of scale in the asset management and custody bank subindustry of the capital market industry for the period of 2010 to 2017. They measured company size in two ways: total assets under management of the firm and total revenue generated by the firm. The authors evaluated cost efficiencies with cost measured in terms of total expenses, and they evaluated two important components of total expenses: total distribution expenses and general administrative and selling expenses. Using a returns to scale (RTS) DEA model, they found that most asset management firms initially exhibit increasing RTS until they become too large. The trend persisted when general and administrative expenses were evaluated and when total distribution expenses were evaluated.

TOPICS: Portfolio management/multi-asset allocation, portfolio construction, wealth management, retirement

Key Findings

• • Initially most asset management firms exhibit increasing returns to scale (IRS) until they become too large.

• • As companies expand in terms of total assets and total revenues, they do reach a point at which size is too large and cost inefficiencies manifest in the form of decreasing returns to scale.

• • Whenever asset management and custody banks reach their most productive scale size and begin to experience decreasing returns to scale, they make structural changes by adopting new technologies and/or changes in the processes so that their total operating expenses decline and they can grow again without a proportionate increase in operating costs.