Warren Buffett has said many times that he is a better businessman because he’s an investor and a better investor because he’s a businessman. “Each pursuit teaches lessons that are applicable to the other,” he wrote in his 2014 shareholder letter. If he’s right, executives running investment businesses should be at an advantage. Exposed to both disciplines, they are well-placed to combine the lessons from each.

Sadly for their shareholders, few in the industry are able to capture the synergies Buffett describes. London-based asset management firm Schroders is the latest to fail. As investors, its staff are doing a good job. Based on the most recent data, over three-quarters of the assets they manage on behalf of clients are performing ahead of benchmark on a five-year view. As a business, the firm is doing less of a good job. Its stock languishes at a ten year low and its newly-appointed CEO warned on his first outing last month that asset flows continue their long-running march out the door. In public markets, the firm has suffered net outflows in all but one of the last seven years.

The problem is that Schroders is structurally overweight an underperforming sector. “As active fund managers, we have little low value-added passive business, while our development of high-risk, single strategy hedge fund products has been limited,” the company said in 2005, close to the peak in active fund management. Since then, it has only become more determined. “We have conviction in active asset management and are confident that our strategy is the right one,” management states in its latest interim report.

Schroders’ previous CEO attempted to address the issue by investing in different growth sectors. Over an eight year tenure, he did roughly a dozen bolt-on deals, adding exposure in private assets, wealth management and so-called solutions (the business of offering outsourced chief investment officers and liability driven investing to pension funds). But he failed to size these bets adequately. His efforts in private assets comprise a series of subscale investments across private equity, renewable infrastructure investing, private debt and real estate. Their contribution to performance has been muted. Overall pre-tax profits slipped from £618 million before the acquisition spree to £488 million last year even as the share of assets under management in the three growth areas increased from 35% to 56%.

Schroders isn’t alone. In mid-2014, Pimco was a highly profitable bond manager, running $1.88 trillion of assets. Then its star manager, Bill Gross, resigned and assets followed him out. Over a 12 month period, net outflows reached $290 billion. Profits tumbled from €2.7 billion in 2013 to €1.8 billion in 2015 (in euros as reported by Pimco’s owner, German insurer Allianz, whose stock was down 14% on the event). Gross himself ran diversified portfolios of securities. But the firm was a lot less diversified, investing a disproportionate share of its franchise in a single asset: him.

Gross went to join Janus Capital, a firm with a track record of ignoring the lessons of investing when it came to managing its own business. In 2000, it was one of the fastest growing asset management firms in the US, taking in half the money that poured into mutual funds. But its funds were overly concentrated and when the tech bubble burst, its flagship fund lost 60% of its value. The firm’s stock fell from $50 at peak to around $14.

Lack of diversification, suboptimal investment sizing, overcommitment to underperforming positions – all potholes in investing that investment management firms themselves occasionally drive into. One firm that has avoided them on its journey to become the largest asset manager in the world is BlackRock. This week, it announced a $12 billion acquisition of private credit firm HPS Investment Partners, a sizable bet that makes it a top five player in private credit. It comes two months after the firm closed on its acquisition of infrastructure manager Global Infrastructure Partners, a deal we discussed earlier this year. Having moved aggressively into passive asset management in 2009 through the acquisition of Barclays Global Investors, the firm is now steering the other way, into higher-margin alternatives, building what friend of this newsletter Huw van Steenis calls a barbell portfolio.

Relative to the heft of its passive business, the new businesses BlackRock has picked up are small. Passive strategies account for 67% of the firm’s client assets; even pro-forma for the deals, alternatives contribute 4%. But alternatives are so much more profitable that they will make up over a quarter of BlackRock’s earnings once the latest deal closes, compared with around 40% from passive. As the active piece in the middle contracts, those weightings will only increase. “The barbell has tolled,” as Huw says.

To see how BlackRock has navigated the shifting terrain of the asset management industry, the challenges it overcame and how it is now positioned, read on...