Recall that the primary way investment firms make money is by charging clients management fees, often reported as a percentage of overall AUM. That means there are two key drivers of an investment firm’s revenue: the level of its AUM and the level of its management fees. Let’s consider each in a little more detail.

The first area to investigate when analyzing an investment firm is how its AUM has been trending recently. While strong growth is always preferred, speed isn’t necessarily everything: it’s also important to understand what’s been driving that growth. A firm’s AUM generally increases for two reasons: the value of its investments rising and fresh inflows of client cash. The former factor is much more dependent on financial market movements: if stocks around the world are going up, then an investment firm will likely see its AUM increase. But this kind of growth is cyclical and, to an extent, outside the company’s control. That’s why client inflows are considered to be a higher-quality source of AUM growth: they imply the firm is doing a good job at beating benchmarks’ and competitors’ performance and is consequently attracting more business.

Another important thing to look at is the composition of the investment firm’s AUM. Is it diversified across different geographies and asset classes – think stocks, bonds, commodities, and so on – or is it highly concentrated in just a few places? You’d generally favor the former scenario. Take, for example, an investment firm with the bulk of its AUM invested in emerging-market stocks. If for whatever reason emerging markets experience an extended period of underperformance, that’ll hit the firm’s AUM – and therefore its profit. An investment firm with a more diversified AUM composition would meanwhile fare much better.

And it’s not only where the AUM is that matters, but who it is – in other words, what sort of clients are invested in the firm. As previously mentioned, there are two main types of client: individual retail investors who invest in the firm’s products either directly or through an intermediary, and big institutional investors such as pension funds, endowments, sovereign wealth funds, and so on. This latter bunch are typically more “sticky” and therefore more attractive: they tend to keep their money with an investment firm for longer than retail clients.

The second principal driver of an investment firm’s revenue is the weighted-average management fee charged across all of its products. Once again, it’s worth considering not just the absolute amount (the higher the better) but the trend. Note, however, that the entire industry has seen management fees decline over the past decade, thanks to competition from low-cost passive investment alternatives like index-tracking exchange-traded funds (ETFs). So don’t be too surprised if you see a downward trend in a firm’s management fees – what’s perhaps more telling is how this compares to its peers.

Analyzing diversified financials

We won’t spend too much time on this: successfully analyzing diversified financials involves looking in detail at their individual divisions, and so you already know how to analyze a diversified financial firm’s banking and investment management aspects

But it’s true that these companies may also have investment banking departments. The main thing to remember here is that performance is cyclical: when economic times are good and corporate deal-making activity is on the rise, investment banks’ advisory arms get lots of business, lots of fees and lots of profit. Their trading divisions, meanwhile, tend to do best when market volatility is high: this leads to a higher volume of buying and selling and therefore more commission from executing trades. In both instances, the opposite also holds true.