ANNUAL REPORT AND FINANCIAL STATEMENTS 2011 | 17


commutation may be exercisable in 1H 2012. At 31 December 2011, the Group has assessed which investment teams would be able to exercise this right if it had crystallised at that date and a charge of £3.6m has been recognised in the 2011 Income Statement in respect of these arrangements. If the first commutation had occurred at 31 December 2011, the Group would have issued approximately 10.9 million new shares in satisfaction of its obligations.


Under the second commutation, the Group can, if it wishes, acquire profit share from each or any investment team. The maximum amount of profit share which can be acquired through the first and second commutation is typically 20% of the profit share of each investment team. An accounting cost of £2.5m has been recognised in the 2011 Financial Statements in respect of those teams where it appears economically attractive at December 2011 to exercise the commutations. If the second commutation had occurred at 31 December 2011, the Group would have issued approximately 12.6 million new shares in satisfaction of its obligations. No commitment to exercise those commutation rights has been made.


The aggregate commutation expense of £5.7m therefore reflects the charge of £6.1m for the first and second commutation options, less a £0.4m credit, which primarily relates to options which are no longer assumed to be exercisable.


Net revenue Net revenue for the year was £267.0m (2010: £243.2m). This included £11.8m (2010: £12.9m) of performance fee income. Performance fee income was earned from a variety of fund and client types, with the most significant contributors being the Thames River funds and F&C REIT, our property business. Performance fees from Thames River were biased towards 1H 2011. Thames River contributed £40.5m of non-performance fee income to the Group during the year.


While our strategic partners remain an important part of our client base, we believe our strongest growth opportunities are with third- party clients – for institutional business and in the retail and wholesale channels. While £7.8 billion of gross new third-party business was funded during 2011, net new business was flat, reflecting the difficult market environment faced by retail and wholesale clients.


Net funds flows and related annualised revenues represent a key performance indicator and are indicative of the growth potential of the business. In this regard, it is pleasing to report that despite difficult market conditions in the second half of the year, which had a detrimental impact on flows in our mutual funds business, we remained in positive flows for our third-party business for the year as a whole.


Revenue margin Our revenue margin excluding performance fees, measured as our net management fee income divided by average assets under management, increased from 22.6 basis points in 2010 to 24.4 basis points in 2011. While we have historically used revenue margin


as a key performance indicator, our emphasis on this measure will decline, in light of the revised strategy for the Group’s institutional business announced in October 2011. The Group indicated that its institutional strategy will increasingly focus on highly scalable products, with relatively low revenue volatility and a high incremental profit margin. Accordingly, success in implementing this strategy could see the Group add large volumes of low fee margin business, but whose profitability would be reflected through an improving operating margin and operating profits.


Operating expenses The Group’s underlying operating expenses, excluding amortisation of intangible assets and exceptional items, were £202.1m in 2011, compared to £177.0m in 2010. During 2010, Thames River was included in the Group’s results for the four months from completion of the acquisition and its costs for the period were some £12.6m, comprising £6.6m of operating expenses and £6.0m of profit share payable to LLP members. Thames River’s results have been included in the Group Income Statement for the full year in 2011 and its costs for that period were some £21.1m of underlying operating expenses and £18.3m of distributions to LLP members. This difference represents the majority of the year-on-year movement in our cost base.


One of the key costs for an asset management business is remuneration costs, which are correlated to staffing levels. At 31 December 2011, our headcount, on a full-time equivalent basis, was 847 compared to 962 at 31 December 2010. The majority of the reduction in headcount arose from the transfer of back and middle office staff as a result of the outsourcing agreement signed with State Street during the year. As we implement the headcount reductions arising from the strategic review we announced in October 2011 and the “rightsizing” initiatives associated with the outsourcing arrangements, we anticipate that this headcount number will reduce further.


During 2011, we incurred a number of exceptional operating costs, which are excluded from our underlying results. These include employment expenses, outsourcing expenses and litigation expenses.


During 2011 we announced two cost reduction programmes. The first – which we have termed “rightsizing” – will allow us to recognise cost savings in a range of functions as a result of our back and middle office outsourcing. These include our retained operations support and IT functions. The second cost reduction programme is an integral outcome of the strategy review, which targeted cost reductions in a number of our corporate functions and in business overheads. The majority of these cost savings will be realised through headcount reductions and during 2011 exceptional employment related costs of £8.7m have been recognised in respect of termination and benefits payments which represent the one-off cost to be incurred to generate the annualised savings. Whilst some of those amounts have been paid during 2011, part of this cost represents a liability for redundancies which will occur in


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