A combination of excessive regulatory costs, threats from passive fund providers, fears about tech disruption and the need for client diversification could expedite the upswell in M&A activity across asset management companies
Admittedly, M&A activity at asset managers is at levels unseen in more than 10 years. According to data from Sandler O’Neill, a US investment bank, there were 253 transactions announced in 2018, an increase from the 210 recorded in 2017, and surpassing the 243 that took place in 2007. Further analysis by Mercer reached a similar conclusion, highlighting that deal count in the first three quarters of 2018 was up 45% over the same time period in 2017, buoyed by mega transactions such as Invesco’s acquisition of OppenheimerFunds.
Post-financial crisis rules have not been kind to the asset management sector with a wide-range of new regulations including AIFMD Alternative Investment Fund Managers Directive) and MiFID II (Markets in Financial Instruments Directive II) all taking their collective toll on the embattled industry. While a $1 trillion-plus manager is endowed with plentiful resources – comparable to that of a premier investment bank – to shoulder additional regulatory costs, the same is not true for smaller managers running – say – less than $10 billion in assets.
For some small to mid-sized asset managers, the cost of regulation is unsustainable. Many investment firms routinely point out they would have been unable to establish a funds’ business in today’s regulatory environment versus that of 2005 or 2006. Instead, smaller asset managers often see little option but to pool their resources with equals and consolidate in order to stay afloat. While the last few years have been tough on the industry, experts are confident that the peak of regulatory intervention has passed though.
However, Neil Robson, a partner at Katten Muchin Rosenman, disagreed that regulation had accelerated consolidation in the funds’ industry. “I do not believe that regulations have caused widespread M&A in asset management directly, although it is clear that some of the rules have had an impact on launch activity. It is evidently much harder nowadays to spin out of a larger manager or bank and set up a start-up fund than it used to be,” said Robson.
- The Passives rise up
Passive investing has undergone phenomenal growth over the last few years, assisted by its cheaper fees relative to active managers, and the equity market rally, which has helped inflate performance. Having comprised 20% of equity assets under management in the US in 2007, passives now account for 45% of all equity assets. In Asia, passive equity funds have accumulated nearly 50% of assets, an increase from 15.8% in 2007. Bloomberg estimates passives will control in excess of 50% of all assets in 2019 if these trends continue.Again, this could prompt greater M&A at some under-pressure active management firms.
However, there are caveats to this. While passive managers such as ETFs (exchange traded funds) and index trackers are certainly drawing in more retail flows, and are outperforming active managers in aggregate, not everybody is hitting the panic button just yet. Firstly, passive strategies are highly correlated to the movements of major indices, and a number of experts have expressed reservations about their wherewithal to effectively manage equity market volatility when the next downturn arrives. If passives funds fail to do this and wildly underperform, retail investors could once again reallocate into active management.
- We need different clients
A reliable pool of concentrated investor assets is a nice thing to have when things are running smoothly but it does deepen managers’ exposures to local market volatility risks. Cross-border M&A can help managers avoid such risks by spreading their distribution footprints beyond core markets. Strategy diversification is another catalyst for M&A, evidenced by the growing number of traditional fund houses acquiring alternative investment managers, and vice versa as firms look for new revenue sources and clients.
Private equity is one strategy that is in particularly high demand, as the asset class continues to deliver strong performance and raise capital at a frightening speed relative to many of its peers, most notably hedge funds. However, there is trepidation in some quarters about acquiring private equity with experts pointing out the industry has reached the end of its cycle, illustrated by its receding performance, which in turn may lead to investor fee compression. This could deter some asset managers from purchasing private equity firms.
- Tech disruption
Technology is likely to be a mixed blessing for the asset management industry. Firstly innovations like blockchain and AI – which are being developed by service providers – will more likely help asset managers reduce their operational costs than hurt the industry. As such, automation may actually stem M&A. An altogether bigger challenge to funds is the threat of big-tech groups like Amazon and Google to their traditional distribution models.
If Amazon were to transition into distribution, it would be well-placed to sell mutual funds to 100 million plus Prime subscribers. For instance, a study by Bernstein found 37% of Prime customers would use an Amazon robo-adviser. With such clout and investor penetration, big tech providers could exercise massive fee pressure on managers, resulting in further consolidations. However, Amazon has yet to enter into distribution, and many believe its reticence so far has been borne out of fears it could suffer reputational damage if it lost money for its customers. If this is the case, fund managers can breathe for a bit longer.