After several years of false starts, the long-promised consolidation of the investment industry has begun to emerge in full effect. Over the past 18 months, the march of adviser consolidators has been joined by several platform deals, and a steady stream of asset managers are beginning to fall into line, too.
As margin pressures are brought to bear, three mega-mergers stand as the flagbearers of this trend for fund firms.
The first, which has seen France’s Amundi swallow up Italy’s Pioneer Investments to create the world’s 10th largest asset manager with £1.1trn in assets, has less relevance to UK intermediaries. But two subsequent deals indicate how this merger and acquisition (M&A) activity is just as prevalent at home as it is abroad. Henderson’s merger with American firm Janus Capital, announced in autumn 2016, was followed at the start of 2017 by the news that Aberdeen and Standard Life were combining to create a £660bn fund manager.
Chart 1 shows the number of deals has been relatively stable in recent years. But in its latest annual overview of the industry, Boston Consulting Group (BCG) acknowledges that the pace of change is starting to increase, and suggests the risks for providers and fund buyers may be on the rise.
“Conditions that promote consolidation have been present in asset management for several years. Flows have concentrated, distributors have consolidated their suppliers and fixed costs have risen as a result of technological and regulatory change. However, M&A activity has only slowly picked up in recent years.
“Now, with the industry’s economics continuing to deteriorate, activity will likely accelerate in quantity and magnitude. We expect deals to become larger and often cross-border, giving rise to more challenging post-merger integration.”
Big deals, big risks
As the BCG report implies, the absorption of one sizeable firm into another brings risks. Chief among these for intermediaries is the possibility that respected managers may leave, investment processes may be distorted, and reliable fund management cultures may end up changing.
“Merger announcements pressure flows, as consultants and advisers are usually reluctant to push funds from companies that are merging, due to likely dislocation among investment staff and the possibility for performance issues,” RBC analyst Peter Lenardos observed earlier this year.
James Calder, research director at City Asset Management, told Money Management’s sister title Investment Adviser in March there were other factors to consider from deals such as Standard Life Aberdeen.
“I would be gobsmacked if Standard Life Investments developed market equity managers that had to fall on their swords to accommodate Aberdeen managers. But there may be concerns about capacity, such as will the managers be comfortable managing much bigger funds [if the Aberdeen and SLI portfolios are merged]?” Mr Calder said.
Those firms that do retain their independence could benefit from investors’ growing unease regarding M&A deals.
But it is not just large companies that are seeking to consolidate their positions. Smaller asset managers are also seeking bolt-on deals, as shown by Liontrust’s deal for Alliance Trust Investments last December. Meanwhile, Invesco’s acquisition of European ETF manager Source in April indicated that the trend is also starting to play out in the passives space.
However, it is the larger deals have caught the eye. Importantly, both Janus Henderson and Standard Life Aberdeen were described by analysts as “defensive” moves borne out of a need to shore up positions rather than with an eye on major expansion. Senior management at both firms disagree with this perception, but smaller peers may be asking: ‘if these businesses aren’t safe, then who is?’
Sizing up
It is not as simple as suggesting that only the sizeable will survive: fund buyers’ perennial preference for boutique offerings will help ensure the market remains relatively well balanced. With this preference in mind, some suggest it is the middle of the market that will be hollowed out: caught in a no man’s land between the giants’ economies of scale and the small players’ distinctive cultures, they are unable to establish a meaningful position.
It may be possible that the opposite is true. As the funds industry goes global in its reach, UK firms that once considered themselves to be mid-tier players in terms of assets under management (AUM) are now recategorised as smaller businesses.
This redefinition of the bottom end of the market could also be accelerated by the fact that the truly small are simply unable to continue operating in the face of greater regulatory costs. One significant change will be the introduction of Mifid II on 1 January 2018.
For asset managers, the most significant part of the legislation is the unbundling of dealing commissions from money paid to analysts for investment research.
As smaller fund firms tend to have fewer in-house analysts, the likelihood is that many will have been dependent on this external research to help generate ideas for their portfolios. Because it was previously bundled in with dealing charges, the cost of this research has hitherto been charged back to investors. In the new world, asset managers must conduct their own research, and raise their fees, or take the hit to profitability.
To this end, UBS analysts said last September that they “expect any consolidation to be focused on the small and mid-sized asset managers in the coming years, where rising fixed regulatory costs will compress margins the most.”
Regulatory rush
The pressures keep on coming for fund groups. The latest was in the shape of the FCA’s asset management market study published in June.
Some considered the final report to have a conciliatory tone, particular when compared with last November’s critical interim findings. But there are proposals that will increase the strain on providers, such as the need for at least two independent directors on funds’ boards. UK fund firms will be required to find around 480 independents as part of the plans to improve governance, which are estimated by the regulator to cost £27.7m a year.
“The active management industry challenges of revenue margin pressure, weak flows, rising operational costs and further regulation are not going away any time soon. Consequently, we continue to expect further sector consolidation,” broker Numis said in response to the report.
Analysts at ratings agency Moody’s agree, saying: “We expect the combined impact of these measures to increase asset managers’ costs, driving further industry consolidation.”
Passive consolidation
A major driver of the tougher environment for active managers is the increased interest in cheaper, typically passive, investment products. It is not just the number of individual passive funds that have boomed in recent years (see page 40); so have the number of providers eager to take a slice of this pie.
But while this segment of the investment industry is booming, the gains are not being distributed evenly. The market is dominated by a handful of large firms, were Vanguard and iShares chief among them in Europe. Unlike their active peers, there is little advantage to being a smaller fish in the passive pond: most investors continue to focus on headline fees, and the biggest providers have used their scale to bring these down to levels that are simply unaffordable for their rivals.
As a result, Invesco’s deal for Source was viewed by many as the first in a series of similar acquisitions – notwithstanding the fact Source had proved to be successful in raising assets for the likes of its commodity products in recent years.
However, not everyone is convinced of this theory. Detlef Glow, head of Emea research at Thomson Reuters Lipper, notes that predictions of consolidation have been made for several years with little sign of concrete action.
Active managers may have finally started to join forces, but Mr Glow says sales growth for exchange-traded funds (ETFs) – even if it is unbalanced – may be a barrier to passive combinations.
Caution ahead
Whatever the general trend, the findings of the BCG report suggest advisers considering how to treat merging providers should remain sceptical of the lofty promises made by fund firms.
As the report outlines: “When ill conceived or badly managed, [M&A deals] can be calamitous. Firms undertaking a deal must understand the strategic imperative it serves, and they must have the right team, whether internal or external, to get the job done.”
