It has almost been a constant refrain since the mid-1990s that the asset management industry will consolidate, making it more and more difficult for the ‘mid-size’ asset manager to survive. Twenty years on and the discussion continues to be a lively one.
It is true that the pressures in the industry make consolidation a very attractive alternative to ‘toughing it out’ in the day job. Having experienced half a dozen or so mergers or acquisitions in the industry,
I thought it would be useful to look at them from a variety of perspectives and try to understand the underlying incentives and risks to such transactions.
Putting the most important people first (ie, clients), I am sorry to report that, despite marketing to the contrary, M&A activity is rarely done in order to benefit them. Corporate activity is unsettling for all concerned and a distraction at least for management and, often, key fund managers. Much will be made of things such as accessing ‘broader and deeper research facilities’ or being more influential in trading.
However, no M&A activity is really going to improve a client’s returns. Perhaps there will be some improvement in reporting or monitoring infrastructure, and even then, it is likely that smaller managers have given them more bespoke solutions than the now larger entity has the appetite to do.
If I sound cynical about M&A benefits for clients, it is because I am. The most you can hope for is stability of the manager you have employed and continuation of the specific investment process that you bought in the first place. Neither is guaranteed.
What’s in it for the acquirer?
Looking at it from the acquirer’s perspective, there are three broad categories: synergies, where the whole is more profitable than the parts; additional talent/product areas that can be used to increase product flow through distribution; or finally, access to an entirely new market for existing products. Often, the goal is a complex mixture of these things.
Synergy trades have the potential to be the most significant disruptor for current clients. Ironically, they also tend to be the most attractive for shareholders. Think of all of the duplicate departments within asset managers: operations, IT, HR, legal, finance, etc.
If one can maintain the same level of revenue, but take out a substantial portion of the cost, profitability can improve substantially and the benefits to shareholders are clear.
Institutional or retail intermediated businesses are more difficult to purchase for synergies, as the systems and operations etc, have likely been reviewed regularly by clients and consultants. Significant changes to these areas will almost certainly create the need for new due diligence and could well result in termination.
It is important to retain the major fund managers. ‘Major’ rather than most talented. As a rule, the manager who controls the most assets is often the one you need to retain in the short run. You can end up creating large incentive packages for individuals with little talent and little long-term future with the new firm.
From a client point of view, large retention packages for managers create some risks. Is the package aligned with performance or with just showing up for work? The best managers always have opportunity to go elsewhere, so often the package is aimed at keeping them in their seat rather than performing for clients.
Also, what is the time structure of the retention package? If it has a ‘cliff’ vesting (eg it all pays out in year three), then the business may face a very precarious time at the expiry of the term. Numerous firms have seen an exodus of true talent as soon as retention packages are paid out.
Obviously, in any synergy trade there may well be overlap in the fund management teams and products. If politics plays a larger part than ability in the selection of surviving teams, the client will ultimately suffer from poor quality product.
The other two areas of interest to acquirers, additional talent/product or new market opportunities are more likely to be explained to clients as ‘bolt-ons’ that don’t impact the current business. In reality, both can have a significant influence on internal culture and pressure on managers as well.
Bringing in a new team or talent will inevitably be a costly affair. The rest of the teams will either know the cost or speculate about it. This can create discord amongst the various teams and disgruntlement with individuals, particularly if the new talent starts out by underperforming.
Similarly, buying a firm that opens up a new area of distribution – say a European firm purchasing a US business or vice versa – can suddenly place a drain on existing talent and products as the new distribution team take key individuals on roadshows in the new territory.
What’s in it for the acquired?
Switching now to the acquired firm, what might the motivations be? Healthy firms might be seeking wider distribution than they are able to build on their own. Unhealthy firms may seek the cover of a larger transaction to provide them time and resources to restructure problem parts of the business.
The priority will be the stability of the client base. The message that ‘nothing in the investment process is really changing, but everything will be better from here on out’ is transmitted through every means of communication available, from press
releases, letters to clients and meetings with senior management. In a few cases, it may even be the truth!
The actual impact on investment products will vary, and acquirers may indeed leave things alone for some time. However the one thing that may well change is the culture of the firm. Going from a smaller firm to a larger one always has an impact on culture.
Much will be made of the ‘chemistry being excellent’ as two investment firms come together. This may not of course reflect reality, but it is the correct analogy. Ultimately it will actually be a chemistry experiment, with the full range of potential outcomes including the explosive variety!
What’s in it for the fund managers?
As a fund manager at a firm being purchased, your thought process might be roughly as follows. ‘Do they need me in the new entity? How much will they pay me to stay and keep my clients? Will my daily routines change significantly? Will I need to move location? What will my commute be like? Will my systems and access to my portfolio be better or worse? What are the politics in the new company? How does one get paid or promoted?
‘Who do I need to get close to? Are my benefits the same as before? I like the smaller company feel, do I really want to be part of a much larger firm?’
All these questions really add up to evaluating a whole new job. Why not look elsewhere at the same time? Why have change imposed on you rather than choose it oneself?
Ultimately, regardless of the reason, the best acquisitions are dealt with quickly and efficiently. Decisions on who has what role and who is leaving the firm need to be made very early on. This clarity is extremely important.
When decisions like this are not made immediately, the uncertainty hangs over people and in such a situation, the ones who are the most talented will find other opportunities.
Acquisitions can often become feeding frenzies for head-hunters, who recognise that in a time of uncertainty, even the most loyal individuals will take a call.
It is important that both firms have excellent teams working together on integration from before the transaction is finalised. There are many examples of firms who are very good at swallowing up other business and teams. Whether they are good at digesting them is another thing entirely.