M&A on the rise as asset managers battle falling revenues

Driven by the need to create economies of scale and face increased regulatory costs and fee pressure, consolidation in the asset management industry is accelerating. 

Among the high-profile names who have chosen this route are Henderson and Janus Capital, Amundi and Pioneer, and more recently Standard Life and Aberdeen.

M&A activity in the asset management space has increased 150 per cent since 2012, in terms of number of transactions, according to Oliver Wyman/Morgan Stanley research. And transaction volumes are expected to increase further as active asset managers battle to free up investment budget, in the face of falling revenues. 

The 10-15 per cent cost savings typically associated with scale-driven M&A could buy valuable time, according to the research, but are unlikely to have the transformational impact on businesses that many asset managers need.

Asset managers need to bring down costs in order to sustain margins, but the most attractive M&A deals will be those that bring together complementary capabilities, in the areas of distribution, investment expertise or technology, says Christian Edelmann, partner and global head of Wealth & Asset Management at Oliver Wyman. 

Time for passives?

Also, even without considering a merger or acquisition, there is significant scope for reducing costs in asset management firms.

The rising use of cheap, passive vehicles is certainly contributing to cost pressure, but ironically, through more intensive use of ETFs, active managers could save costs, says Mr Edelmann. 

Active asset managers themselves may be the biggest growth driver for passive vehicles. When managing their portfolio against an index, they can implement 50 to 60 per cent of their core equity fund exposure through an ETF, rather than the traditional approach of holding individual stocks. This would lead to a cost saving potential of about 5 to 8 basis points in large and mid-cap equities. 

“Using passive structures in actively managed funds is one of the levers we are seeing and enables active asset managers to bring down costs,” states Mr Edelmann.

But fund selectors are not convinced. “The idea that costs have to be reduced by asset managers and these have to use passive vehicles is controversial, to say the least,” says Gary Potter, fund of funds manager at BMO Global Asset Management. 

“Costs are under the spotlight because distributors or financial advisers still want to take their full share of the fee, and the pressure is falling on the asset manager. But you have got to have value for money.”

Passive vehicles do offer basic exposure to stockmarkets, but “the minute you introduce advisory fees into a client solution using passive investments, you are absolutely guaranteed to underperform the index,” says Mr Potter. 

Asset allocation decisions are responsible for the large majority of the volatility in the return, but not of the return per se, he says. “Investing in the right manager, and the right fund at the right time, is far more important than asset allocation.”

At FundQuest Advisors, which started selecting ETFs three years ago and is now looking into adding smart beta too, CEO Stéphane Pouchoulin also warns against the use of ETFs in actively managed portfolios, particularly when it comes to absolute return funds, which are increasingly popular and are not tied to any benchmark.

Another key cost saving lever, according to Oliver Wyman, is allocating distribution efforts on the basis of expectations of revenue potential from different clients or client segments. 

Unlike investment banks, which have become much more effective in the way they manage their distribution channels and understand client economics, asset managers are not very good at it, states Mr Edelmann. 

In portfolio management, asset managers can become more effective by leveraging big data and using artificial intelligence, and can also save costs in product management. The research estimates up to 50 per cent of the fund base could be reduced.

This conviction is reinforced by the analysis that flows are skewed towards funds that are five years or younger. 

“Asset managers need to be more rigorous in the product launch process and making sure to understand the growth potential of the fund, what is unique about it, and also have a more regular and robust process of reviewing their product portfolio,” says Mr Edelmann. 

Research shows that if for three to five years, a fund has not attracted assets, then it is very unlikely it is going to happen in the future. At that stage, it makes sense to merge or eliminate the fund. 

Mackay Williams’ analysis confirms that a fund has a rather short cycle, on average, and stands its best chance of achieving sales success – measured at more than €100m ($106m) – in years two to five. After that it is “a slow decline”. 

According to Broadridge data, there are 34,000 funds available for sale in Europe, and more than 60 per cent of them have under €100m in assets.

Asset managers need to innovate to meet clients’ changing needs, but it can be “a matter of putting some old funds into new clothes, from a marketing point of view,” says Diana Mackay, founder of Mackay Williams.