The Truth About Asset Management M&A

Boutique deals are more likely to work than transactions done for scale. But integrate them — don’t keep them independent.

Illustration by II

Illustration by II

Almost half of asset managers are skeptical about the future of boutique firms. But they’re wrong.

Amanda Tepper, founder and CEO of strategy consultant Chestnut Advisory Group, said boutiques are important to the health of the industry, despite the fact that the biggest firms have attracted the most assets in recent years. In fact, when it comes to mergers and acquisitions, deals involving boutiques are the ones more likely to succeed than those done by managers to get bigger.

“This is exactly why we believe ‘boutique advantage’ acquisitions can create huge value for all constituents, with one big caveat: The transaction must be well-executed,” wrote Tepper and Todd Glickson, senior advisor, in Chestnut Advisory Group’s new report on M&A in the asset management industry.

Allocators find that boutiques most often provide differentiated risk-adjusted returns, deep investment expertise, customized products, and strong support for their team, according to the report, which will be released shortly. The report incorporates research from 450 professionals, including institutional investors, financial advisers, consultants, and asset managers.

“What do boutiques have that investors want? New and differentiated ways of thinking, and therefore new and different products outside the norm. Investors like the idea of potentially finding the next Bridgewater,” Tepper told II. “That’s why we say there will always be a healthy appetite for boutiques. It’s part of a healthy ecosystem in the industry.”

Chestnut found that 17 percent of institutional investors want to increase their investments in boutique managers over the next 5 to 10 years. Thirty-six percent of consultants and 21 percent of financial advisers intend to allocate more to boutiques over the same time period.

Winning boutique deals involve firms that acquire unique products that they didn’t have and that their clients need. Managers also need to buy boutiques that fit with their brand and culture, according to Chestnut. Tepper stressed that what the firm calls “boutique advantage deals” could mean buying an actual niche asset management firm, an investment capability or team that the firm doesn’t have, technology, or even software reporting.

Forty percent of asset managers surveyed by Chestnut expect demand for boutique investments to decline over the next five to ten years. In contrast, only 9 percent of consultants believed the same.

“That speaks to how poorly asset managers understand what investors want today,” she said.

Tepper is a contrarian on boutiques, believing that they should be fully integrated, rather than left independent. “Even if it’s more painful, boutiques need to become part of that firm. It’s more likely to lead to the maximum benefit,” said Tepper.

“[But that] means that most of these transactions probably shouldn’t happen at all,” she added. Tepper explained that if founders want to sell 100 percent of the firm, but want the acquirer to keep the name, identity, and culture, then they don’t want to change at all, even though they’ll be owned by someone else. “That’s unlikely to work,” she said.

The report quoted a head of research at a major consultant saying that the firm found “only 1 of 65 asset manager M&A transactions benefited clients.” The rest “inevitably led to adverse changes at the acquired manager as people’s roles changed and people left. And that is the norm.”

The Chestnut report also argues that successful M&A deals that are predicated on scale are rare. These transactions need to combine low-fee funds with unique products that stand out from the competition — a tough combination to pull off.

For both boutiques, but particularly for scale-driven M&A, Tepper said, “We wanted to debunk the idea that ‘We’re not a top 3 firm and we’re losing assets, I’ll think I’ll buy my way out of this problem.’ No, you probably won’t. It will be much harder than you think.”

The primary driver behind a firm’s desire to get bigger is the prospect of declining fees and the effect on margins.

“Our experience is that the ‘scale-seeking’ investment firm acquisition thesis proves to be a mirage in most cases. One asset manager research participant told us, ’70 percent of asset manager M&A is a waste of time,’” wrote Tepper and Glickson. “We agree with the sentiment.”

Tepper explained that managers overestimate the cost savings and fail to imagine that the bottom-line impact is actually “fleeting.”

She attributes this to the fact that cost cutting ultimately affects investment and other professionals who create the products and deal with clients. As a result, these cost-cutting efforts take longer and don’t produce the expected results.

The biggest impediment to these scale plays, however, is the lack of pricing power that the combined firms actually get from the transaction. Tepper said that in the best case scenario, the merged firm is able to maintain their fee levels on their best products. But many firms that were the result of mega mergers resulted in lower prices as they made bids to gain market share.