Asset management mergers are increasing, with deal-making at the highest levels in a decade. But that’s not necessarily a good thing, according to a group of U.K. asset managers who argue that the pace of transactions could ultimately decimate the number of boutique firms.
Although there’s compelling economic logic behind asset management tie-ups, the New City Initiative, a boutique asset management think tank representing several U.K. firms, argues in a white paper released today that these deals also stifle competition and create new risks for investors.
In the paper, the group raises the question of whether regulators need to get involved to save small- to medium-size asset managers, “especially if there is evidence that these transactions are drowning out competition and undermining investor choice,” the report stated.
“Failure to find a solution to these issues will ultimately deprive investors of choice and potentially even returns, forcing them to allocate into only but the largest, dominant asset managers,” according to the report.
There are good reasons for the flurry of deals in asset management. Investors have been withdrawing their money from active funds and switching into lower fee passive and quantitative products for years, a trend widely expected to continue. At the same time, technology and operational costs are rising, and the regulatory burden has also increased. One way for firms to compete is to gain scale and lower the cost to manage each dollar.
NCI doesn’t dispute the drivers of M&A in the industry, but it argues that boutiques are worth saving, as studies have shown that small- and medium-size boutiques outperform larger firms and index funds. Institutional Investor reported on a study from Affiliated Managers Group that showed that small managers generated 62 basis points of outperformance annually between 1998 and 2018.
“The research also added that investors with boutique only exposures would have generated 16 percent more wealth than if they allocated into mega managers over the last 20 years,” according to the white paper.
The paper also argued that asset management M&A is leading to concentration risk for investors. Yesterday, PwC released research showing that the five largest U.S. mutual fund managers will grow 4.8 percent annually through 2025, while the rest will struggle to expand. Between 2015 and 2018, the five biggest mutual fund managers pulled in $1.6 trillion in net new assets. Everybody else lost $552 billion, according to PwC.
Not all M&A deals reduce competition, asset management executives say.
“We’re not pulling the capabilities of our boutiques out of the market or merging them with some huge entity so that these funds are lost to investors,” said Steve Peacher, president of SLC Management, Sun Life’s institutional, multi-boutique business. Among others, SLC has acquired investment shops Prime Advisors, Ryan Labs Asset Management, and Bentall Kennedy.
Instead, SLC, which keeps its investment teams independent, helps the smaller firms it buys grow by providing seed money for new products, distribution to reach new investors, and a larger — and hence more stable — organization to attract and keep talented people.
Peacher agrees that smaller firms face some higher costs or complex requirements that larger parents can provide, such as cyber security defenses.
“If a boutique sells itself to a larger entity, as long as the organization maintains its distinctiveness, then the market shouldn’t lose the advantage that the smaller manager has developed,” he added.
Some observers think the risks of an industry concentrated in the hands of a few players, as NCI contends, is also overblown. First, although detailed statistics weren’t available by press time, concentration is a lot less, once passive assets are taken out of the equation, these people say. A few big firms dominate index funds.
“I don’t worry too much about concentration risk. With passive, does it matter if your money is with BlackRock, Fidelity, State Street or Vanguard?” asks Russel Kinnel, director of manager research at Morningstar. “People hear concentration and they think there is a risk of collapse. The fund company that is losing money doesn’t get to raid your S&P 500 fund.”
Kinnel added that smaller funds and firms can offer products that larger firms can’t. “Investors are well served by having a diversity of firms out there,” he said.
Peacher isn’t worried about competition, at least for now.
“There’s so many asset managers in the market,” he said. “There are more mutual funds than listed stocks, so we’re a long way from being a business that is too concentrated.”