Thibaud Kast

Thibaud Kast

Columnist

thibaud.kast@edhec.com

Focus on M&A

If the last few years have been a period of high M&A activity in the asset management industry, 2017 appears to be the year when fund management firms began to merge and acquire with a different strategy. Indeed, we observed fewer deals than during the previous year, but at a much higher cost. So far 2018 is following the same trend (See Figure 1). How can we explain this high number of deals? Is the industry getting more intensely competitive? Do these deals benefit the investors?

We will try to answer these questions by analysing the acquisition of Alliance Trust Savings by Interactive investor. This recent deal came in a period of uncertainty with the occurrence of Brexit and shows the different positions of firms in the asset management industry.

Figure 1: Summary of Q3 2018

Figure 2: Aberdeen and Standard Life post merger’s AUM

The Merging Period of Asset Management Firms

High M&A activity began in 2017 between investment managers, reaching levels as high as before the financial crisis; this illustrated the intense pressure on the market for firms to consolidate. Last year, the total value of deals was more than 40 billion; the number of deals decreases significantly, 2017 is the year with the lowest volume since 2006 according to Dealogic. It is interesting to see that M&A activity lead to a $2.9tn turnover in AUM, with very few deals involving more than $100bn of assets to be transferred. In the recent years, many intra-groups consolidations occurred: Prudential merged its UK insurance business with M&G and BNP Paribas combined three of its asset management businesses.

The Standard Life-Aberdeen deal last year is a prime example of the current global trend. This deal was an £11 billion merger: the biggest in UK fund management history. This mega-deal led analysts to wonder about the changes in the asset management merger and acquisition activity.

Such a deal brought short-term uncertainties into the market regarding the integration, staff management and funds administration. These uncertainties could affect performances. Nevertheless, in the long-term, investors are confident and understand the future benefits. In addition, in case of a merger where there is overlap, there is usually a loss in asset under management (AUM). (see Figure 2)

Investors will also be concerned about the outcome of the deal and therefore will be reluctant to put more investment in the company until they know about the individual products and team after the integration. In the case of Standard life-Aberdeen, it will be quite complex to prevent these concerns given the size of the deal. However, in terms of AUM crossover, it will not be very significant. Standard Life focuses on developed market equity and debt and absolute return while Aberdeen is an expert in emerging market equity and debt and quantitative funds with multi assets.

Figure 3 US Asset and wealth management deal trends

Nevertheless, early movers, who got into M&A activity before 2017, represent only a few companies: Amundi, Pioneer Investments and Black Rock Inc. (buying Barclay’s Global Investors). Nowadays, businesses are actively considering M&A to grow compared to before. The consolidation wave among investment funds created by Janus Henderson and Standard Life Aberdeen is just starting. Up until Q3 of 2018, this trend is verified by the mega-deal in the Q2 by Hellman & Friedman’ acquisition of Financial Engines for $3 billion in the US. (see Figure 3).

In December 2017, in their ranking M&A prospects, White & Case set the rating of fund managers as “very strong”, which is the highest one shared only with the fintech and payment processing companies. Also, there is a growing interest for cross-border acquisitions: parts of the world with a large pool of savings capital. This includes companies such as Australia, Japan and China, especially in real assets and property. In fact, deal volume of the industry went up 32% in the beginning of 2018 compared to the same period in 2017, according to a report from Mercer Capital.

PwC’s prediction is that the global AUM will more than double in value from 2012 to 2025 as a result of the intense M&A activity in the industry. The trend is to strengthen their business via M&A instead of organic growth. However big deals such as the Standard life-Aberdeen are not expected to account for a big proportion of the future deals.

In 2017, there were 781 deals; Europe had the largest target values with $15.6bn followed by the United States with $13.3bn and Asia-Pacific with $10.6bn. The second largest deal in the asset management industry was Softbank acquiring Fortress for 3.3bn. Most of the deals are due to companies buying rivals struggling with the effects of new regulations following the financial crisis. 

Another explanation to this increased M&A activity is the rise of fund managers with passive investing (following indexes), which causes prices to decrease, putting some pressures on fees. Meanwhile the MIFID II lead to a rise in the cost of research for the companies. As a result, profit margins are getting smaller in the industry. Indeed, falling profit margins is due to new regulation, such as MIFID II in Europe, and fiduciary rules in the US with the Dodd Franck act. These additional compliance costs are being offset through M&A.

Alternatively, it is very interesting to mention the recent partnership of Lloyds with Schroders. This is a new joint venture offering financial planning and investment services to the wealthiest clients. Lloyds is returning to financial advising, though it had stopped since the financial crisis. Lloyds is one example of a bank that went back to this activity because of its lucrative line of services and response to growing demand. A few other banks followed suit such as Royal Bank of Scotland or Santander.

Analysis of the Recent Acquisition of Alliance Trust Savings by Interactive Investor

On the 22nd of October, Interactive Investor (II), the DIY investment platform, bought Alliance Trust Savings (ATS) in a £40 million deal, which represented a discounted price for the platform including their offices in Dundee in which they had their headquarter since 1888. The fair value of ATS platform was £38m and the offices were £4.9m as of 30th of June. In addition, II also agreed to keep the presence of ATP in Scotland in the future, which was crucial for the board.

This acquisition ended quite a long period of uncertainty for ATS, since AJ Belle and a private equity firm were also interested in such a deal. II’s newest transaction follows two recent ones in the last two years: TD Direct and Trustnet Direct. Unlike in previous deals, ATS customers pay similar flat fees to those levied by Interactive Investor, making the process smoother. Interactive Investor was a relatively small player before a deal with TD Direct Investor handed it £14.5bn in assets, making it the second-largest platform in the UK. The ATS acquisitions follow its objective of increasing the customer base and building up assets as fast as possible to compete with Hargreaves Lansdown, which has 40% of market share in the DIY industry. This illustrates that investment managers are intensely looking for scale to face the pressure of prices and regulations.

Chief Executive of Interactive Investor, Richard Wilson said, “This is another important step in our ambition to build the UK’s best investment platform. The acquisition brings together the country’s two largest fixed price providers, adding significant scale to II, and reinforcing our ability to deliver excellent choice, value and service to all our customers.”

As a result, II will gain 100,000 clients to reach a 400,000 base and their AUM will grow from £20 billion to £35 billion.

Concerning Alliance, the past 18 months have been transformative. The company has a unique and innovative strategy that focuses on global equity portfolios (genuine active management). This sale followed the one of their Trust investments to Liontrust in April 2017 and their agreement to sell most of their private equity assets. The money received will be reinvested in their Global equity portfolio, which represent almost 100% of their AUM. In the past, the platform had issues with the integration of Stocktrade, announced losses in 2016 and had to write down intangible assets. All this led to this change in strategy, therefore ATS posted profits in June.

Will this benefit ATS’s customers? In the future they may pay less fees. It is currently hard to determine since the deal is still early in the process. However, if it goes well, they will benefit from the same pricing structure as II’s customers: £22.50 every three months in administration fees, which is £90 a year in comparison with the £120 that they are paying now. In addition, II has a wider choice of investments than ATS, especially in terms of global shares. We can also highlight that the customers will benefit from investing in a growing company. According to Lord Smith of Kelvin, the Alliance Trust chair, ‘The two businesses are highly complementary and ATS customers, many of whom are Alliance Trust shareholders, will benefit from II’s similar low flat-fee structure, as well as its increased scale and focus”.

What Are the True Motives of the Mergers of Investment funds, Customers Benefits?

The ultimate objective of M&A activity is to reach synergies that will allow the funds to perform better, which will in turn benefit their customers and investors. However, investors may wonder over the last few years if synergy really was the goal. Many companies use M&A to strengthen and diversify their product offerings.

Investment funds are seeking to get bigger and more diverse, but also to reduce the pressure on fees. Nonetheless, they tend to engage in M&A from a position of weakness.

There is also a growing interest for cross-border acquisitions, which are more captivating, have more growth opportunities, and should change the business industry in the medium run.

In addition, one trend is currently for big companies to buy some niche players, which are positioned in areas where the firm is not (private debt, mezzanine debt, …). They want to avoid any effects of indexation. The latest is bringing strong pressures on active fund managers in terms of fees and performances.

Other motives are the new needs of compliance with the new market regulation and capital rules and the cost of it. With this rising cost, the economies of scale became paramount to survive.

The current political environment makes M&A activity favourable in the UK, the largest asset management hub in Europe. The Brexit deal lead to the pound falling. While the GBP/USD exchange rate was at £1 = 1.44€ in July 2015, it is today at 1.12€ and reached its lowest during summer 2017. As a result, in the recent year it has become 10 to 20% cheaper to buy investment funds in the UK.

This situation is similar in the US and some US tax reform could also make it more accessible to borrow funds in order to buy fund managers in the UK.

Some financial pressures are more intense on small asset managers and therefore explain the economies of scales being sought out by engaging in M&A. The smaller firms are also exposed to struggle in terms of technology expectations, access to clients and reinvestment spent on opportunities. Consequently, it increases the interest of buyers in the asset management industry, bigger firms are acquisitive, and overall the industry is consolidating.

However, merging fund managers also face issues such as culture adaptation and retaining key staff, which leads to some problems to deliver value to shareholders. Mergers and acquisitions need to be thoroughly planned and executed especially in regards of the post-integration. This will allow them to achieve leveraging data and technology.

In 2018, the objectives of M&A have so far been mostly based on short-term goals: increase the enterprise growth and profitability within a year.

Conclusion

The investment management industry is evolving rapidly with the growing M&A activity. However, the real motives beyond the acquisitions are rarely the benefits of customers. The best explanation is that the environment is exercising some strong pressure on the firms in terms of fees and regulation and that to ensure their survival, firms must engage in M&A activity. The trend of a lower volume of deals but a growing value can be a sign that hubris and management power may be one of the drivers.

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