March 1, 2020

Monday Morning Memo: Is Big Beautiful in the Asset Management Industry?

by Detlef Glow.

The announced merger between Franklin Templeton Investments and Legg Mason follows a series of other takeovers. It shows that the global asset management industry is further in a consolidation mode, even as the overall assets under management increased massively over the last 10 years.

The ongoing corporate activity regarding transactions is driven by the increased pressure on fees for active management, which is shrinking the revenues of asset managers. The trend started in the U.S., but has also reached Europe. One reason for the increased pressure on the revenues of asset managers is the fact that they are no longer able to pass along the additional costs from increasing regulatory and reporting duties to their investors. This is because investors have nowadays the choice between comparably expensive active management and low-cost passive products.

This trend is also reflected in fund flows. In 2019, the European fund industry for the first time witnessed higher inflows into low-cost solutions such as ETFs and index-tracking funds than into actively managed products during a positive market environment. With regards to these global trends, mergers between asset managers seem to be a good solution to realize economies of scale, as a merger does increase the assets under management and opens the potential for cost cutting. This can lead to a lower cost base and, therefore, higher revenues at the respective asset manager.

Even as this sounds like mergers and acquisitions may be a good solution for asset managers to survive in a highly competitive market environment, there are a number of pitfalls that result from these kinds of corporate actions. One of the biggest issues for employees and investors in the transition process is a possible change in the corporate culture, which can impact the performance of the respective funds managed by the company. For example, there could be large differences between the investment processes, which the buying company wants to align, to maximize the economies of scale from the transactions. Therefore, investors might pull their money from the respective funds if they expect a negative impact on performance.

Additionally, any change in the corporate culture may also cause talent to leave the company because they might not agree with the philosophy or general leadership of their new employer. This can have massive impacts on assets under management and, therefore, on the expected revenues of the buying company. In other words, such an event can make a merger or acquisition quite unattractive in hindsight. So, even an acquisition that might look like a very good fit at first sight may not work out as the buyer expected if there is a break in the corporate and/or portfolio management culture.

Therefore, investors need to look out for any changes in the performance pattern of their funds if the fund management company is involved in a merger or acquisition transaction. In addition, a change in the management team of the fund could be another indicator for an impact of the merger on the future return expectations of a fund. The same is true when a fund gets merged into other funds.

Even as big seems to be beautiful in a business in which economies of scale are one of the keys for success, a merger or acquisition can have negative impacts for the companies involved or the investors of the respective funds. Nevertheless, it is already foreseeable that the mergers and acquisitions activities in all parts of the value chain of the asset management industry will continue because the pressure on asset managers and their service providers from regulators and investors will not go away.

The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv.

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