Asset Management firms have taken two divergent strategies to address relative underperformance and/or fund outflows. The first approach (seen frequently through 2008-09) was the cutting of operational bases, including reducing the head count of those costly portfolio teams. The second is to acquire asset books from other firms to increase the asset:people ratio and derive economies of scale from a flattening operational base. Certainly we observed some firesales through the credit crisis but more recently a number of fair-value to above fair-value acquisitions have occurred. The first approach is a product of McKinsey-like Lean thinking (find me a firm not full of yellow, green, brown and black belts ‘consultants’ these days) but ostensibly a passive-defensive strategy. This approach tends to have quick but limited results; if the sector expands and competitors expand then the firm will lose market share.
The second approach aims to capture market share. It is more costly short term but can provide a levy-like jump in expected earnings growth. It is the more aggressive (riskier) approach as operational costs can become unruly during the acquisition period. The acquiring firm also had the difficulty of managing both the incumbent portfolio team and the inherited team from the acquired firm. The firm has to decide who to keep, who to handcuff from leaving and who to ‘release to the market’. I have seen examples in recent years whereby the acquirer has failed to pick the right line-up.
The first eschews leverage in favour of operational savings. It bets on competitors being unable to grow their asset bases sufficiently or being less operationally efficient. Such firms may have focussed/preferential distribution streams and protected ownership. Fidelity, Invesco and Threadneedle are all good examples. Smaller houses often lack scale to acquire other houses and will therefore focus on growing assets organically and building strength in key sectors with relatively modest team sizes. Artemis and Hermes are good examples of this.
In the face of downward cost pressures more aggressive firms leverage their larger resources (people, systems) to manage larger scales of assets at a similar level of operating cost. What we have seen is a ramping-up of consolidation and acquisition among asset managers since the credit crunch and, in the UK in particular, in response to the Retail Distribution Review (‘RDR’). Some firms have attained scale through passive propositions, which tend to be staff-lite by design. Examples include Schroders, Blackrock, BNY Mellon, Henderson and Aberdeen.
The role of the fund selector cannot be underestimated here. It is often the pressure (expectation) of institutional and large retail buyers that has encouraged this effective arms race between houses. Firms have responded to the regulatory and buyer backdrop by building assets and head count at a rate of knots. Most CIOs that I have spoken to lately all harbour ambitions to increase their asset base often through a handful of supertanker funds.
The question then is whether our end clients have benefitted from this expansion: whether more assets and more people mean better returns? The answer is one of efficiency.