Adding assets
Profit pressure can be countered by adding new assets to the existing cost base. As a result, we expect to see an increase in acquisitions by asset managers. Unfortunately, acquired assets tend to come with their own cost base, meaning there is a challenge to carefully choose targets and execute well.
The pressure to acquire will intensify if markets continue to fall, which raises another issue. The merging of entities could make business sense; however, there is a danger that an early acquirer may pay too high a price and damage, rather than enhance sustainability. Equally, poor markets may cause an increase in the number of ‘slow motion deaths’ as the lack of profitability causes cash to run out, resulting in closure of the business.
To the future
While it is tempting to predict widespread industry consolidation, previous predictions of this sort have come to nothing.
Instead, we believe there will be great boutiques, great mid-size firms, good large firms and many in flux between them. We are expecting the nameplates of existing managers to change substantially over the next few years. In the past, there may have been a negative bias to a change in ownership. Going forward, it is important to remain open-minded as some of these changes could be materially positive for the survivorship of a firm, or a team within a firm.
Consolidation is not necessarily bad
How many managers does the industry need? There is no correct answer to this question, and thus no correct industry structure. That being said, there is such a thing as too much active management. Reducing the number of managers in the industry would not change the odds of achieving positive alpha (still less than 50%), but it would mean that less of the underlying asset return would be spent on the pursuit of alpha.
As already noted, it is unlikely that we will see widespread consolidation, but some rationalization (particularly amongst hedge funds) instead. This has implications for plan sponsors and consultants alike. Monitoring the business aspects of an asset manager takes on a heightened importance. Changes in assets under management and/or product mix might just be an early indicator as to the financial health and sustainability of a firm.
Janet Rabovsky is the Practice Leader, Investment Consulting, Central Canada for Watson Wyatt Worldwide.
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