A version of this article was originally published in Financial News
The 2020 rollercoaster rolls on for asset managers, with record highs and dramatic falls for financial markets. In March, European asset managers faced £32.9 billion in outflows, the highest since the global financial crises, resulting in a drop in fee revenue and dwindling cash reserves as redemptions peaked at 3.1% of AUM (UBS, European Asset Managers – March Updates: Fund Flows, Markets & Valuation, April 2020) .
We are now emerging from the crisis and firms are beginning to plan again for the long-term. As the world slowly returns to the “new normal”, these firms should do so with deal opportunities higher-up the agenda.
Current market conditions provide rare opportunities for deals at relative discounts to ‘normal’ market prices, and those firms with strong balance sheets can take advantage. For smaller boutique managers hit by a reduction in fee income, we expect this will encourage them to consider partnerships. While founders will hesitate to “sell at the bottom”, many may prefer to be on the front foot and select their future partner, rather than being the recipient of an unsolicited bid. For larger asset managers, the past few months may spark a strategic shift and associated divestments.
Beneath the immediate uncertainty surrounding COVID, we believe there are three drivers for M&A:
Seeking scale will become even more important
Consolidation will continue as asset managers seek to outmanoeuvre each other in pursuit of value for investors. Deals can provide a fast-track to scale by acquiring firms to grow their AUM while achieving operating cost synergies. But as COVID increases the pace of change in social trends and working arrangements, buyers must be forward-looking in order to identify and deliver above-average operating cost synergies.
In this hunt for scale, firms need to look at the underlying reason why they are not already at scale – was there an underlying issue preventing the business from growing organically and why will an acquisition solve this? Acquisitions for scale work if there is a clear foundation on which to build the combined business and a shared culture across the two management teams.
Firms must adapt their proposition to changing client demands
International lockdown has massively reduced global energy consumption, seeing a 26% average reduction in emissions from mean 2019 levels. Recent events have demonstrated the power of widespread behavioural change. What does this mean for asset managers? Demand for sustainable investments is likely to continue to increase as the public reflects on the positive impacts to the environment we have seen over the last few months. Our recent research found that 40% of UK asset managers identify ESG as a top priority for 2020 product launches, with 65% looking to acquisitions as a way to achieve this.
With a limited number of target firms and growing demand for ESG expertise, prospective buyers will need to act quickly to capitalise on deal opportunities. Successful deals will integrate the ESG philosophy across the existing investment team, embedding the methodology across the wider business.
It will also be interesting to see how the active / passive debate evolves in light of the market movements earlier in the year. Successful managers will have parts of their business that can thrive in each part of the economic cycle. Both acquisition and divestment can accelerate portfolio rebalancing and we may see deal activity to fill any capability gaps.
Geopolitical Pressures will continue to drive M&A
While coronavirus has captured news headlines, geopolitical undercurrents continue to swell and must not be forgotten in long-term corporate decisions. For UK asset managers, the economic wobble from COVID may reverberate more emphatically as a result of Brexit negotiations, especially with the possibility of an extension thrown into contention.
While most firms have already established the necessary legal structures to continue cross-border activity since the EU referendum, secondary market impacts could yet increase M&A activity.
An unpredictable impact on FX movements may improve the business case for deals. Equally, client books ‘marooned’ in EU territories, no longer connected to a UK domiciled parent, may encourage further consolidation. Forward-thinking firms will adapt with more complex distribution solutions to navigate cross-border restrictions and service multiple jurisdictions. Targets who offer a route to more cost-effective distribution of funds across multiple regions will be snapped up by buyers seeking compliant geographic growth.
From diversifying product ranges to reshuffling operating models, the pre-pandemic drivers of M&A activity remain. As society adapts post COVID-19, these drivers may even become more prominent. Healthy firms will find themselves with golden deal opportunities to keep up with market trends.
For more on M&A activity within the asset management sector, reach out to Alpha’s specialists.