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Aon Retirement and Investment Blog

Consolidation within the Asset Management Industry

For decades, asset management has been a fairly lucrative industry. Revenues for asset management organizations increased through attracting new clients coupled with the growth of the equity market. In traditional equities, fee structures have largely been asset-based—meaning the fee paid by investors is directly connected with the size of the portfolio. Since the global financial crisis of 2007–2008, the number of equity products has more than doubled. Low barriers to entry, the ability to outsource noninvestment functions, and the growth of sub-advisory relationships are some of the factors contributing to the rapid increase in equity products and managers.

While the number of equity products and firms listed in the eVestment universe has continued to increase, the growth appears to be slowing. Additionally, there’s evidence of manager contraction on the margin already occurring. There hasn’t been much material change in the landscape of mid- and large-sized asset managers to this point, yet some mergers have occurred. Over the last year, several independent investment management organizations with smaller assets under management have liquidated operations, merged with other small asset management firms, or been acquired by larger investment management organizations. We’ve seen a strong uptick in asset management firms strategically reviewing their product offerings. This has led to the pruning of products that aren’t widely used or that have become uncompetitive in their peer universe. Additionally, there’s a rationalization of investment vehicles that has led to liquidation of pooled vehicles with a low level of assets across managers of all sizes. Despite the proliferation of equity products over the past decade, we believe headwinds will continue to force equity managers to rationalize their product offerings. 
Here we’ll discuss three headwinds that will challenge investment management firms.
1. Active Management Performance and Outflows
Active U.S. equity strategies have struggled to outperform their passive counterparts recently. According to the SPIVA U.S. Scorecard, just over 5% of U.S. equity managers outperformed the S&P 1500 Index over the five-year period ending June 30, 2016. When the universe is broken out by size categories, the results are fairly uniform: The mid-cap active universe fared the best with roughly 12% of the universe outperforming the benchmark and small-cap the laggard with just under 3% of the universe outperforming the S&P 600 Index. The results are slightly better when examining the 10-year period with the exception of the actively managed mid‑cap universe.
We also reviewed the success of active management relative to the broad capitalization universes in the eVestment database. The results are more favorable as the large- and mid-cap benchmarks typically placed in the top third of the universe over the last one-, three-, and five-year periods—but they were roughly median over the last 10-year period ending June 30, 2016. The active small-cap universe had a different result, placing above median for all time periods analyzed. We should note that the data in eVestment would introduce more survivorship bias than the comparisons compiled by SPIVA. Active management success has been more frequent when examining the universes outside of traditional U.S. equity.
Sustained underperformance from active management within the U.S. equity universe has contributed to the shift in investor appetite where passive strategies are preferred to their active counterparts. According to Morningstar, U.S. equity passive strategies had inflows of $133.9 billion over the one-year period ended May 2016. During that same period, active U.S. equity strategies had outflows of $185.8 billion.
2. Market Turbulence
Most equity markets, particularly developed markets, have experienced strong positive returns since the global financial crisis. This has allowed investment managers to continue to increase the revenue base of the organization even if the firm has not attracted new investors. With some markets—particularly the U.S. market—hitting all-time highs, there’s increased likelihood of a market contraction. Potential reasons for this include a weaker U.S. economy, interest rate increases, and unsustainable valuation levels following a lengthy period of favorable returns. If the market experiences broad declines, it will impact the asset base of the investment management community and lead to a decline in overall revenue despite relative performance results.
3. Changes in Distribution
The changing landscape for actively managed strategies negatively impacts a firm that historically has catered its product offerings and investment vehicles to the defined benefit market. Within the corporate universe, more pension plans have gone into de-risking mode as defined benefit plans have closed. This has resulted in the remaining equity allocation being managed more conservatively than in years past, causing a decrease in opportunities for certain actively managed products. Additionally, the emphasis has shifted toward the defined contribution universe, which has historically been more focused on pooled vehicles, such as mutual funds, as the primary investment option.

What to Pay Attention To
Consolidation activity has already begun at the vehicle, product, and firm level across the equity investment management universe. As outflows mount, we expect the pace of consolidation will quicken. When a change at an organization occurs, here are some key issues to consider:

  • What synergies do these organizations have?
  • Are the cultures of the organizations similar enough to coexist?
  • Are there overlapping strategies or products?
  • What’s the incentive structure going forward?
  • How will the organization retain key investment staff?
  • What will the initial warning signs be if the merger isn’t successful?
  • Is this beneficial to clients? 
Each change is typically reviewed over a series of discussions with leadership and investment staff of an investment management firm leading up to and subsequent to the finalization of the transaction. For investors, a cautious approach is usually warranted when any material change occurs at an organization. It typically takes some time for an organization that goes through a merger to fully integrate the two firms and realize the expected benefits.
Chris Riley is an Associate Partner and head of the Global Equity Manager Research team based in Chicago.

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