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Midsized firms feeling squeeze in a landscape of big and small

David Hunt thinks midsized firms are being hurt because investors want to work with fewer managers.

Midsized active managers could be in serious trouble if they fail to prove their mettle.

Large managers have the benefits of scale. Boutiques can be nimble and offer a unique edge. But midsized managers increasingly are under scrutiny, especially in a low-return environment where experts say too many managers are chasing a shrinking pool of institutional capital.

That shrinkage can be tied to investors' embrace of passive strategies, fewer defined benefit clients as plans freeze or transfer risk, clients' preferences for working with fewer managers and plans' moves to bring more asset management in-house.

“It's a challenging time to be a midtier competitor in this industry,” said Jeff Gabrione, director of research at AndCo Consulting, Chicago. “Clients want managers big and stable enough that there's no risk (that they'll go out of business soon). But they also want a manager that's not in every other plan. It's a tough balancing act between those competing desires.”

Noted David Hunt, president and CEO of PGIM: “The larger, more sophisticated asset owners want to do business with a smaller number of firms. We're heading down a path where winners are going to win a disproportionate number of assets.”

Mr. Hunt added that, as a result, midsized firms are struggling. Industry sources generally define midsized managers as those with assets of between $20 billion and up to $100 billion, although some experts consider managers with up to $500 billion as midsized.

Several sources said the combination of fewer clients, a continued low-return environment and increased regulatory costs means that midsized managers have two main options: focus on what they're best at, or grow through a merger or an acquisition, which come with their own challenges and opportunities.

Ryan Anderson, senior consultant and director, manager research, at Pavilion Advisory Group Inc., Montreal, agreed. “Clients are looking to reduce the number of relationships they have and looking to reduce fees, which is a big issue,” Mr. Anderson said. “Because of the environment we're in, clients are asking their managers to do multiple things for them, so obviously the big firms have the resources to do that.”

Specialized searches

Deb Clarke, Chicago-based global head of investment research at Mercer Investment Consulting, said that client searches are becoming more specialist- and solutions-based. Add in the fact that many corporate defined benefit plans are frozen, derisking or in the process of completing risk transfers, and there are fewer contracts out there to win.

But other sources said the main reason why midsized managers are struggling is because they're unable to stand out in an industry that's become ultracompetitive.

“There's a group (of managers) that aren't going to be extinct, but are certainly on track to being an endangered species because they all look the same and are fighting over a marketplace where new money is drying up,” said Benjamin F. Phillips, a New York-based principal and investment management lead strategist at money management consulting firm Casey Quirk by Deloitte Consulting LLP. “And investors see it.”

Mr. Phillips added that the goal of a midtier manager is not to become smaller or larger, but to become competitive. “They have to get out of businesses where they're not growing. They have to make themselves more efficient by concentrating on their competitive advantage.”

Matthew Kaminski, director of manager research at investment consultant Fiduciary Investment Advisors LLC, Windsor, Conn., also pointed out that midsized firms need to streamline operations and specialize to remain competitive.

“Specialization helps. Streamlining and being more efficient works, too. It's why we've seen consolidation in the space,” said Mr. Kaminski. “Managers need to focus in on what they're good at.”

Ms. Clarke said managers need to “go back to the drawing board and say: "what's our skill set, where can we exploit that competitive advantage to provide value for our clients?'”

And Manuel Arrive, senior director, fund and asset manager group at Fitch Ratings in Paris, said there is a polarization between beta and alpha-focused firms. “The industry is split between more passive, lower-cost producers and the active, higher-margin shops. Managers aim to position themselves on that spectrum. There's still space for more traditional players, but they are probably under more pressure.”

But it's not just the midsized managers that need to reconsider their place. Case in point: BlackRock Inc., the world's largest manager with $5.2 trillion under management, announced in April it was reorganizing its active equity investment platform and relying more on lower-priced strategies based on quantitative computer models.

“Clients aren't going to pay for underperformance or even beta. They're not going to pay fees for mediocre results,” said Mr. Kaminski.

M&A at healthy pace

M&A activity is continuing at a healthy pace in the money management industry. Data from New York-based investment bank Cambridge International Partners LLC show the value of M&A transactions in the industry totaled $25.5 billion in 2016 globally, up 18% from 2015.

Recent examples of M&A among midsized managers include:

  • Henderson Group and Janus Capital Group, which announced in October they would merge and create a money manager with $325 billion in assets, with the rationale including increasing global reach and cost savings;
  • Amundi announced in December it would acquire Pioneer Investments to form a e1.28 trillion ($1.39 trillion) money manager, a deal that will bolster Amundi's institutional client base and provide a U.S. platform for money management and distribution;
  • Standard Life PLC and Aberdeen Asset Management PLC agreed in March to merge, creating a manager with 660 billion ($818 billion) in assets, also with the goal of adding scale.

“With investment managers under increasing competitive pressure to meet client expectations in a challenging environment, we see plenty of scope for further industry consolidation,” said Andreas Utermann, London-based CEO and global chief investment officer at Allianz Global Investors. “As a category, we see the squeezed middle of midsize asset managers being the most ripe for consolidation. These firms may not possess the specialist focus of a boutique or have the breadth of client offering and diversification of global firms.”

AllianzGI, which has €480 billion of assets under management, acquired fixed-income specialist Rogge Global Partners in 2016, when Rogge had $35 billion in assets, and announced the acquisition of New York-based private credit manager Sound Harbor Partners, with about $1 billion under management, in December.

Mr. Utermann said AllianzGI is “clear about the role we intend to play in this reshaping of the industry. With clients' investment needs at the center of our attention, targeted acquisitions sit alongside organic growth. We have an appetite to do deals where it makes strategic sense for us to do so and where it will add value to our proposition for clients, helping us meet their future investment needs.”

Importance of scale

Scale is often touted as driving consolidation, sources said.

In the passive space, in particular, scale is “critical — it is a lower margin business so passive asset managers need scale to be profitable. It is less important for a focused, specialty player with deep investment expertise that is recognized in the fees they charge, because cost bases and margins ultimately are higher there,” said Mr. Arrive.

For a midsized player, scale is more important because “critical mass is now needed on core markets, areas of expertise and products,” said Mr. Arrive. “And here we have seen a race for scale — we have seen all managers trying to build or increase scale on their core markets through various actions,” which also highlights the importance of distribution, he said.

The importance of scale was highlighted by Martin Gilbert, CEO of Aberdeen, at the Pensions and Lifetime Savings Association annual investment conference in Edinburgh on March 8. “You either want to be big or small — where you don't want to be is in that sort of middle ground,” he said.

Mr. Gilbert added that Aberdeen and Standard Life Investments were both “at that sort of bottom end of the premier league, and hopefully (the merger) takes us slightly further up that league table.”

This article originally appeared in the May 1, 2017 print issue as, "Midsized firms feeling squeeze in a landscape of big and small".