Investment management companies feature prominently in the great merger bazaar of late. At my executive search firm, my colleagues and I are perched on ringside seats beholding this spectacle.
Clients and prospects ask us to opine on what trends we observe, pressuring us to divine something more insightful than "everyone seems to be acquiring someone at ever higher premiums."
And when we correlate the underpinnings of recent transactions with client assignments, a number of key developments crystallize:
* broadening of style offerings;
* acceleration of globalization;
* more liftouts of portfolio management teams; and
* growth of alternative investing for institutional and private asset management clients.
These trends, linked by diversification and other common denominators, will radically change how investment companies manage their business and their customers' portfolios.
Portfolio managers are reared on the dogma that diversification is good. Yet they have clung, with religious fervor, to the notion that one is bound to a particular investment philosophy, such as value, or growth, or momentum. Traditionally, firms were organized predominantly along one given style.
Such recent transactions as Alliance Capital Management LP/Sanford C. Bernstein Inc., Liberty Financial Cos./Wanger Asset Management LP and CDC Asset Management/NVEST LP indicate that the days of the single-style shop are numbered, if not over.
Our own search work confirms this view. Presciently, growth-oriented clients have been recruiting value managers since late 1999. More recently, value-oriented clients have begun diversifying into growth to avoid repeating their two-year investment under-performance and business downdraft.
Diversification underlies the ongoing move toward globalization. Firms have been linking up across borders for some time now, but the pace is accelerating -- as evidenced by such deals as Unicredito Italiano SpA/Pioneer Group Inc., Allianz AG/PIMCO Advisors Holding LP and Old Mutual PLC/United Asset Management Corp. Moreover, clients with purely domestic strategies long have been seeking to add seasoned international portfolio managers with good -- and preferably transferable -- track records.
The recent mergers define a rising price boundary for the liftout phenomenon (the industry's equivalent of the neutron bomb --only the buildings remain). For decades, investment firms have been valued between 1% to 3% of assets; and a firm's mix of business (fixed income vs. equity, active management vs. passive) largely determined where in this range its value would fall. Recent valuations have risen to 5% or 6%, regardless of profile.
As acquisition prices increase, many potential bidders have dropped out. These participants have turned to executive search firms like mine to recruit teams, rather than buying their employers. Teams have transportable performance records and assets generally follow them, which shortens clients' breakeven horizon. High takeover premiums have driven upward the premiums for teams, which in turn has propelled individual compensation to loftier levels.
Business economics, diversification and pension mathematics combine to drive the rapid transformation of "alternative investing," e.g., hedge funds, fund-of-funds, private equity and venture capital. Simply put, firms that do not have this capability are seeking to acquire it, predominantly through recruiting. In this segment, team liftouts feature prominently for obvious reasons. While alternative investments historically have been the purview of the "rich and famous," this rapid mobilization of resources is targeting institutional funds.
Traditional asset classes have reached valuation levels that inexorably will drive institutional sponsors to seek investments proffering expected returns in the high teens or greater. As fiduciaries, sponsors allocate among investments based on return estimations over very long-term horizons. Neither stocks nor bonds will achieve low double-digit actuarial return requirements over the next few decades.
Therefore, plan sponsors have no choice but to seek other investments that will help drive average portfolio returns higher. Moreover, investment companies, used to downward fee pressure in their mainline businesses, are attracted to alternatives by the much higher margins this segment supports.
Higher margins, diversification and demographics also are driving clients' demands for private asset management capabilities. Fees are higher. The business is presumed to be less performance-sensitive than mutual funds and institutional asset management. And the next decade will witness the transfer of some $10 trillion between generations.
A relatively small clique of venerable firms traditionally has focused on the wealthy, offering legal advice, accounting and trust services in addition to investing. But the prospective change in their underlying client base has emboldened newcomers to borrow a marketing phrase and solicit the younger generation under the guise of "this is not your father's trust company." This trend is exemplified by the recent Charles Schwab & Co./U.S. Trust Corp. merger as well as by client demand for investors and marketers experienced in the field.
These trends are powerful, with far-reaching ramifications. It is easy to conclude that the confluence of style diversification at the firm level, continuing globalization of businesses and the advent of hedge fund traders in more traditional companies will dramatically alter how business is conducted and, perhaps, how portfolios are invested. Are these developments sustainable?
Many people have suggested these are all bull market phenomena. We feel that several countervailing forces will equilibrate matters in such a way that the above-listed trends will be able to sustain even severe shocks. True, a bear market may cause investment company valuations to fall to more historic norms -- but that would encourage bidders who have already dropped out to get back into the game.
In any merger, some people are going to be unhappy about it. Often people leave, concerned about a waning of power, or for other reasons. After its acquisition by Deutsche Bank, some Bankers Trust Co. people left to join Merrill Lynch & Co. In a bull market, you see less of this disgruntlement because assets and revenue continue growing even without new clients. So there is more money to spread around in bonuses.
A downdraft heightens dislocations; but other firms will be looking for teams. To the extent that teams become more mobile, there are firms ready, willing and able to hire them. That will make talented individuals, and teams, even more accessible to new employers.
While a market correction might temporarily slow down the dramatic assets-under-management growth enjoyed by clients over the past couple of decades, demographics will ensure that the industry remains in a growth mode for the foreseeable future.