Asset management firms continue to put considerable faith in acquisition strategies. Last year saw major increases in the number of U.S. deals (133 compared with 116 in 1999) and the value of assets acquired ($12.7 billion compared with $6 billion in 1999).
The acquisition by Deutsche Bank AG of Zurich Financial Services' asset management business suggests the market impact of the terrible terrorist attacks will not slow the trend. Acquisition fever has been explained by acquiring firms under four main headings:
* Quality of earnings - acquiring an asset management business will provide a more stable source of quality earnings;
* Economies of scale - through size it will be possible to reduce support functions and cut costs;
* Synergy - the combination of brands and performance records will allow the two firms to perform better than their simple addition; and
* Globalization - customers require global reach and presence.
These perceived reasons for acquisition feed into a more general theory that asset management increasingly is going to be dominated by a few large players. There are several U.S. industries that have consolidated very rapidly. This justifies a sense of urgency to buy while good targets remain available so as not to be left behind.
This widespread reasoning is, in our view, based largely on myth.
A good starting point is to take a close look at the four explanations.
Quality of earnings. Historically, asset management has been a relatively steady and non-capital-intensive business within financial services. But few firms have assessed accurately the degree to which their historically steady earnings pattern was due to the beneficial impact on their fee income of higher equity markets.
On a macroeconomic scale it can be shown the industry as a whole was on a starkly downward trend during the bull market - but this was hidden by the huge benefits created by the rising equity markets.
Once the markets cease to cooperate, as they have done recently, the impact on profitability is becoming clearer. Expenses across the industry have grown with revenues as the flattering effect of equity market growth on margins has encouraged more expenditure. As such, the asset management industry's reputation for steady earnings is likely to be undermined, if not destroyed, as we enter a period where "free" revenue gained from consistent equity market increases can be used to offset rapid expense growth.
Economies of scale. Unfortunately, actual practice shows very few examples of acquisitions leading to the sort of fundamental operational change that would allow the two merged companies to act as one.
The result of most acquisitions in the industry has been the creation of conglomerates - and not consolidation. The key reason for this is that value within asset managers is their intellectual capital and branding - both of which are notoriously difficult to consolidate. The new owners of asset managers tend therefore to act as holding companies, or old-fashioned conglomerates.
Within this structure, economies of scale are almost impossible to achieve. Numerous studies and some empirical examples show that non-integrated asset management firms that live within a larger corporate group tend to lose value as compared to being independent.
Synergy. The reality is that intangible assets, such as brand, performance record and high-performing investment teams, are all assets that are very difficult to combine successfully.
It is interesting to note that customers have voted very clearly on this subject. One survey of pension officers asked the question: "All things being equal, what kind of manager do you prefer to hire?" The response gave an overwhelming 86% support to "independent, employee-owned companies." Only 14% expressed a preference for a subsidiary of a larger organization.
Global products and capabilities. This sounds good in theory, but it is remarkably hard to find actual customers who put value on the fact that the manager of their assets in country A also owns a business in country B. Yet for the managers, the cost of running a global operation is very significant.
Economic theory suggests it is only a matter of time before the conglomerates are forced by economic and shareholder pressure to unwind what they put together. This does not mean the industry will necessarily stay small and localized, as there are many ways for businesses to work together by contract, or business linkages or joint ventures of all types. But we predict several of the large conglomerates created in the asset management industry will deconsolidate over time - to the benefit of shareholders and customers alike.