Consolidation, move to passive mean big gains for largest firms

The big keep getting bigger.

Total worldwide assets under management of large money managers rose 114% in the 10 years ended Dec. 31, while total assets of the smallest firms dropped 40% during the same period, an analysis of data from Pensions & Investments' annual money manager surveys show.

(For this analysis, large was defined as $100 billion or more in total AUM; small was defined as firms with $2 billion total AUM or less.)

Plus, the 100 largest firms as a group have grown faster than the top 500 for each year from 1996 through 2014 — with the exception of 2002. The number of smaller managers also dropped, to 160 firms at year-end 2014, from 236 at year-end 2009 and 282 at year-end 2004.

“There are a number of factors driving the increased concentration among the largest firms,” said Jeffrey Levi, a partner at Darien, Conn.-based money management consultant Casey, Quirk & Associates LLC.

Mr. Levi cited such factors as the shift in investor appetite to passive from active management, increased M&A activity and, quite simply, “an oversupply of managers.”

Executives interviewed agreed the biggest firms are gaining market share because asset owners are entrusting their money to managers with the largest breadth of capabilities.

“A lot of business is going to firms that have full-service capabilities across the board, because some investors want to have relationships across multiple strategies,” Andrew Komaroff, chief operating officer of Neuberger Berman Group LLC, New York, said in a phone interview.

Mark McCombe, New York-based senior managing director and global head of BlackRock Inc.'s institutional client business, shared a similar sentiment. “In a world where investing is more challenged from a stubbornly low-yield environment, it's becoming more important to deepen your investment capabilities,” he said.

Several industry experts agreed the shift in investor appetite to passive from active management is accelerating flows toward the largest managers. “The growth of passive management is a major factor,” said Mr. Levi, adding that passive management “has proven to be a fairly concentrated business.”

P&I data show that, for U.S. institutional, tax-exempt assets managed internally, the 10 largest managers of passive indexed securities controlled 94.4% of the total in 2014 vs. 90.8% in 2004.

Consolidation within the industry is also a factor, although some sources are split as to how much impact it has on where the assets are going.

Casey Quirk's Mr. Levi said he recently has seen a considerable amount of mergers and acquisitions, and in particular has seen a number of large transactions in terms of deal price and AUM, like the sale of Russell Investments.

“A lot of firms are looking to make changes to their operational models, and M&A is a fast way to do this,” Mr. Levi said. “The barriers to entry are much higher than they used to be, so a lot of (large) managers are impatient about organic growth.”

Domonkos L. Koltai, a partner and co-founder of investment bank PL Advisors, New York, however, doesn't believe that M&A activity is a significant driver of AUM concentration — at least not when compared to the move toward passive investing.

“Some consolidation within the industry is happening through M&A, mostly through multiboutique structures that roll up ownership of boutiques to support distribution,” Mr. Koltai said. “But that activity is not a meaningful driver of greater concentration for the industry.”

In 2014, money manager M&A transaction value in the U.S. tripled to $16.9 billion from the previous year. However, data from investment banking firm Cambridge International Partners Inc. show the jump was helped significantly by two big deals: the $6.25 billion paid by TIAA-CREF to acquire Nuveen Investments Inc. and the $2.7 billion paid by the London Stock Exchange to acquire Russell Investments.

Branding and reputation also are major factors determining asset flows, the experts said.

“Brand seems to matter more” than in the past, Mr. Levi said. “Firms with size and scale tend to have stronger brand presence.”

Kevin Jestice, a principal and head of Malvern, Pa.-based Vanguard's institutional investor services, said: “If you earn the clients' trust, you build loyalty among clients. Trust becomes a scalable platform as well.”

“When you talk about the big getting bigger, the trusted brands have really resonated, particularly in the last 15 years,” Mr. Jestice added.

Despite the increased investor appetite for passive strategies, asset owners are continuing to allocate to alternative assets.

“There are a handful of specialist firms in a sweet spot and growing like fire, while smaller, traditional midsize firms are getting beaten up by the shift to alternatives,” Mr. Levi said.

And looking forward, Mr. McCombe said “there's no doubt that the push toward alternatives will continue.”

So what does this mean for boutique managers?

Greg Ehret, executive vice president and global chief operating officer for State Street Global Advisors, Boston, said “smaller managers might have some trouble,” as regulatory pressure might propel more consolidation, but Vanguard's Mr. Jestice said: “Different investors want different things, so there'll always be room for smaller firms.” n