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Money Management

Invesco’s acquisition of Guggenheim’s ETF business enhances smart-beta offerings

Invesco (IVZ) said Thursday it is officially purchasing the ETF business of Guggenheim Investments for $1.2 billion, its second announced acquisition of an ETF provider in four months.

Invesco's Powershares ETF business is the fourth-largest in the U.S., with $129.2 billion in assets under management as of Sept. 12, Morningstar data show.

The purchase, when completed, will add another $36.7 billion in AUM. The deal is expected to close in the second quarter of 2018 and will be financed through a combination of cash and debt.

Martin L. Flanagan, president and CEO of Invesco, said in an interview that because Invesco has already built an ETF platform, it will be able to run the Guggenheim ETF business at a high 85% operating margin, a much higher number that Guggenheim was able to achieve. He would not say what privately held Guggenheim's ETF operating margin was or the operating margin for Invesco's existing ETF business. Invesco overall has a nearly 40% operating margin.

Guggenheim officials were not immediately available for comment.

Mr. Flanagan said few other asset managers besides Invesco could have made the deal work, because without a substantial ETF platform, the cost of building “the plumbing” to merge ETF businesses would be too costly.

“Scale absolutely matters in this business,” he said, noting that most ETFs launched by new ETF companies have less than $1 billion in assets.

Even considering Invesco's existing ETF platform, an investor presentation released Thursday in conjunction with the announcement shows the company expects transaction and integration costs for merging the Guggenheim platform into its own of up to $50 million in 2018.

In April, Invesco announced it was buying European ETF company Source, with $18 billion in ETF assets and another $7 billion in subadvised assets, from private equity firm Warburg Pincus. That deal has yet to formally close. Invesco said in a news release its global ETF AUM will total $196 billion as of Aug. 31 with the acquisitions.

Publicly traded Invesco has large active equity and fixed-income businesses and more than $900 billion in total AUM. But it has not been hit as hard as other managers who have seen net outflows as investors have into passive strategies from active.

Invesco started diversifying in 2006 when it bought the Powershares ETF business and WL Ross and Co., a distressed debt investment firm that had been lead by Trump administration Commerce Secretary Wilbur Ross, said Mr. Flanagan.

He said Invesco official did not anticipate the current move toward passive strategies back in 2006.

“We did not see the crisis,” Mr. Flanagan said.

But he said it was determined that the company needed to diversity its investment platform to offer a larger range of investment strategies. Today, he said, Invesco has a $140 billion alternatives business in addition to its ETF franchise.

“If we didn't build the breath of this capacity starting in 2006, we couldn't be doing this,” he said of the Guggenheim transaction.

Mr. Flanagan said the company is “agnostic” as to which investment offering is best but said asset managers with narrow capabilities don't have that choice. “If you only have one capacity, the answer to everything is your one capability and that's just not the way of the future,” he said.

Analysts say the ETF purchases are a bet by Invesco that investor interest in the fast-growing ETF business — and in particular Guggenheim's specialty, smart beta, factor-based ETFs — will continue its rapid growth in coming years.

In a research note Thursday, Todd Rosenbluth, director of ETF and mutual fund research at financial research firm CFRA, said he thinks the deal will help PowerShares gain “much needed scale” to compete with established ETF providers and newer entrants. “Indeed, the 'big three' iShares, Vanguard and SSGA have expanded their market share to a combined 83% in the past two years, while PowerShares/Guggenheim have a combined 5.3% market share, down from 5.9%,” he said.

Mr. Rosenbluth said CRFRA expects investors to increasingly use passively managed ETFs to build asset allocation strategies, helping to drive continued asset growth for the industry. “PowerShares has been positioning itself in recent years to be a beneficiary of this shift and we view the expected deal favorably,” he said.

Guggenheim's ETF group was formed by the money manager's acquisitions of Claymore Group in 2009 and Security Benefit Corp. in 2010, which sold ETFs through its Rydex/SGI subsidiary. Guggenheim said it paid approximately $400 million for Security Benefit Corp.; the purchase price for the Claymore Group was not disclosed.

Even with these acquisitions, Invesco's AUM will significantly trail BlackRock (BLK), Vanguard Group and State Street Global Advisors. Morningstar's data show that as of Sept. 12, BlackRock was the largest with $1.2 trillion in ETF AUM under it iShares brand, Vanguard was second with $770.5 billion and SSGA third with $553.4 billion.

But Mr. Flanagan said Invesco PowerShares is a leader in smart-beta ETFs, and with the acquisition of Guggenheim, its market share of the U.S. smart-beta market will increase to 19.9% from 19%, which is only surpassed by BlackRock with 21%.

“We think that is where you add value,” Mr. Flanagan said of smart-beta ETFs.

He said BlackRock, Invesco and SSGA have prospered with billions of dollars in inflows into cap-weighted ETF strategies.”People look at cap-weighted indexes as safe and cheap, and I personally get nervous that too many plans and individuals have built their portfolios with cap-weighted indexes,” he said. “Its really a momentum play right now, where we are in the market, and just investors are probably unaware of risk they are taking.”

Analysts say they wouldn't rule out Invesco buying other ETF providers in efforts to continue to build scale to compete with its larger competitors but Mr. Flanagan said the company is not looking for any other ETF acquisitions.

In a statement, Guggenheim Investments President Jerry W. Miller said with the ETF sale, the company will be “sharpening its focus on core strengths, including active portfolio management, across both our institutional strategies and other retail businesses.”

Mr. Flanagan said Guggenheim officials approached Invesco a few months back about a potential sale, saying they felt that their ETF franchise would be a better fit for Invesco.