Consolidation and interest from Asia key to 2017 deals

Consolidation, the trend to passive, bank divestitures and increased interest in U.S. managers from Asia-based buyers drove M&A activity in the institutional asset management industry in 2017, findings from New York-based investment bank Cambridge International Partners LLC show.

And although the largest deal of the year — the merger between Standard Life Investments Ltd. and Aberdeen Asset Management PLC — led to a lot of soul-searching and hand-wringing over fears of vulnerability and forced consolidation within the industry, it ultimately didn't lead to an increased number of similar premium-free deals.

Data from Cambridge International show that 171 deals took place in 2017 globally, compared to 178 in 2016. Meanwhile, deal volume in 2017 reached $26.3 billion, vs. $25.6 billion the year before.

Transactional activity in 2017 continued to be driven by consolidation in asset management. Seven of the top 10 transactions reflected a consolidation theme, up from the five out of 10 in 2016.

"Consolidation in the asset management space was the principle driver of activity," said John Temple, president of Cambridge International, New York.

Other industry sources agreed that, as investors look to lower costs by reducing the number of firms with which they do business, consolidation will continue — and will continue to drive M&A activity.

There's been a considerable amount of M&A within the industry as several large managers have sought synergies to facilitate margin expansion, said Joshua M. Emanuel, chief investment officer, Wilshire Funds Management, Santa Monica, Calif.

"You're going to see more of it," Mr. Emanuel added.

Investors are moving toward larger managers that have more capabilities, which will put more ​ pressure on smaller and midsize managers, said George Gatch, managing director, CEO of asset management clients at J.P. Morgan Asset Management, New York.

And because the smaller managers don't have the distribution or investment capabilities to provide to big institutions, they'll likely use M&A to gain scale.

"There's going to be a move away from the have-nots to the haves'' in terms of capabilities and resources, said Mr. Gatch.

The merger between Standard Life and Aberdeen, announced in March, was the largest deal of the year, Cambridge data show.

After facing years of outflows due to the industrywide shift to passive strategies and overexposure to emerging markets, both firms agreed to combine in a no?premium merger. The result was Standard Life Aberdeen PLC, whose investment unit — Aberdeen Standard Investments — had £646.2 billion ($866.6 billion) in assets under management and administration as of Sept. 30.

Keith Skeoch, CEO of Standard Life, and Martin Gilbert, CEO of Aberdeen, are now co-CEOs of Standard Life Aberdeen.

Mr. Temple noted the merger was very similar to the Janus-Henderson deal that took place in 2016. Both were mergers where no premium was paid over the market price, and both were set up with co-CEOs, which "is not a usual structure."

The reasons for both transactions also included incremental revenue synergies and reduced costs for increased scale.

Cost savings at Standard Life Aberdeen are projected at £200 million annually, which is 11% of the combined cost base. Mr. Temple noted the savings aren't considerable, especially so since it was easy to imagine that "by jamming these two organizations together and getting rid of overlapping functions, you could lose revenues of 11%, too."

Following the merger, Mr. Temple saw "a frenzy of merger discussions around the industry."

Many in the industry were shocked to find Mr. Gilbert, a fiercely independent manager, felt it necessary to not only merge with Standard Life in a no-premium transaction, but also agree to share the CEO role, Mr. Temple added.

That made other money managers question if now was the right time for a deal of their own. However, despite a considerable amount of "soul-searching and navel-gazing" from other asset managers, the Standard Life Aberdeen merger didn't appear to have led to similar deals from other managers, said Mr. Temple.

The increased appetite for exchange-traded funds and index funds also drove a considerable amount of M&A.

Although strong equity markets didn't reverse the flows into passive strategies, they did mitigate them for active managers.

Still, active managers that are having problems producing alpha continue to lose assets. The ones most affected by the shift to passive strategies are continuing to be affected, and transactions in 2017 reflected those troubles.

"2017 has been quite a big year for ETFs," said Mr. Temple, citing Invesco Ltd. buying both European ETF provider Source U.K. Services Ltd. from Warburg Pincus LLC and Guggenheim Investments' ETF business this year.

Unlike active management, where a good active manager is a good active manager, regardless of assets under management, ETFs and passive index businesses are scale-driven.

The big challenge in the ETF/passive market is that most managers must decide whether to compete in this scale-driven business or focus on making their active management business as passive?proof as possible.

Not that it's an either/or proposition, but managers need to decide where to focus their attention and resources — and neither decision is cheap, Mr. Temple said.

Bank exits also continued to be a big driver of M&A activity within money management, particularly outside the U.S. with sales of asset management units by Banco BPM in Italy; Australia and New Zealand Banking Group Ltd. and Westpac Banking Corp., in Australia; Citigroup Inc. in Mexico; and Société Générale S.A. in China.

"It's clear that active asset management and bank cultures don't go very well with each other," Mr. Temple explained. "Asset management is a culture-driven business, not a scale-driven business."

Although there are still banks that own and run investment managers, asset management is not a core business for banks. The Cambridge executive explained banks historically have been more focused on collecting assets, rather than creating alpha. In other words, compensation schemes for a bank's portfolio managers typically are about how many assets those portfolio managers have in their portfolio, not how much alpha they have created, according to Mr. Temple.

Plus, when capital pressures hit, and the bank's CEO needs to improve capital ratios, selling the asset management business is an easy way to do that.

"You can sell them for well above book," Mr. Temple said.

Private equity, international and insurance operators were all big buyers of asset management firms in 2017.

Last year private equity purchases accounted for 20% of the $26.3 billion of transaction volume. Three of the top 10 deals of the year featured private equity firms as buyers of asset management firms. These deals were Stone Point Capital LLC and KKR & Co. acquiring a majority stake in Focus Financial Partners LLC; TA Associates' buyout of Old Mutual Wealth's Single Strategy Business; and Goldman Sachs Asset Management's Petershill program buying a 12% stake in Riverstone Holdings LLC.

"Private equity can be prepared to pay up," Mr. Temple said.

Japanese and Chinese buyers also expressed strong interest in U.S. managers, with SoftBank Group Corp., HNA Group Co. Ltd. and Nippon Life Insurance Co. making big investments during the year.

In February, SoftBank, a Tokyo-based internet and telecommunication company, announced it would buy U.S.-based private equity and asset management firm Fortress Investment Group LLC for about $3.3 billion.

"The Fortress transaction is quite extraordinary," said Mr. Temple.

Another deal Mr. Temple found noteworthy in 2017 was the Nippon Life-TCW transaction.

In December, Nippon Life Insurance Co., Japan's largest private life insurance company, announced it planned to purchase a 24.75% minority stake in TCW Group from the Carlyle Group.

Mr. Temple noted the Fortress deal is significant not just because of its size, but also because of the nature of the buyer. SoftBank is typically known for acquiring technology firms, not asset management companies, he said.

Meanwhile, the TCW deal is noteworthy because of the strategic nature of the relationship, with Nippon Life giving TCW assets to manage and providing distribution to TCW products in Japan.

Real assets, such as infrastructure and real estate, were very much in favor in 2017, according to Mr. Temple.

That was demonstrated by Lovell Minnick Partners buying real estate and infrastructure manager CenterSquare Investment Management and master limited partnerships manager Tortoise Investments; and Blackstone Group LP and Brookfield Asset Management Inc. acquiring energy infrastructure managers Harvest Fund Advisors and Center Coast Capital Advisors, respectively.

Aon PLC agreed in September to acquire real estate investment management and consulting firm The Townsend Group for $475 million. Also in September, Columbia Threadneedle Investments agreed to acquire Houston-based real estate investment firm Lionstone Investments.

Minority investments in alternative managers from private equity firms also continued in 2017, with Neuberger Berman Group LLC's Dyal Capital Partners and Goldman Sachs' Petershill Fund making three such acquisitions each.

In 2018, Mr. Temple said several significant deals are in the works, including the £48.7 billion ($64.9 billion) BT Pension Scheme in London looking to sell Hermes Fund Managers. Mr. Temple also expects Deutsche Bank's initial public offering for its asset management business as another major deal in 2018.

Looking ahead, he added industry headwinds, such as fee pressures, will keep buyers cautious, regardless of how markets perform.

Also, Mr. Temple expects to see continued targeted acquisitions of smart beta firms, managers able to outperform their index, and of well-performing active managers. Deals in alternative asset classes such as infrastructure, real estate, private debt and private equity, too, will remain strong.

The industry might even see an increased interest in hedge fund managers that recovered in 2017 from a long period of underperformance, Mr. Temple suggested.