Consolidation has been considered a solution to the pressures on the active management industry, but it is not an end in itself.
- Two major mergers have been announced this week as consolidation in the investment industry continues apace
- The pressures on the investment industry, both in terms of fees and performance, have been well-documented
- Consolidation is not enough of itself, particularly while the industry continues to support poorly-performing managers
Consolidation has been a feature of the asset management industry for a number of years, but it hotted up this week with the announcement of two major mergers – between Jupiter Asset Management and Merian Global Investors; and between Legg Mason and Franklin Templeton. Why the rush for size? And what does it mean for investors?
Of course, the two mergers are different. Legg Mason and Franklin Templeton is a melding of two big beasts. Jupiter and Merian are not trying to create a behemoth, but to bring talent together in a more efficient way. Nevertheless, they are the latest in a long line of consolidation – Premier/Miton, Liontrust/Neptune to name just a few.
The pressures on the active management industry have been well-documented. There is the rise of passive, which reached new and giddy heights in 2019. As passive saw inflows, it became harder to beat the index. Any global manager with an underweight in Apple and Microsoft faced an uphill struggle but matching index weightings risked putting a lot of client assets in a single holding. There are fee pressures too. If an investor can get the market at 10bps, active needs to be doing something important to challenge it.
ESG has been both an opportunity and a challenge. On the one hand, it is a way active managers can truly differentiate themselves in a way that passive managers, who operate on wafer-thin margins, cannot. However, to do it well takes considerable resources. Companies that have fallen behind may find that merging with a better-prepared partner helps them meet the challenge.
Consolidation is one answer: it allows asset managers to pool skilled analysts, to reduce ‘non-core’ costs such as marketing and reduce costs to investors. However, there is a danger, well-flagged by analysts of the sector, that consolidation doesn’t bring these benefits, but instead sees larger and larger funds develop that are incrementally less likely to deliver alpha. Consolidation is not an end in itself.
That said, consolidation does not necessarily deal with the problem of too many inadequate funds, run poorly by managers collecting chunky pay cheques. Managers can trade for too long on an ancient track record – Woodford is perhaps the most obvious example, but there are plenty more. One former star has seen consistent underperformance over five years at the helm, is fourth quartile over one, three and five years, has negative alpha scores, fourth quartile volatility and a significantly negative information ratio. Yet he remains in place, charging an OCF of 0.85% and running almost half a billion in assets. While there is a business rationale for keeping the fund open, how long before the industry decides it cannot rely on its customers not noticing poor performance?
The active management is vitally important – for price discovery, for proper allocation of capital, for the function of capitalism itself. Size may help it deliver better outcomes for investors, but it is not a given. Active managers need to look at their true differentiation at a time where they are facing existential challenges. That means capping funds, rewarding real talent and being more circumspect about the fund managers they continue to support.
