Stuck in the Middle
8/11/22 | Janet Campagna
It is no secret that the race to acquire scale is causing bifurcation and restructuring in the asset management industry.
In general, funds continue to flow into the mega firms that can operate profitably at low cost to the investor, while boutique players defend premium pricing with specialized edges. It is the small and mid-size firms that find themselves in the crosshairs of this bifurcation; their growth prospects may hinge upon either successfully banding together to become a mega firm or being productively absorbed into a mega firm. In either case, the economic pressure for mergers and acquisitions in the asset management industry, driven by declining fees in both active and index products, is not likely to abate soon.
As a result, some small to mid-size firms may be tempted to succumb to M&A opportunities that seem to offer a pathway to scale. Before choosing this path, however, firms may want to begin with a look back at the source of their initial success. Often a firm's initial growth, and the bulk of its assets, can be traced back to a flagship strategy, which also defined the firm's edge and its brand. In many cases, firms then pursued opportunistic paths forward by, perhaps, haphazardly adding strategies, people and resources. Rather than an incremental approach that leveraged and built upon well performing capabilities, firms often sought to capitalize on market trends and created mediocre offerings that failed to attract meaningful assets. These efforts often muddied the message, diluted the brand and left clients confused about the firm's value proposition.
In contrast, the successes of both mega and boutique firms can often be traced to an obstinate commitment to a singular focus that clients viewed as value-added. For some mega firms, this meant concentrating on driving down costs for investors, for others, the development of a strategic plan to evolve their capabilities and provide a trusted brand. Mega firms focused on maintaining a level of quality and performance in expanding in ways that were consistent with their positioning in the market and their promise to investors and employees. On the other hand, boutique firms focused on honing a distinct investment capability with limited capacity and rationalizing a premium price.
As few management teams make the decision to shrink themselves to success, the temptation of M&A activity is strong. Sadly, history is strewn with examples of combinations, even those carefully vetted by investment bankers, that failed to live up to expectations of profitable growth. While combinations of asset management firms may seem ineluctable, both acquirers and targets must exercise caution to make sure that both their models and messages really are compatible. And even compatibility in principle can fail if implementation is not properly managed.
The best path forward for mid-size firms may be to simply assume they will be swept up in this M&A bifurcation squeeze, either as a target or an acquirer. Viewing their business in this light can lead to a candid assessment of strengths and weaknesses and a fresh look at the believability of a firm's edge and the effectiveness of its messaging against external and internal audiences.
Here are some questions that firms need to honestly assess:
· What caused the firm to stall on the road to growth while others grew to mega status?
· What are the gaps in models and messages?
· Will a deal address these deficiencies and what new challenges could it create?
· Do the existing management structure, compensation plans, sales and distribution strategies, and technology represent roadblocks to successfully implementing a deal?
· Is your firm’s culture consistent with your aspirations and values?
By identifying and proactively addressing problem areas, firms can present themselves as more desirable targets or as destinations for other firms to join. In addition, they can use the findings to address their shortcomings and create a stronger platform for jumpstarting organic growth.
The challenge for many mid-size firms lies in both the initiative to undertake an authentic self-assessment and the conviction to act on its findings. Perhaps they can be motivated by the realization that while they may not be ready to take a critical look at their business, others, including their employees, clients, rivals and potential acquirers already are.
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