Investment management is a people business, and there are aspects to a people business which do not yield to financial modeling. This week, Matt Crow addresses industry conundrums for which there are no easy answers.
A weekly update on issues important to the Investment Management industry
Investment management is a people business, and there are aspects to a people business which do not yield to financial modeling. This week, Matt Crow addresses industry conundrums for which there are no easy answers.
2022 proved to be a challenging year for the stock market as a whole and the RIA industry. With persistent inflation, rising interest rates, a tight labor market, and heightened geopolitical tensions, it’s no surprise that this resulted in the decline of nearly all stock market sectors over the last year, which was especially true for the RIA industry. But with the prospect of a potential recession in 2023, the worst may still be ahead.
RIA M&A activity set new records in 2022, even as macro headwinds for the industry emerged throughout the year. However, deal volume was most significant in the first half of 2022 and began to cool in the second half of the year, particularly in the fourth quarter. Although transaction volume is still up over the prior year, there has been a decline in the size of these transactions.
The RIA industry saw a strong fourth quarter rally, driving most categories of publicly traded investment managers to outperform the S&P in the last quarter of the year. Alternative asset managers, however, declined from their early-November peak to perform in line with the S&P during this period. In our blog this week, we take a look at the performance of the RIA industry by sector and AUM in the fourth quarter of 2022.
It has become a tradition for the RIA team at Mercer Capital to end the blog year with a “unique” annual summary of industry events, riffing off Clement Clark Moore’s classic “A Visit from St. Nicholas.” We hope all of you in the investment management community are enjoying the holiday season and looking forward to the many opportunities of the new year. We look forward to hearing from you in 2023. For now, please enjoy the finest only holiday poem written about money management.
As the RIA team at Mercer Capital looks back on 2022 and ahead to next year, we’ve noticed a few themes emerge in discussions with clients that we expect to hear more about in the new year. Don’t think of these as predictions but simply the current state of market behavior—the implications of which will soon be evident.
Two weeks ago, Westwood Holdings Group completed its acquisition of Salient Partners’ asset management business. The deal is expected to add $4 billion in AUM and $31 million in annual revenue to WHG, pricing the total consideration at 1.5% of AUM and just under 2x revenue. Masking losses through acquisitions is typically a risky proposition, but this may be an instance where it actually makes sense.
Most of the 9/30 quarterly results are in, and public RIA performance was all over the map. Mostly, it was a rough quarter in a rough year. Sagging AUM led to revenue cuts which dropped straight to the bottom line. Some firms mitigated their downside by cutting bonus compensation and marking down earnout payments for acquisitions. We did a survey of a cross-section of asset and wealth management firms. Ultimately, it appears some business models are working better than others.
Before this year, yields didn’t move much and generally stayed between 2% and 8%, depending on the term and credit quality of the issuer. That all changed last November when the Federal Reserve and other central banks began raising interest rates to fight mounting inflationary pressures in the global economy. Now RIA aggregator bond yields are in the 6% to 14% range after fairly steady gains throughout this year.
While multiples for publicly traded asset and wealth managers have been hit hard this year, RIA valuations in the private market have been more resilient as a proliferation of professional buyers and capital in the space have supported deal activity and multiples. Nevertheless, market conditions are beginning to have an effect. Run rate performance for most firms is down significantly, and borrowing costs for leveraged consolidators are rising. The upward momentum in multiples that persisted throughout last year has stalled, and deal structures have started to shift more of the purchase price into contingent consideration to bridge increasingly divergent buyer and seller expectations. Read more about it in this week’s post.
The RIA industry extended its losing streak last quarter with all classes underperforming the S&P, which also continued its decline. The market itself is part of the problem as this industry is mostly invested in stocks and bonds, which have been down considerably since the first of the year. The additional underperformance for asset and wealth managers is likely attributable to lower industry margins as AUM and revenue fall with the market while labor costs continue to rise.
As September of 2022 came to a close, asset management is experiencing one of the most challenging years in history. Losses are both deep and widespread. The consequence is a tough quarterly letter to pen to investors, a hit to revenue, and an even bigger impact on profitability.
The continued strength of RIA M&A activity amidst the current environment dominated by inflation, rising interest rates, and a tight labor market is noteworthy, given that all these factors could strain the supply and demand dynamics that have driven deal activity in recent years. Rising costs and interest rates coupled with a declining fee base will put pressure on highly leveraged consolidator models, and a potential downturn in performance could put some sellers on the sidelines until fundamentals improve.
Last week, The Association of Trust Organizations held its annual meeting at the JW Marriott in Las Vegas to discuss industry trends, practice management, and recruitment during the Great Resignation. As a sponsor and panelist, we outline 5 takeaways from the meeting in this week’s blog.
The differential in interest in public investment management businesses and private investment management businesses isn’t sustainable. Will higher interest rates eventually wear down leveraged acquirers, as they have in other growth-and-income sectors? Will PE investors start to question the merits of trading companies from fund to fund instead of testing valuations in the open market? Will the public RIA group follow Pzena’s lead and go private? Or will public investors’ newfound interest in dividend stocks lead them to RIAs? It’s tough to forecast a public RIA resurgence but never say never.
We think of investment management firms as a “growth and income” play. The space has attracted capital specifically because RIAs produce a reliable stream of distributable cash flow with the upside coming from market tailwinds and new clients. For all the trade press touting interest in RIAs, investing trends over the past fifteen years have had a mixed impact on the investment management community.
For asset managers, cheap capital makes stock picking less important. Persistent alpha is harder to prove. Passive and alternative products are more competitive. Investment committees are surly. Fee pressure is rampant.
For wealth managers, cheap capital has made diversification look kind of pointless and bordering on stupid. In the rearview mirror, owning anything other than the S&P 500 has, since the credit crisis, looked like a mistake. While this may not have had an immediate impact on revenue and margins, it does nothing to cement advisor/client relationships.
But what about valuations? Where do RIAs fit in an environment that favors growth stocks?
Last week Pzena Investment Management, Inc. announced that it had entered into an agreement to become a private company again via a transaction in which holders of PZN Class A common stock would receive $9.60 per share in cash, a 49% premium to its closing price before the announcement ($6.44). In this week’s post, we attempt to rationalize this premium and any implications for the investment management industry.
Schwab recently released its 2022 RIA Benchmarking Study. The survey contains responses from over 1,200 RIAs representing $1.8 trillion in AUM to questions about firm operating performance, strategy, and practice management. The survey is a great resource for RIA principals to see how their firm’s performance and direction measure up against the average firm. In our blog post this week, we highlight some of the key results of the survey.
The RIA sector continued its losing streak last quarter, underperforming all classes of the S&P, which also saw a decline. Because this industry is primarily invested in stocks and bonds, which have declined significantly over the past six months, the market is contributing to the issue. Asset and wealth managers continued underperformance is probably due to lower industry margins as AUM and revenue decline along with the market while labor costs continue to rise. In this week’s post, learn more about this and its effects.
The continued strength of RIA M&A activity amidst the current environment dominated by inflation, rising interest rates, and a tight labor market is noteworthy given that all of these factors could put a strain on the supply and demand dynamics that have driven deal activity in recent years. Rising costs and interest rates coupled with a declining fee base will put pressure on highly-leveraged consolidator models, and a potential downturn in performance could put some sellers on the sidelines until fundamentals improve. Despite these pressures, the market has proven robust (at least so far).
What does all this mean for your RIA if you are planning to grow through strategic acquisitions, considering internal transactions, or considering to sell? Read this week’s post to find out.
Growth at a reasonable price (margin) is an old concept in investment management, but it bears extending to practice management as well. RIAs are fortunate not to have to spend billions on factories, only to grieve them as “money furnaces” (sorry Elon). But that doesn’t mean RIAs don’t have the same imperative to invest in the people who compose their businesses.
Valuation professionals generally accept that public market capital is cheaper and leads to higher valuations than can be achieved by closely-held businesses. The words and actions of market participants who invest in RIAs do not necessarily align with this belief.
You’re not the only one dealing with turnover. The pandemic spawned the Great Resignation, and rising inflation means there’s probably a better salary (or signing bonus) out there for anyone that’s looking. The ensuing talent war has created more industry turnover than the end of broker protocol in 2017, and RIA principals are having to invest more time and resources into recruitment and retention than ever before.
“Chaos isn’t a pit. Chaos is a ladder.” This phrase comes to mind as we discuss ways for smaller RIAs to capitalize on this chaos in this week’s post.
2021 may be remembered as both the busiest M&A year in history for the investment management industry, as well as the year in which valuation multiples in the space peaked. Transaction volume surged last year and carried into the first quarter, as deals negotiated during a period of cheap money, strong multiples, and the threat of changes in tax law drew both buyers and sellers to the negotiating table. It’s time to question what impact the change in market conditions has for the investment management space.
