A weekly update on issues important to the Investment Management industry
On June 10th, Fidelity Clearing & Custody Solutions and Merchant Investment Management announced a new partnership to increase wealth managers’ access to capital for acquisitions and growth initiates. The deal opens up a sizable new sales channel for Merchant, and in return, Fidelity’s behemoth platform tacks on a few additional selling points to entice M&A-minded RIAs.
Significant underperformance relative to both the market and growth alternatives has led to continued outflows from institutional investors, which in turn has hampered AUM, revenue, and earnings growth despite relatively favorable market conditions. Since the multiple has also slid for these businesses, it appears that the market is anticipating more of the same. Against this backdrop, we address this post’s original question as to whether or not value managers are indeed undervalued at the moment.
On paper, the RIA model is a value generating machine: a reliable stream of distributable cash flow resulting from sticky, recurring revenues and growing effortlessly with the investment returns available in a diversifiable variety of financial markets. The reality, of course, is more nuanced.
While it’s no secret that the last year has been especially challenging for the RIA industry, Affiliated Managers Group (AMG) and Focus Financial (FOCS) have underperformed most of their peers by a fairly significant margin in the last few months. AMG is down nearly 50% over the last year, and Focus has lost over 50% of its value since peaking last September. For this post, we’ll offer our take on the driving forces behind this decline.
If there is one consistent story in these RIA rollups, it’s that building them takes longer than anybody expects. Duran worked on building United Capital for nearly 15 years. Some things require scale that cannot be acquired in one lifetime, however, and that’s where the CEO of Goldman Sachs, David Solomon, saw an opportunity.
Much of the sector’s recent press has focused on the current M&A environment as well as practice management issues for RIA firms, so we’ve highlighted some of the more salient pieces on these topics and a few others that are making news in the investment management industry.
During Q1 2019, most classes of RIA stocks underperformed the market despite its relatively sharp increase through the first three months. Investors still seemed concerned about the RIA industry’s prospects in the face of fee compression and continued asset outflows. RIAs are responding to this pressure in different ways. Some are actively expanding product offerings to meet clients’ changing demands; others are staying true to the traditional RIA model and responding to revenue pressure by developing cost efficiencies. As we do every quarter, we take a look at some of the earnings commentary of investment management pacesetters to gain further insight into the challenges and opportunities developing in the industry.
Over the weekend, the Financial Times published an article touting the rising level of merger and acquisition activity in the U.S. wealth management industry. The piece echoed much of the typical commentary on the RIA industry’s prospects for deal activity: a large, profitable, but fragmented community of firms needing scale to develop the necessary technology infrastructure and serve sophisticated client needs. The article talked to leaders in several PE-backed consolidators and some M&A specialists in the space, all of whom talked their book in general agreement that valuations were strong and consolidation was on. What the article didn’t address is that while private equity has indeed been actively pursuing the investment management industry, the public markets seem to have lost interest.
Ordinarily, we’d expect investment manager stocks to outperform the S&P in a stock market rally. This isn’t always the case though. So far this year, most classes of RIA stocks have underperformed the market despite its relatively sharp increase through the first three months. The explanation isn’t necessarily obvious.
Several trends which have driven the uptick in sector M&A in recent years have continued into 2019, including increasing activity by RIA aggregators and rising cost pressures. Total deal count during the first quarter of 2019 was flat compared to the same period in 2018, while deal count was up 35% for the twelve months ending March 31, 2019, compared to the comparative period ending March 31, 2018. Reported deal value during the first quarter of 2019 was down significantly, although the quarterly data tends to be lumpy and many deals have undisclosed pricing.
While market declines are a threat to the profitability and valuations of any asset management firm, active managers face the additional threat of relative underperformance driving outflows, even in periods of rising markets. Low fee passive strategies have become increasingly popular due in part to both the perceived underperformance of active managers and an increasing focus on fees. But to what extent have active fund outflows been driven by mediocre performance versus competition from passive strategies, and what is the impact on asset management firm valuations?
Last week, Matt Crow, Brooks Hamner, Taryn Burgess, and Zach Milam attended the 2019 CFA Institute Wealth Management Conference in Fort Lauderdale. We didn’t get a total headcount, but attendance appeared to be up from last year’s event. There are probably a number of explanations for this, but perhaps the most plausible was the interest in this year’s focus on the psychological side of wealth management, which explored behavioral finance tendencies and how emotional decision-making can impact investment performance. For this post, we’ve elected to summarize some of these presentations and their implications for financial advisors.
As difficult it is to imagine a valuable car such as the Ferrari 250GT SWB being forgotten, what we see more commonly are forgotten buy-sell agreements, collecting dust in desk drawers. Unfortunately, these contracts often turn into liabilities, instead of assets, once they are exhumed, as the words on the page frequently commit the signatories to obligations long forgotten. So we encourage our clients to review their buy-sell agreements regularly, and have compiled some of our observations about how to do so in the whitepaper. We hope this will be helpful to you.
CFA Institute Wealth Management 2019 happens April 1-3 in Fort Lauderdale. The Investment Management Industry team of Mercer Capital will be there.
Investment management is a younger profession than many, but it too has evolved and is evolving, into an industry of sub-specialties of manufacturing (asset management) and distribution (wealth management). Wealth management is in a dynamic period, with changing client service models, challenges to profitability, the augmentation and distraction of technology, consolidation in some ways and fragmentation in others.
Recognizing this, we thought it would be useful to put together a whitepaper on valuation issues that are unique to the wealth management industry. While there are certainly characteristics of wealth management firms that are common to all RIAs, there are enough distinctions to caution anyone from painting the profession with too broad a brush.
The market approach is a general way of determining the value of a business which utilizes observed market multiples applied to the subject company’s performance metrics to determine an indication of value. The “market” in market approach can refer to either public or private markets, and in some cases the market for the subject company’s own stock if there have been prior arms’ length transactions. The idea behind the market approach is simple: similar assets should trade at similar multiples (the caveat being that determining what is similar is often not so simple). The market approach is often informative when determining the value of a wealth management firm.
There are three general approaches to determining the value of a business: the asset-based approach, the income approach, and the market approach. The three approaches refer to different bases upon which value may be measured, each of which may be relevant to determining the final value. Ultimately, the concluded valuation will reflect consideration of one or more of these approaches (and perhaps several underlying methods) based on those most indicative of value for the subject interest. This week, we take a look at how the income approach is used to value wealth management firms.
Wealth management firms have significantly evolved over the last several decades for various reasons. For purposes of this post, we provide a bit of history on the industry, basic characteristics of today’s wealth management firm, and take a look at recent performance.
In a world where non-stop financial commentary is as commonplace as it is tedious, one man’s market insights get an unusual amount of attention: Warren Buffett’s annual shareholder letter. Buffett is an ironic icon of the investment management industry. He’s made his fortune from active investment management, but regularly articulates his skepticism of the same. He’s doubtlessly inspired more people to found RIAs than any other individual, yet his firm, Berkshire Hathaway, is not an RIA. And his annual treatise on the performance of his company is full of common-sense wisdom that, based on Berkshire’s track record, is anything but common.
Much of the sector’s recent press has focused on the current market environment as well as practice management issues for RIA firms, so we’ve highlighted some of the more salient pieces on these topics and a few others that are making news in the investment management industry.
As we do every quarter, we take a look at some of the earnings commentary of pacesetters in investment management to gain further insight into the challenges and opportunities developing in the industry.
This week we say goodbye to perhaps the greatest advocate of passive investing. John Bogle’s contributions to indexing strategies and ETF investing have had huge impacts on both active and passive management, which we’ll address in this week’s post.
Now that January is almost over, we know that many of you have wrapped up quarterly investor communications and can now take a moment to think about your firm’s operations, direction, and other practice management issues. A useful place to begin your plan for 2019 is doing some fundamental research on your own business, starting with the P&L.
Asset manager M&A was robust throughout 2018 against a backdrop of volatile market conditions. Several trends which have driven the uptick in sector M&A in recent years continued into 2018, including increasing activity by RIA aggregators and rising cost pressures. Total deal count during 2018 increased 49% versus 2017 and total disclosed deal value was up nearly 140% to $18.0 billion. In terms of both deal volume and deal count, asset manager M&A reached the highest levels since 2009.
