Whether they'll come out with savings or a worse-performing investment vehicle depends on several factors
Since 2009, investors’ preferences and assets have shifted inexorably toward passive vehicles as the majority of higher-fee active managers failed to show enough stock-picking prowess. For many mutual-fund firms, consolidation has been the only way to survive — and shareholders should take notice.
Citing a study by Deloitte Casey Quirk, a report by Barron’s said that the annual number of mergers among publicly traded asset managers doubled from 2009 through 2018. While some can get by thanks to competitive positions like low fees or specialization, many more occupy the middle ground that’s become more barren as fees get lower.
“M&A is a way to build scale to offset some of that fee erosion,” Jeff Stakel, a principal at Deloitte Casey Quirk, told Barron’s. “The benefit to the client that these organizations point to is a more streamlined cost structure to be more competitive in the market and retain investment talent.”
Passing savings to investors
Before, there might have been doubts over whether cost savings would be passed on to fund shareholders through lower expense ratios. But in today’s competitive and choice-laden investment-fund industry, merging fund firms have no choice but to offer investors any fee advantage they can.
Figures from the Investment Company Institute show that the average expense ratio of active equity mutual funds has declined from 1.04% in 1997 to 0.76% in 2018. The U.S. Fund Fee Study released by Morningstar earlier this year also showed average expense ratios for passive strategies at 0.15%, compared to 0.67% for active ones; flows into the lowest-cost quintile of funds accounted for all of the net new money that went into funds in 2018.
Certain types of mergers can provide other benefits for fund shareholders. In 2019, three finance professors from Canada, Holland, and Italy performed a study of 176 asset manager consolidations from 2001 through 2013, which affected over 8,500 distinct funds. They found mergers that significantly increased the assets of the acquirer improved the funds’ risk-adjusted performance by 1.4% to 1.8% each year. When a large firm acquires a small boutique, however, there was no noticeable difference in results.
“[Merging] firms reallocate their existing fund managers so that the average manager still manages the same amount of capital in total, but that capital is more concentrated in fewer asset classes or investment styles,” explained David Schumacher of McGill University, one of the authors. While some critics argue that firms could sweep bad results under the rug through fund terminations or mergers, Schumacher argued that such changes have been modest from a historical perspective.
Another important factor to active management success, according to Morningstar’s director of manager research Russel Kinnel, is how portfolio management and sub-advisory teams get reorganized. As an example, he talked about what happened when USAA International, which manages a five-star mutual fund, was acquired by another manager called Victory Capital.
After the acquisition, Victory replaced MFS, the sub-advisor behind USAA’s stellar long-term fund performance, with in-house management teams that Victory had from previous acquisitions. The new managers have been described as “undistinguished” with “limited analytical resources,” but the fund’s star rating still currently stands at five stars.
“So, Victory wins; the [executives] at USAA win, as Victory cut them a check; but the USAA fund holders are just hosed,” Kinnel said.