According to a study released today by investment bank Putnam Lovell NBF, alternative asset managers represented nearly one-third of all acquisitions in the asset management industry in 2006 (59 transactions totaling $175 billion). In part, the firm chalks this record number up to increased demand for absolute return products:
“Demand for absolute return continues to rise: institutional investors seek all-weather portfolios that can guarantee long-term payment obligations to retiring Baby Boomers, who in turn want products and packages that create a constant stream of retirement income. This shift has created equal opportunities for both fund managers who can provide the necessary market outperformance and investment banks with hedging instruments that can sponge away associated risk.”
Meanwhile, the firm has a warning for traditional long-only managers: innovate or die. With so much of the asset management industry built on a foundation of index-hugging, “aggressive product development” is now a must:
“As investment offerings that can replicate broad market performance at lower fees multiply, asset managers find themselves forced into one of the most aggressive product development cycles seen in decades. Those without strong non-correlated investment performance are seeking the talent to create and (more importantly) maintain it. The smaller cadre of firms that currently possess such expertise is seeking to protect it from hot money by limiting capacityâ€”and auctioning it to the highest bidder.”
It’s been a banner year for all hedge fund M&A to be sure. But Putnam Lovell reports that interest in single hedge fund manager acquisitions has eclipsed interest in funds of hedge funds. Why? Apparently potential acquirers have clued in to the relative ease with which a fund of funds can be established in-house. At the same time, a glut of independent funds of funds after a 32% 5 year CAGR has quenched the thirst for acquisitions.
Like us, Putnam feels that the lines between retail and institutional asset management will continue to blur – as retail investors begin to buy-in to strategies that were once the sole domain of institutions.
“Some 42% of the 2006 deal tally, accounting for three-fourths of assets acquired, involved diversified targets, firms managing money for both retail and institutional clients…as professional buyersâ€”such as large fund complexes, multi-managers, annuity providers and structured note assemblersâ€” become more influential worldwide in developing investment solutions for individuals, the distinction between institutional and retail product becomes blurry and irrelevant.”
The lines between retail and instititutional aren’t the only ones blurring. The distinction between long-only and hedge funds will also melt away, says the firm.
“…long-only managers have been quick to expand their repertoire to include alternatives as well as portable-alpha strategies with similar demand and revenue characteristics to hedge funds. Equally, alternatives managers are starting to seek broader long-only product sets, partly to placate their growing institutional client base. In short, as the line between traditional and alternative asset managers fades awayâ€”turning more into a distinction between long-only and long-shortâ€”pricing metrics will converge.”
Does that leave providers of alternative investments without a competitive differentiator? Not quite. But according to Putnam Lovell, acquirers are more discerning. In 2007 they will be on the hunt for new sources of true alpha.
“Alternatives will retain their current sex appeal, although the further institutionalization of hedge funds and FOHFs has moved such vehicles into the mainstream. The torrent of new money earmarked for hedge funds–$110 billion in 2006, roughly equal to new commitments in 2005 and likely the ballpark for 2007â€”ensures a higher degree of correlation to broader market benchmarks. Consequently, buyers are looking to new frontiers for non-correlated returns. Several of the larger transactions involving alternatives managers in 2006â€”such as Amvescap’s purchase of private-equity firm WL Ross & Partners, or Unicredit’s acquisition of collateralized-debt specialist Vanderbilt Capitalâ€”had nothing to do with hedge funds. Further focus on new, truly alternative, investments will drive deal flow in 2007.”
Putnam Lovell says alpha’s separated-at-birth twin, beta will continue its corresponding rise from obscurity:
“As alpha becomes more elusive, beta will become an even cheaper commodity. Assets in exchange-traded funds already have surged past the $500 billion mark, growing more than five times faster than the industry as a whole. As large vendors of plain-vanilla ETFs apply further pricing pressure, innovative competitors that can defend slightly higher fees will become even more valuable. Amvescap bought ETF builder PowerShares Capital Management not only to recapture flows leaving the actively managed AIM and Invesco complexes, but also to capitalize on the firm’s unique indexing strategies. Private equity is pouring into other vendors with differentiated ETF strategies, such as WisdomTree Capital Management and XShares Advisors. Further such investments are likely if the US regulators permit the sale of actively managed ETFs.”
Finally, the report echoes an opinion held by many in the “hedge fund replication” business – that hedge funds will become more commodity-like in the future. As a result, the business strategies pursued by alternative investment managers will mature beyond just the “lifestyle” issues of their founders.
“The furor over hedge funds and FOHFs will begin to subside as the products become more commodity-like in nature. Investment banks already are building structured products that mimic hedge fund returns, and long-only managers are adapting long-short strategies where suitable and profitable. Players with strong, sustainable performance or niche strategies always will command (and deserve) premiums, but some buyers will focus more on finding the next frontier of alpha: be it private equity, infrastructure leasing, dark liquidity, or (most likely) something else. As hedge funds become an even more serious business, strategy considerationsâ€”not ones linked to lifestyleâ€”will drive deal activity.”
As usual, this annual survey is full of interesting insights. If you’re thinking of selling or buying your asset management firm, you may aso find some useful comps in this free 44 page report.