Nearly two years ago, we wondered if 2007 would be the “year of convergence between hedge funds and mutual funds”. Then last February, we told you about a report that concluded the market turmoil of January 2008 had “sharpened the argument for the convergence of traditional and alternative asset management”.
Well, the more things change, the more they stay the same. Freeman & Co., a boutique M&A advisory firm specializing in the asset management industry, said in a press release last week that “The ongoing credit crisis has hit banks and other financial institutions hard, forcing some to divest asset managers and creating opportunity for aggressive buyers.”
Unlike the mega-hedge-fund-deals of the past, however, the first half of 2008 was marked by more mid-market transactions (up 57% vs. the same period last year). The biggest growth was in the traditional asset management space (+23%) and “other” financial institutions such as private banks (+85%), not hedge funds.
Here’s what Freeman & Co. had to say about the next year. As you read these predictions, bear in mind that they were issued just days before Lehman showed up at the Pearly gates.
“Divestitures will increase as banks seek to raise capital and the report highlights firms controlling approximately $600 billion AUM that have each had their stocks prices drop by over 50%. Partial spin-outs such as the original PNC / Blackrock deal may be the preferred route.”
“Strategic realignments should increase as banks consider keeping their distribution capabilities, but selling or partially spinning-out product manufacturing. However, these Merrill Lynch / BlackRock style deals will be done out of capital necessity, not strategic visions.”
Unfortunately, the “strategic realignment” never happened for Lehman. But it will likely happen for many other asset managers who stand to be sold – and eventually forced into a marriage with another asset manager or, God forbid, some sort of alternative asset manager. Says Eric Weber of Freeman & Co.:
“…we are beginning to see more strategic discussions as banks reposition their overall businesses and decide what place, if any, asset management will have in their firms.”
If some of these divested asset managers do eventually co-habitate with alternative managers, there may be serious “conflicts of interest” according to the FT. In a story yesterday, the paper cites another research report that predicts several challenges in integrating traditional and alternative asset management. The article lists the following, for example:
Being simultaneously long and short: “First, they have to explain to clients why apparent conflicts of interest, such as having large holdings of the same stock in a long-only portfolio as it has shorted in a hedge fund, are not significant.”
Managing two parallel compensation structures: “38.5 per cent agree they should [integrate compensation structures], while 53.8 per cent strongly disagree, despite the argument this might give managers an incentive to concentrate on the latter to the detriment of their long-only investors.”
Leading blogger and former head of Deutsche Bank’s hedge fund business, Roger Ehrenberg, predicted the convergence of hedge funds and long-only funds at the end of 2006. While he was writing specifically about the convergence of hedge funds and private equity, his message is just as applicable to the convergence of hedge funds and traditional long-only management that we’re seeing today…
“Hedge fund? Private equity fund? These are increasingly artificial distinctions that will eventually be expunged from the investment vernacular…let’s stop using language and labels that mis-represent what’s really going on here. There is a race for alpha, a somewhat small group of investment professionals that will be able to lay claim to this alpha and a limited number of ways of realizing this alpha.”
Later this week: Research on whether the “converged” asset management business model can really work.