The asset management industry is at an inflection point.

Traditional public active managers had enjoyed a high-growth, high-margin business until the global financial crisis of 2007–2010, which ushered in an era of lower fees and eroded margins as investors shifted to exchange-traded funds and passive strategies. At the same time, regulations and technology requirements caused asset manager cost bases to creep up while prolonged low interest rates put pressure on large blocks of insurance assets held as fixed-income vehicles.

As all this was happening, competition heated up with new disruptive entrants, especially private equity funds going after large pools of insurance assets, such as KKR’s $4 billion deal for Global Atlantic. Meanwhile, the flow of assets under management to megamanagers (that is, those with more than $1 trillion in assets) intensified. Companies such as Vanguard and BlackRock netted more than 50% of all new money in 2020.

Covid-19 has accelerated some of these changes and the challenges facing incumbent asset managers. For example, the continuing low interest rate environment keeps prices and margins depressed while the required technology investments continue to mount. Central bank commitments are boosting equity markets, however, helping to keep asset management an attractive business.

We see five models for success in the years ahead, all of which rely on M&A.

Trillion-dollar managers: Scale matters. The aforementioned megamanagers are well positioned to weather industry challenges. While few can aspire to achieve this position, those in the club reap enormous scale benefits from distribution reach to operations efficiency to funding ever-increasing technology needs. We expect to see more bolt-on M&A as companies take this path to growth. Consider the journey by France’s Amundi, which over the past five years has gained scale through bolt-on acquisitions. For example, its 2017 purchase of Pioneer Investments, the asset management subsidiary of Italian bank UniCredit, enabled Amundi to expand its distribution network in Italy, Germany, and Austria, where Pioneer Investments already had an established presence, while consolidating its overlapping investment products to generate significant efficiency and scale benefits. The challenge for asset managers turning to scale M&A will be to sustain their nimbleness and innovation as their organizations become more complex and potentially more bureaucratic.

Scale through consolidation: Midsize traditional active managers will join forces to create efficiencies that will enable them to fund capabilities such as portfolio design and construction; risk/volatility management; and environmental, social, and governance—this is in addition to boosting distribution. Several high-profile consolidation deals took place over the past 12 months—including the Franklin Templeton acquisition of Legg Mason and Morgan Stanley’s acquisition of Eaton Vance, outbidding JPMorgan Chase, which publicly stated that it is aggressively looking for M&A opportunities in asset management. Despite the steady flow of M&A activity among midsize asset managers, the field remains fragmented and ripe for continued consolidation.

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M&A in Asset Management: Five Paths to Success

As exchange-traded funds and passive strategies gain investors’ interest, traditional asset managers face mounting costs and new competition from private equity.

Cost at scale for midsize asset managers: Over the next three to five years, we expect to see the emergence of ecosystem players (such as State Street, LSE/Refinitiv, Simcorp, and BlackRock) that will provide end-to-end software as a service to asset managers for needs such as data and distribution. The ecosystem approach will enable midsize players to achieve scale cost levels, allowing them to focus on the clients and products with which they can achieve the most value.

Manage and enhance the performance of stable asset pools: Private equity investors and other large funds will continue acquiring insurance blocks, driving higher risk-adjusted returns by expanding the investment capabilities beyond traditional insurance capabilities.

Alpha niche strategy: Some asset managers are divesting businesses that hurt their performance and divert focus away from alpha investments. These companies are shedding commodity asset classes that add no value while streamlining and simplifying operations and critically reorienting to alpha-generating strategies such as private assets and hedges.

As the asset management sector continues to change, companies that choose the right model for success and that hone their M&A capabilities will be those that evolve ahead of the pack.