Money management firms should develop economies of scale now, while the industry is prosperous, according to a new report by investment banker Goldman Sachs & Co.
"When the good times stop rolling, it will be difficult for all but the biggest firms to continue growing organically," Goldman says in its report, "Asset Management in the 21st Century: New Rules, New Game."
No surprise, of course, that investment bankers who help broker mergers and acquisitions are calling for more deals. And the report concedes that many asset managers believe their organizations are viable without giant scale.
But Goldman argues that continued consolidation is inevitable as the industry conforms to the economic reality that the top 20 asset managers increased their share of money under management to 49% in 1996, from 43% in 1986.
The question is not whether performance is more important than scale, Goldman analysts say, but, "For a given level of performance, is scale important?"
grow while the market is up
"A group of our medium-scale clients believe that by focusing on their existing asset base, they can continue to be profitable indefinitely," the report says. Many of these companies are institutional managers enjoying growth through market appreciation and new mandates.
William Cvengros, chief executive of Pimco Advisors Holdings LP, says the Stamford, Conn., fund firm is a "living example" of an asset manager responding to Goldman's belief that size is important. Last year it bought Oppenheimer Capital Inc., a fund firm with $60 billion under management. Pimco currently has about $100 billion.
"The bottom line is, scale helps you where the big numbers count: distribution, branding, financials and reach," he says.
Naturally, there are those who own their own mutual fund firmswho disagree with Goldman. One critic is Marc Blum, chief executive of $45 million-asset World Total Return Fund LP in Baltimore, which serves institutional investors. "Obviously, they have an interest in consolidation," says Mr. Blum. "There's always a future for good niche performers in any field, and it's as true in the mutual fund business as others."
Owners of mutual funds are making a good living through asset management fees, and if they are not ready to sell out in order to retire, then they won't. Also, he argues, once owners sell out, they have little incentive to keep up the quality they brought to their own firm.
The Goldman study says, however, that prices for niche firms are so high, the temptation to sell may be too great. And this stock market won't last forever.
Demographic changes will influence both the evolution of the industry and competition among managers.
The "prime saver" population, people ages 40 to 60, has fueled the boom, pouring money into retirement plans, but the growth in the number of prime savers began to decline this year and their absolute number is expected to shrink by 2006.
Then the "dissavers," as the report calls people age 65 and over, will adjust their portfolios from growth to income orientation. This, in addition to macroeconomic dynamics, will cause growth in the investment management industry to slow. That will increase competition, especially in the retail sector and ultimately force the government to confront the matter of privatizing Social Security.
The shift from defined benefit pension plans to defined contribution plans has started "a convergence of sorts," the study states. "Institutional asset managers continue to seek growth by marketing retirement programs to the institutions they have traditionally called on; the mutual fund companies market their retail product to employers. We refer to this hybrid market as the instividual market."
Hybrid companies, by Goldman's definition, are those whose total assets are at least one-third institutional and one-third invested in mutual funds. Their number grew to 25 in 1996 from 10 in 1986. Of Goldman's top 200 asset managers, 132 now offer some mutual funds.
Deregulation has important implications, the study states. According to Goldman, bank deposits grew less than 1% annually in the 1990s, compared with the more than 22% growth in mutual funds. Insurance assets posted a 7.7% annual growth in the 1990s.
insurers have an edge
Both banks and insurance companies have systems to distribute asset management services. Insurance companies, however, hold a more intimate relationship with their clients that focuses on long-term financial planning -- a slightly different relationship from what most banks have with their customers.
"Mutual funds are sold to, not bought by, these retail investors; hence, insurance companies are arguably better positioned to market funds to these clients," the Goldman study states.
Also, insurance companies provide advantages in the fixed-income arena, with greater flexibility in designing products with guaranteed return, Goldman says.
The Internet will be a huge channel for retail fund sales, the report says, predicting 50% annual growth in mutual fund assets held in online accounts between 1998 and 2002. It also makes it easier for "anyone with a little seed capital" to gain access to investors, which increases competition among money managers, the report says.
like cattle on the range
Brand names will be the key to retaining and attracting customers, it continues, with unbranded goods losing shelf space.
The report also urges independent asset managers to act now if they want to seize European opportunities. One of the most promising strategies, it says, is forming a strategic combination with a European universal bank.
Goldman takes some heat when it comes out with such surveys, because of its interest in consolidation.
But a competitor, Bruce McCever, chairman of Berkshire Capital Corp. in New York, says the current study is less "self-serving" than its previous one. "It seems more relevant and more focused towards the industry than on 'Just sell yourself now!' "
