A soft M&A environment in the asset management industry is expected to continue with the Trump administration, despite its vow to simplify business for corporations.
While overall deal activity lagged in 2016 at 126 total deals, compared to 144 in 2015, a PwC report on M&A suggests the ambiguity surrounding economic, tax and regulatory agenda of the new administration has created a vacuum for uncertainty in the year ahead.
"[The] asset and wealth management sector is going through a major transition which will likely change the way retail investors are being advised and their savings are managed by the industry," said Sam Yildirim, the U.S. asset management M&A leader at PwC.
In a recent conversation with Money Management Executive, Yildirim said that while President Donald Trump's latest decree, which calls for the removal of two regulations for every new rule created, may not have any direct impact on future deal activity, she said, "Any uncertainty will impact the deal's valuation and acquirers' board's willingness to move forward."
"When my compliance teams consider this area, their key concern is to be able to prepare yourself with something that you don't know fully what it looks like," Yildirim said. "It's a challenge and firms are incurring a lot of costs paying experts and advisers in the area to really ready themselves. It's really eating into their margins."
An edited transcript of MME's conversation with Yildirim follows.
When considering the last year of M&A activity, what do you foresee as a possible trend in 2017?
When thinking about M&A in the asset management space, you should really split that conversation in two: alternatives versus the traditional space.
In the traditional space there was similar sized deal activity in 2016 versus 2015. The driver in traditional deals was consumer dating in order to strengthen their position in the market. That may be in terms of strengthening their distribution; strengthening the type of products they have available for the market or strengthening their bottom lines through cost synergies. But, really the theme was consolidation in order to strengthen the company.
In the traditional space there was no slowdown. The level of activity was equal to the prior year. But, compared to expectations, there were fewer transactions. The reason: We expected larger amounts of consolidation to take place than has actually taken place throughout the year, and I think part of that is due to difficulty in the deal environment.
There are a number of large changes occurring in the sector and the impact of those changes is difficult to quantify at this point in time. That has caused some of the transactions to be delayed. Also, there are still a lot of asset managers out there trying to understand what this new market means to them before they can really determine whether they want to buy, sell or do nothing.
If we take each of those uncertainties, there is a question about how far is this movement from active to passive going to continue? Is there a point once the volatility returns to the market? If you look back over the last five or six years, the markets are going up. ETFs have benefited from that and ETFs are benefiting from the Department of Labor's changes and robo advisers. All of these factors are really feeding ETF growth, but at some point this is going to stop and there will be equilibrium.
It is unclear where that point will be and to what extent individual managers are going to be affected. That's creating uncertainty and I think that's one of the larger uncertainties out there. When you look at the net cash inflows and outflows, a lot of traditional managers have had either no net cash flows of they lost assets. Depending on their areas of focus, between equity and fixed-income and large versus small cap, the impact is different. But, when you do a transaction you need to think about what the company will look like once there's a level of equilibrium between the active and passive market.
How are the policies of the Trump administration shaping the outlook for M&A?
There is not enough clarity yet as to what the new administration is going to do, but a lot of people believe there is a delay in implementing the DoL's fiduciary rule. There is also a group of people who believe the administration will repeal this and not replace it. It will be difficult to repeal it all together, considering that a lot of large players are supporting this change. A lot of activity has already occurred to prepare companies for this change.
The industry would react if the new administration repeals it, but I think a delay is likely to be welcomed considering there are so many smaller firms who have not yet fully understood what it means to them and what actions they need to take to become compliant.
Do you foresee any challenges working with compliance departments considering regulatory vagueness from Trump's latest decree to revoke two regulations for every new rule, for instance?
When my compliance teams consider this area, their key concern is to be able to prepare yourself with something that you don't know fully what it looks like. It's a challenge and firms are incurring a lot of costs paying experts and advisers in the area to really ready themselves. It's really eating into their margins.
From a deal perspective, clearly any uncertainty will impact the deal's valuation and acquirers' board's willingness to move forward with the transaction to the extent that those unknowns can be material.
One of the biggest challenges that I have been finding in 2016, and into 2017, is really seeing quantitative analysis that shows us what management expects the impact to be.
If you're looking at a firm, it is important to understand the new share classes they're introducing, what the fees and expenses those share classes are going to be, how some of the marketing payments and allowances are going to change and where the firms may lose shelf space with wirehouses and large distributors. All of these areas are clearly where we are heavily focused.
While there is plenty of qualitative information and explanations, there is not enough quantitative data. As you can imagine, all of these items that I have talked about impact your revenues and expenses, which goes to the deal valuation. Qualitative analysis is not sufficient in order to be able to take the transaction to a point where the buyer and seller can agree on the value.
What types of M&A trends in the alternatives space should managers expect?
In terms of private equity, there is still interest in terms of minority investors who want to take stakes in private equity firms.
Many of these investors are both international as well as U.S. firms. I think many are now coming around to the idea that bringing a minority staking partner may be beneficial to their business. I would expect we will continue to see this trend. By completing private transactions at valuations that are better than the market, multiples are hopefully going to drive the analyst community to being a little kinder to the alternative firms from a valuation perspective.
Hedge funds have had significant challenges in 2015 and 2016, as well. While managers there are open to the idea of a transaction, they are more likely to wait out this period until they have stronger flows and stronger performance, so that their performance fees aren't underestimated going into transactions. I expect 2017 will see a larger number of transactions here.
On the real estate side, I expect these funds will get offers either to do a full acquisition or minority staking transaction, and I expect to see more deals in that space.
Do you foresee trade orders from the Trump administration, such as the recent executive action to pull out of the Trans-Pacific Partnership, having any short term impact on M&A?
I doubt it. We are talking about foreign investors investing in the U.S., and I don't think that is going to slow down Asian, or other global investors coming into the U.S.
I don't know about the political aspects about this, but if you consider other dynamics going on — U.S. growth rates are better than many of the other developed economies, the asset management market is a lot more mature and a lot more sophisticated, and when you look at the size of the market in the U.S., there are so many factors in our market that are very appealing to foreign investors. Unless there is some new law that gets passed that stops that ideology, I would expect them to continue to focus and invest in the U.S.
That being said, there are clear synergies between the U.K. and U.S. players. There may not be a lot of them, but I expect to see some and I expect to see larger deals completed between those two countries.