BlackRock will this week kick off third-quarter earnings season for a fund management industry where the widening gap between its winners and losers has unleashed a wave of consolidation.
Asset manager Eaton Vance was last week sold to Morgan Stanley in a $7bn deal, underlining how midsized fund managers are scrambling to be absorbed by larger groups or combining with peers in an effort to secure the scale required to compete with the likes of BlackRock and Vanguard.
The relentless pressure on fees across the industry from the popularity of cheaper passive investment products has crushed margins and accelerated consolidation efforts.
BlackRock, the world’s largest fund manager with $7.3tn in assets, has benefited and exploited these industry trends, particularly during the pandemic. Its shares have risen 20.4 per cent this year as the eight-member S&P Asset Management index has dropped 3.4 per cent. Shares in Baltimore-based T Rowe Price, another of the larger asset managers, are up 15.4 per cent.
“Two things drive the share price performance of asset managers, organic growth and strong margins. BlackRock and T Rowe have that,” said Greggory Warren, sector strategist at Morningstar. “People are willing to pay up for it,” he added.
BlackRock’s Aladdin risk management system, unrivalled by competitors, has also helped diversify its revenues with attractive subscription-based fees. In March, BlackRock was controversially awarded a contract from the Federal Reserve to buy bonds, including its own fixed income exchange traded funds.
Mr Warren expects third-quarter results, which begin with BlackRock on Tuesday, will lay bare the severity of the challenges confronting the mid-tier and smaller asset managers. Those pressures risk being compounded this quarter should financial markets pull back as the US economy faces more disruption from the pandemic.
Analysts at KBW expect investors will focus “on expense trends, each manager’s ability to combat a still challenged flow and revenue outlook, and managements’ view of strategic M&A”.
The coronavirus crisis has deepened the plight of midsized asset managers already struggling to distinguish themselves both from bigger rivals that benefit from scale as well as smaller niche players, said Michael Spellacy, global head of capital markets for consultancy Accenture.
“There is a continued divergence between the winners and those barely surviving,” he said. “You’re seeing the middle being acquired or shrinking.”
The industry was already animated by the prospect of more consolidation even before Morgan Stanley’s swoop on Eaton Vance. At the start of October, Trian, the activist fund run by Nelson Peltz, disclosed stakes of almost 10 per cent in both Janus Henderson and Invesco. Asset manager Legg Mason, another of Trian’s investments, was acquired by Franklin Templeton earlier in the year.
“We are in the early innings of a consolidative phase,” said Mr Warren, pointing out this was unfolding both through M&A but also within groups as fund managers combine products.
Analysts note that Morgan Stanley’s acquisition of Eaton Vance stands out for its high valuation, which may not be repeated in future deals.
KBW estimates Morgan Stanley paid in the region of 17.2 times their 2020 EPS estimate of $3.29 for Eaton Vance and 13.4 times its forecast for ebitda of $560m.
Robert Lee at KBW said the high valuation for Eaton Vance reflected its “unique product mix, competitive positioning, and long-term record of positive organic revenue growth.” He expected “normal” deal multiples for a traditional manager without Eaton Vance’s attributes may be closer to 8 to 9 times a target’s ebitda.