Responding to recent M&A news such as Nuveen’s takeover of Schroders and the broader discussion around the impact of consolidation, Tom Caddick, managing director, Nedgroup Investments, has shared his thoughts with Funds Europe.
Caddick notes that from the operational side of the industry, consolidation can make sense. The operational challenges facing asset managers, including multiple platforms, systems, different connectivity, automation in some areas but not others – all lend themselves to consolidation that benefits the underlying client.
It remains important to recognises how too much consolidation can stifle competition, but a relatively limited number of bigger players offering more automated services “makes sense”.
However, for asset management per se it is imperative to recognise that it is not a commoditised industry, particularly in active management.
“I do feel as an industry, we’ve had a sort of existential challenge that has come in from passive investing. And I still don’t think we as an industry have quite gotten around to understanding it and seeing where it sits within.”
The growth of passive has come alongside slightly lower growth rates in markets, putting greater focus on understanding cost. This can be “perfectly healthy” given, for example, the post RDR wave experienced in the UK, and subsequent focus on cost, value for money and so on, Caddick says.
But he adds that where the issue lies in the discussion of cost, is “thinking value equals price, rather than what your end client is actually getting”.
While passive is contributing to driving consolidation – “you’ve either got to grow your top line or shrink your middle, and if you can do both, brilliant; but if you can’t grow your top line you’re going to try and cut costs” – and is linked to views on achieving scale, there are other challenges.
One picked out by Caddick is the feeling that regulation is structured to favour larger entities. “When you are running tens of billions, as I did, I know the challenge of trying to invest into a smaller fund. Half the time you need the big fund to be able to bulk out your exposure. That’s just the simple mechanics of it. Under a Ucits regulatory framework, that’s what you needed to do over time.”
Tailwinds for consolidation point to the big getting bigger, but also the potential commoditisation of asset management, leaving the concept of trying to generate superior returns or being ultimately client focused taking a back seat. Caddick adds, however, that “I certainly wouldn’t want my message to be big is bad”.
Place of active
The increasing burden of costs imposed on businesses makes it difficult to start off small and grow. It implies a long time frame to succeed.
Caddick cites the US market, for example, where he suggests a different ‘psyche’ may influence the view of active management – including the American dream approach that creates aspiration and celebrates success. But he goes on to suggest it is about more than that: active is not a homogeneous area any more than passive. And so, where big data suggests active equals underperformance this is too broad-brush as “active done well” can generate superior returns over time.
“Choose areas of the market where actually there is alpha to be had, where there are superior excess returns generated, and be patient.”
Change issues
Related to the active/passive debate is career risk, which Caddick notes can be a valid reason for avoiding certain allocation decisions. It is understandable that people, especially early in their careers, would not want to put their head above the parapet.
But it is not just an issue of bias linked to personal risk – there is also a structural element at play, he argues, as the industry has become more short term in its approach to managing risk, when, say a minimum investment time horizon should be 4-7 years with the ability to ride volatility in the short term, to achieve the compound returns over time.
The industry has become “shorter and shorter term in the way in which we judge success and returns”, which may breed a certain behaviour in the way people invest and the risks they are willing to take.
Boutiques
The ongoing consolidation pressure alongside the challenge of performing as an active manager raises the question of what the role of boutiques may be going forward.
Caddick says that the question of how a boutique is defined is not about size, but more about specialism in his view, with key characteristics including ‘skin in the game’ alongside the specialism and an entrepreneurial approach that is long term.
“When you’ve got an alignment of interests between manager and client/investor, I think that creates quite a healthy environment for everyone concerned. I want to know that their success and my success are interlinked.”
Success can create other risk. Managers can be ‘rewarded’ for success by being removed from the very things that they are good at, such as being promoted into a committee or given the keys to the executive suite, Caddick notes.
Experience gap
Another emerging structural challenge to the industry that is linked to the consolidation story is the so-called experience gap.
This is based on the idea that it has become rarer to find managers with long term track records on one strategy or one area or one approach. Notwithstanding the ability of investors who have come out of tertiary education with the relevant exams and training, they do not have that same level of experience in decision making.
Working through the dot.com bubble, the GFC, Covid, and multiple geopolitical events in between is “very difficult, very different” compared to studying it or trying to apply investment theory, Caddick says.
He adds that this experience gap matters because the propensity to take appropriate risk at times will be diminished, and may result in not taking as strong a position against poor behaviour. The question then becomes whether the experience gap matters for clients and how to react if that is the case.
Caddick gives the example of Brexit. It had a significant short term impact on sterling and the market. Being through that type of events means “you’ve been through those moments of knowing that something’s happening, knowing that you need to be in the office for half-five that morning, regardless of the outcome, because you needed to be in just in case.”
“You have lived those moments, made those decisions or understood how you’ve responded and how you might want to tweak your responses – the theory doesn’t cut it.”
The problem now is that certain events have squeezed out that experience, Caddick continues. He says the impact of Covid should not be underestimated. It created a moment of reflection, so, notwithstanding that many came through the pandemic and remained with the industry, it “shook things up”. Caddick likens this to the impact felt on the high street or restaurants: not all that survived came back.
“I also think consolidation in the industry is having that impact. Bigger structural changes are occurring. The threat some people perceive coming from passive squeezing margins, life events and now consolidation…where are the consolidated entities going to squeeze their cost base? It’s going to be service and ops support, and it’s going to be effectively doing more with the assets that they’ve got in a different way.”
“What we’re talking about there is really that sort of experience gap that’s starting to form.”
Culture
Alongside the demographic shift, Caddick notes the importance of culture as a factor in both his own recruitment activities but also when considering the broader consolidation trend. “It matters a lot if you get a mismatch in M&A.”
“It’s not about like minded people. You need a core thread that runs through in terms of what you’re looking to achieve, how you’re looking to achieve it. What’s your true north? That is really important.”
