Big is not always beautiful
By Noël Amenc, Professor of Finance at Edhec, and Director of the Edhec Risk and Asset Management Research Centre
Noël Amenc
Since the end of the 90s, the asset management industry has seen a vast movement of mergers and acquisitions. One of the principal motivations highlighted by the acquirers is the importance of the effects of size on the profitability of management companies.
The most usual and simplest method for checking the impact of size on the profitability of management companies involves regressing the returns on equity (ROE) onto the amounts of assets under management (AUM). However, this approach is not robust. It assumes that the merged entities are only comparable using their size alone, while all the strategic studies show that other criteria influence the performance and operations of management companies. Moreover, it is curious to observe the statistical (or indeed strategic) naivety that underlies most of the studies. After learnedly explaining to us, with supporting figures, that the future of the sector is determined by threshold or size effects, the authors lose no time in highlighting the organisational, geographical, distribution mode or offering factors that also have a strong influence on the profitability of management companies, without understanding that the very existence of these factors calls into question the previous reasoning on the size effects.
The benefit of the consolidation can nonetheless be evaluated indirectly, because the merger can improve the allocation of skills between the acquirer and the target. This is the main theoretical justification for mergers and acquisitions. To allow that transfer of expertise, and therefore optimisation of resource allocation, to be carried out, there must be some substance to the intersection of the occupations, offerings and organisations of the merged companies. The idea of acquiring companies that are not part of the same type of offering, market or occupation at all, on the pretext that there would be no redundancy, is the erroneous good idea of mergers and acquisitions in the 90s in the financial industry, particularly in asset management. The consolidations of management volumes by geographical zone or asset class are not sufficient to justify the goodwill of an acquisition; the transfer of expertise must lead to significant changes in terms of the management process, the information system, the organisation and the offerings in order to be able to imagine that the new overall allocation of resources will lead to a genuine improvement in cost or revenue efficiencies.
With the efficiency accounted for, what remains is to take account of the productivity that would be obtained by an increase in size. Here again, the conclusions have to be nuanced because while we do globally observe economies of scale or of range, the strategic context has consequences for their effectiveness. In passive management, volumes are unquestionably the key success factor. As evidence, the worldwide market for ETFs, which is experiencing very significant growth and should reach a volume of almost 500 billion dollars in 2005, is concentrated in the hands of fewer than 10 actors.
For active investment management offerings, it is apparent that the economies of scale give way to “performance” effects. In producing alpha, volumes are not the cause of the success but the consequence. This nuance allows us to envisage much lower threshold effects with regard to the capacity of production to deliver satisfactory profit rates. For equity investment, the threshold is 1.5 billion euros and for alternative investment it is 300 million euros for single hedge funds and 900 million euros for FoHFs. We do not observe any significant economy of scale beyond those thresholds.
