US investment firm Brown Advisory has just released a useful primer called “ Inflation in the US Economy”. It provides a very clear overview of how inflation and investments interact. Two charts stand out – the first one below shows how returns on equities and bonds varies depending on the inflation rate. It confirms three essential relationships: equities do very well in the 1 to 2% regime but returns from 3 to 5% are also pretty impressive. Interestingly bonds also do well in the 3 to 5% scenario. I would add one additional coda – as discussed before on this blog two other variables matter. Markets don’t like inflation surprises (when rates go up more than expected) and markets also keep a watchful eye on what are called sticky prices (where prices don’t ebb and flow with the business cycle).

The second chart below also reminds us why inflation rates have been so depressed over the last decade. We’re all aware that some goods and services (mostly services it has to be said) have increased substantially in price but that has been mostly compensated for by declines in the price of goods (especially technology-related ones).

Brown like most investors expects inflation to increase over the next few years, and that’s pushed their analysts towards a classic value/Buffett strategy of prioritising quality stocks which can withstand pricing pressures: “ Within our stock portfolios, the most important factor we are focused on is pricing power. In an inflationary environment, the quality of a company’s product or service should provide it with the pricing power needed to survive and thrive. Therefore, even as we have tilted more toward value strategies, we are focused on companies with defensible moats around their businesses and capable management teams. Finally, inflation is far from the only risk on our minds. This focus on high-quality companies and credits with reasonable valuations helps mitigate a broad spectrum of risks we face today and generates solid long-term returns.”

More asset management M&A activity

One industry where I think this inflationary analysis is less than useful is in asset management itself. Here price competition is intensifying but the industry is pushed forward by a structural dynamic, namely an aging population, which in simple terms results in more wealthy, old folks who need advice. My own core belief is that over the next 20 years you won’t go too far wrong by investing in a basket of quality asset managers who can somehow survive the scramble to scale up business models. That last point – scaling up – is the subject of a recent note from analysts at Credit Suisse. They predict that we’ll see even more M & A activity in the asset manager/wealth adviser space. They advance seven reasons for increased activity, all of which sound about right to me…

 1)     Investment capabilities: Many asset managers need to upgrade their existing  capabilities in growth verticals – private markets, ETFs, solutions, ESG, active fixed income, direct indexing. They could pursue team lift-outs which are cheaper or acquire a business with earnings via bolt-ons or acquire businesses that come with other products.

 2)     Distribution scale/breadth: Many asset managers would benefit from a larger distribution effort – including with more scale in the US/European retail channel where size is a clear advantage and increased breadth in the largest markets outside of the US (Europe: Germany, France, Italy, Switzerland, UK; APAC: Australia, China, Hong Kong, Korea, Japan, Singapore).

 3)     Earnings accretion & record low US valuations: Until the sharp rebound in equities from the 1Q20 lows, many US traditional asset managers were suffering from low or negative earnings growth and their valuations were dropping to record lows with many trading at just 5-10x earnings. The desire for firms to grow earnings through M&A and take advantages of attractive valuation multiples is a factor for many transactions.

 4)     Visible bank/insurance buyers: Several large banks and insurers are public about their desires to acquire asset managers – Morgan Stanley was the most active but JPMorgan and State Street are now the most vocal. There are other large banks and insurance companies, which could be active but are less vocal on their M&A objectives (ex: Generali).

 5)     Visible bank sellers: Several large banks are public about their desires to sell their asset managers – Wells Fargo just sold its asset management arm to two private equity firms and Banco do Brasil has been vocal about its interest in selling their asset management subsidiary.

 6)     Activism in the US: There has been an increase in activism in the US asset management industry which could encourage more consolidation – most recently Trian acquired stakes in both Invesco and Janus Henderson with M&A as one of their priorities.

 7)     Rising US taxes: Taxes may rise in the US next year which could encourage a pull-forward of transactions into 2021 – especially among the RIA consolidator and multi-manager models where individuals would be impacted by higher long-term capital gains taxes.

 Most probable buyers and sellers globally: We view DWS, Franklin, Invesco, JPMorgan, Patria, State Street and UBS as the likeliest buyers globally while we think the most likely sellers include Banco do Brasil’s Brazilian asset manager, BBVA’s Spanish asset manager, Cohen & Steers, Janus Henderson, WisdomTree and Victory Capital. Activist investor Trian now has stakes in both Invesco and Janus Henderson, and they have not hid their intentions of M&A. We also think the wealth manager rollups (Focus, Hightower, Mercer, CI Financial) and asset manager multi-managers (AMG) will continue to be active acquirers, especially given the prospects of higher taxes”.