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Portfolio > Alternative Investments > Private Equity

Where Are RIA Deals Headed?

By Pete Gougousis

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After an almost 10-year bull market, the investment management sector is at an inflection point, resulting in robust M&A activity. According to the S&P Global Market Intelligence, the number of deals in the space almost doubled from 96 to 180 from FY14 to FY17, with FY18 slightly lower than FY17.

Several key themes are driving this, such as aging firm owners and their succession plans, the need for operational efficiencies and strong infrastructure, and the influx of private-equity capital which also is raising valuations. Incremental to these factors is market volatility during the fourth quarter of 2018, driven by interest rate fears, tariffs, and skyrocketing corporate debt.

The impact of the aging baby boomer demographic has been widely documented. It is also influencing the direction of investment advisory firms and whether founders decide to either transition to existing teams or sell to a corporate or private equity buyer.

Naturally, the industry is heavily dependent on personal relationships and firm culture is critical. We believe that M&A activity would be even stronger than current levels if not for deals falling apart near the finish line due to insurmountable differences in cultures and personalities between buyer and seller.

Therefore, the importance of succession planning within an organization is critical for founders, whether they decide to keep the business intact or sell it.

Recent volatility in the markets and fee compression have caused investment advisors to focus on trimming operating expenses and streamlining processes in order to maintain profitability levels. There has been a significant amount of investment spend in the space recently as companies have aimed to enhance systems and improve the customer experience.

This is even more important as the client market shifts from baby boomers to millennials, who would prefer to monitor and adjust their portfolios from a mobile app, rather than meeting at a branch.

Aside from technology spend, founders also face rising internal costs to satisfy increasing regulatory and compliance requirements. These factors create a crucial cost/benefit analysis and in most cases may result in the founder looking to join forces with another player in the space or private equity.

Influx of PE Investment

Fee-based investment management businesses have historically been attractive to private equity firms due to their stable cash flow generation.

However, the current economic climate has fostered heightened interest from private equity buyers, because other financial services sub-sectors, such as specialty lending and other balance sheet intensive companies, may experience an economic downturn sometime in FY19 or FY20.

As a result, private-equity buyers are reluctant to pursue these types of businesses until there is further certainty of when the next credit cycle will occur.

Consequently, record amounts of dry powder have been put to work in investment management and other consistent fee-based businesses over the last few years. This has caused an uptick in valuations and providing more incentive for founders to sell a portion or their entire business.

Along with the above factors, market volatility in the fourth quarter has had implications for investment management M&As. Assets under management levels are declining which, when combined with fee compression, is causing companies without robust sales functions to struggle to stabilize AUM levels.

Because of this volatility, founders who were considering selling in recent years will likely look for an exit or partial sale in the near term. From the buyer perspective, this can also bridge the valuation gap between their and the seller’s expectations.

We believe the factors outlined above will continue to lead to more M&A in the investment management sector in FY19.

Some headwinds that may impact this activity in the space include potential weakening in credit markets, continued lofty valuation expectations by sellers, and increased client/asset outflows. More specifically, client portfolios remain heavily concentrated in baby boomer accounts.

To the extent further market volatility causes this customer base to accelerate cash withdrawals, buyers may be cautious not to purchase a potential “melting ice cube.” Notwithstanding these factors, we expect continued strong M&A activity for the sector in FY19.

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Pete Gougousis is a managing director and Sam Jones is a director with Alvarez & Marsal’s Transaction Advisory Group. Cailin Gillespie also contributed to this article.

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