Equity and Credit Market Headwinds Continue to Pressure AMG's Flows and Investment Performance

Strategist

Greggory Warren

A confluence of several issues—poor relative active investment performance, the growth of low-cost index-based products, and the expanding power of the retail-advised channel—has made it increasingly difficult for asset managers running predominantly active portfolios to generate organic growth, leaving them more dependent on market gains to drive managed asset levels higher. While we continue to believe there will be room for active management, which is hard to do in an environment where an overwhelming majority of the flows are going into index funds and exchange-traded funds, we believe the advantage (when it comes to getting placement on platforms) will go to asset managers with greater scale, established brands, solid long-term performance, and reasonable fees.

With $635.8 billion in managed assets at the end of September 2023, AMG has the size and scale to be competitive. Having 36% of its assets under management dedicated to alternative strategies and 16% committed to multi-asset strategies and other products, the firm is not as heavily exposed to the impact passive investing has had on active equities. Additionally, its equity lineup (48% of AUM) is diverse, composed of U.S. equities (21%), global/international equities (24%), and emerging-market equities (3%). Limited exposure to the retail market (29% of AUM) and broader geographic exposure also leaves the firm better positioned than some of its peers.

During 2018-22 (2013-22), AMG's annual organic growth rate averaged negative 4.8% (negative 1.0%) with a standard deviation of 3.0% (5.3%), slightly better than most of the other active managers we cover. That said, we expect the firm to face stiff headwinds in the near to medium term, with AMG generating annual organic AUM growth in a range of negative 6% to negative 2% during 2023-27, leading to negative low- to mid-single-digit top-line growth on average the next five years, with adjusted operating profitability hovering between 30% and 34% of revenue on average annually.

Business Strategy & Outlook

We believe the asset-management business is conducive to the creation of economic moats, with switching costs and intangible assets being the most durable sources of competitive advantage for firms in the industry. Although the switching costs might not be explicitly large, inertia and the uncertainty of achieving better results by moving from one asset manager to another tend to keep many investors invested in funds for extended periods. As a result, money that flows into asset-management firms tends to stay there. For the industry, the average narrow redemption (retention) rate, which does not include exchange redemptions, has been 25% or less (75% or greater) annually during the past 5-, 10-, 15-, 20-, 25-, and 30-year time frames. Including exchange redemptions, the rate has been less than 30% (greater than 70%).

In AMG's case, the firm's average annual redemption (retention) rate was 21% (79%) during 2018-22, and 19% (81%) during 2013-22, well below (above) the industry average. That said, during the same time frame(s), the company's organic growth rate averaged negative 4.8% (negative 1.0%) with a standard deviation of 3.0% (5.3%), which meant the firm was struggling to consistently compensate for investor redemptions with new flows into its products. With it is likely the company will do a slightly better job over the next five years (given recent improvements in some of its investment performance), we believe AMG has (at best) an average switching cost profile when compared with the industry and our peer coverage group, mainly as it has not taken full advantage of its below (above) average redemption (retention) rate for its long-term funds.

We believe the more traditional asset managers can improve on the switching cost advantage inherent in their business models with organizational attributes (such as product mix, distribution channel concentration, and geographic reach) and intangible assets (such as strong and respected brands and manager reputations derived from successful and repeatable records of investment performance), which can provide them with a degree of differentiation from their peers. While the barriers to entry are not significant for the industry, the barriers to success are extremely high—as it takes time and skill to not only put together a long enough record of investment performance to start gathering assets but to build the scale necessary to be competitive. This has meant the larger, more established asset managers in the industry have tended to have an advantage over smaller players, especially when it comes to gaining cost-effective access to distribution platforms.

Competition for investor inflows can be stiff and has traditionally centered on investment performance. Although institutional investors and retail gatekeepers are exerting pressure on pricing, competition among participants based on price has been rare, aside from what we've seen in the U.S. market for exchange-traded funds. While compensation remains the single-largest expense for most asset managers, supplier power has been manageable as many firms have reduced their reliance on star managers and have tied manager and analyst pay to both portfolio and overall firm performance. 

Asset stickiness tends to be a differentiator between wide-, narrow-, and no-moat firms, as asset managers that have demonstrated an ability to gather and retain investor assets during different market cycles have tended to produce more stable levels of profitability, with returns exceeding their cost of capital for longer periods of time. While the more broadly diversified asset managers are structurally set up to hold on to assets regardless of market conditions, firms with solid product sets across asset classes (built on repeatable investment processes), charging reasonable fees, and having singular corporate cultures dedicated to a common purpose have done a better job of gathering and retaining assets. Firms offering niche products with significantly higher switching costs—such as retirement accounts, funds with lockup periods, and tax-managed strategies—tend to hold on to assets longer.

Affiliated Managers Group, in our view, has a narrow economic moat. With $635.8 billion in managed assets at the end of September 2023, the company has the size and scale necessary to be competitive. Having 36% of its total AUM and 51% of firmwide EBITDA coming from alternative strategies (which includes multi-strategy, market-neutral, and hedge products) and 16% and 6%, respectively, derived from multi-asset strategies and other products, AMG is not as heavily exposed as some of its peers to the impact that passive investing has had on active equities. Additionally, its equity lineup (48% of total AUM) is diverse, composed of U.S. equities (21%), global/international equities (24%), and emerging-market equities (3%), and generates 43% of EBITDA. AMG's product distribution is also more heavily weighted toward institutional (51% of AUM) and high-net-worth (20%) clients, who tend to be stickier than retail fund investors (and generate 50% and 15% of EBITDA, respectively). On top of that, the company is slightly more global than its peers, with more than a third of its AUM sourced from clients residing outside of the U.S.

Unlike most traditional asset managers, AMG does not involve itself directly in the management of investments. Instead, it looks to acquire equity stakes in successful boutique asset managers, receiving a fixed percentage of revenue in return. These affiliates continue to operate independently, with AMG providing strategic, operational, marketing, and distribution support. This arrangement leaves most of the benefits that typically come with running an asset-management business to accrue to the managers that AMG buys, with the company not even generating the typical cost synergies created by most mergers and acquisitions (since it purchases equity stakes as opposed to entire operations). That said, we think the firm's proficiency at investing in and maintaining relationships with well-respected boutique asset managers has provided AMG with at least one unique competitive advantage. Having initiated its strategy of buying equity stakes in boutique asset managers in the early 1990s, AMG has been working with and adjusting its business model for nearly 30 years. In that time, the firm has built out a target investment universe that includes around 2,000 investment management firms (each with more than $5 billion in AUM), including a select grouping of 100 core prospects, creating a pipeline of potential investments where AMG is generally viewed as the "buyer of choice" by the owners of these boutique asset managers. 

At this point, we believe it would be difficult for another firm to replicate much of what AMG has created with its business model; those that have tried over the years have struggled to generate the level of success that AMG has had with its strategy. We think this cements the firm's position as the buyer of choice for many boutique asset managers. In addition, we remain impressed by AMG's build-out of its global distribution network, which we think has gone a long way toward improving the sales growth of its affiliates and enhancing the impact that the firm can have on asset stickiness. We think the global distribution network can also make AMG a more appealing partner for future affiliates, setting up a virtuous circle that the company can exploit to its advantage in the long run. Looking at its competitive positioning overall, we think AMG is facing a somewhat more competitive environment for investment stakes in boutique asset managers, which puts more weight on its ability to gather and retain assets within its existing operations but would note that one of AMG's greatest strengths over the years has been its discipline when it comes to doing deals.

Narrow

Economic Moat

Affiliated Managers

Affiliated Managers Group, Inc. is an asset management company with equity investments in boutique investment management firms. It provides assistance on strategic matters, marketing, distribution, product development, and operations. The company was founded by William J. Nutt in December 1993 and is headquartered in West Palm Beach, FL.

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Affiliated Managers Group, Inc. engages in the provision of asset management with equity investment. The company was founded by in December 1993 and is headquartered in West Palm Beach, FL.

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