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Fund Firms: How Big Is Too Big?

Jason Stipp

Jason Stipp: I'm Jason Stipp from Morningstar. I have the pleasure today of speaking with Bob Pozen. He is chairman emeritus of MFS and also a senior lecturer at the Harvard Business School. He was in Morningstar today, speaking to us a little bit about some of the M&A trends he had seen in the fund management industry. He is going to tell us a little bit about what he's found and some insights from that research. Thanks for joining me, Bob.

Robert C. Pozen: Glad to be here.

Stipp: The first question for you: you spoke a little bit about some of the growth strategies that you'd seed in the asset management industry, some of them you identified as pretty smart strategies that had succeeded, some of them not so much. From a business perspective, for asset managers, what has worked when they've looked to grow their operations through M&A?

Pozen: What's worked is basically two strategies; one is where an existing manager that's in one line of funds, say in fixed-income has bought somebody who's in another line of funds, like international equities. The best example here would be Franklin buying the international house.

So, that works because it's complementary. They are not really trying to integrate; they're really gaining a whole line of products. The other thing that works is, if you buy assets and you take those assets, mainly fixed-income assets and money market fund assets, but you don't take the people, then you can gain certain economies of scale.

What doesn't work is trying to buy lots of funds to create a financial supermarket where you as a broker-dealer or as an insurance company or a bank have a group of affiliated funds. It doesn't work for two reasons: one is, the high net worth investor is very discriminating. They want open architecture. They are not going to go and buy a fund just because it's affiliated. In fact, that may be a negative. And second of all, the regulatory scrutiny of that sort of affiliated sale has now become much more intense.

Stipp: A broader question for you on growth in general, so whether it's organic growth at the asset manager level or growth through M&A, is there a point at which they become too big. When do they decide that they need to grow and really expand and when have they really reached a point where it's just unmanageable, the size of the business.

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Pozen: Well, I think you have two groups of managers. You have the niche managers who start off focused on one area. They are doing mainly investment management. They have very little servicing or very little marketing. They have essentially outsourced all that. At some point, whether it's $10 billion or $20 billion, they are going to get to the point where they have to decide, are they going to continue to be just a niche manager specializing in high-yield bonds or Asian stocks, or are they going to try to be more broad-based. If they want to be broad-based then they have to decide: Are they going to really invest in the big infrastructure, and many of them at that point say, well, maybe we should be acquired.

Now, the second issue is, when you get people who are very big, meaning $200, $300, $400, $500 billion and more, at what point does that become a sort of diseconomy of scale. There I think you have to distinguish money market funds from other funds. I think there are quite a bit of economies of scale in money market funds, and you can run a very large shop.

But in the equity area, there are only so many good ideas that any research organization is going to produce, and I don't know the exact area, and it depends on the types of stocks, but when you start to have more than $300, $400 billion in equities, it gets pretty tough to continue to have really good stock-picking. Your funds get to the size where it's hard to continue to generate enough ideas to produce a really good performance.

On the other hand, if you want a full line of funds, you probably need $100 billion in equities under management because you got to have those international offices. Now, sector is more important than country, meaning that, you want to know all of the, say, chip manufacturers wherever they are in the world, and they have to be considered. So, somewhere between $100 billion and $300 or $400 billion in equity, that's sort of the sweet spot for a full-line equity house. But after that, unless you're doing money market funds or you are doing index funds, it's hard to generate enough ideas.

Stipp: So, from a fundholder's perspective, if you are a fundholder in maybe a smaller niche shop that's going to be acquired, and you're starting to think about how might my funds be affected during this acquisition. What factors should you look for? How should you know whether it's a good idea to stick with those funds or maybe you should be looking elsewhere? It sounds like potentially all of the assets under management could be one of those things that you look at, but what other things should I be keeping an eye on?

Pozen: Well, the most important thing is, if you're happy with your fund manager now, you want to know whether he or she is likely to continue. In some acquisitions the acquirer goes to great lengths to keep the managers on, to integrate them, and to keep them in the new shop. But these are very mobile people, and they can leave easily, so that's the first most important thing.

The second is, whether the acquirer is going to try to really change things very substantially. Most successful portfolio managers like to be relatively autonomous and they've figured out a way to win. They like to do that. If somebody who's used to being an individual manager is now going to be told they have to be part of a group, I don't know if that's going to work. If people are used to being in group management and then go to individual management, that's not going to work.

I think the third thing for people is just, how much benefit are they going to get from the larger organization. They probably will get better service. They may get better information. They will get a better array of funds, and so those things are there. But I think the most important thing is, is your manager going to stay and is your manager going to stay in roughly the same format that they did before which was successful.

Stipp: Bob Pozen of MFS funds and also senior lecturer at Harvard, thanks so much for joining us today.

Pozen: Glad to be here.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.