Deals & People September 18, 2020

PANC 2020: Adviser Industry M&A From an Academic Perspective

Larger, more established firms are acquiring wealth management and RIA firms.

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Speaking virtually at the 2020 PLANADVISER National Conference, Mark Bruno, managing director of ECHELON Partners, said that, for the past several years, there have been more and more wealth management mergers and acquisitions (M&As), especially in the independent part of the market.

“This is an incredible time for M&As for wealth management,” Bruno said. “Discussions between players are the most active that the industry has ever really seen.”

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ECHELON, an investment bank that focuses exclusively on wealth management, is the No. 1 investment bank providing advisory services for registered investment advisers (RIAs) with $1 billion or more in assets under management (AUM), Bruno said. Since being founded 20 years ago, ECHELON has handled more than 400 investment banking assignments and 1,500 valuations, he said.

This year, ECHELON forecasts there will be 175 wealth management M&As, a 16% year-over-year decrease from last year, or 28 fewer deals. “In 2019, there were 203 wealth management transactions—a record, by far,” Bruno said. “All indications heading into 2020 were that the seven-year streak of M&A deals increasing each year would extend into an eighth year, and then COVID-19 struck.”

Bruno said that because M&A activity for wealth management firms had been so strong for so long, even with advent of COVID-19 and market declines, those events “did not kill deals, but they did delay many. There was a 15% decline in transactions in the first quarter. The deals that are being executed typically involve larger, more established buyers and sellers that have been capable of focusing on M&A during a challenging business environment. Acquisition targets continue to increase in size, along with the sophistication and professionalism of buyers.”

Most notably, many buyers are “acquisition platforms that call themselves integrators,” Bruno said. “They are really trying to help the companies they are purchasing with growth, and, like 2019, this year, a number of firms have done multiple acquisitions. This is making the industry less fragmented. Those being bought can plug into a national or regional network and enjoy significant growth opportunity they would not have seen had they remained independent. We expect more consolidation by these aggregators. ”

ECHELON expects that the pandemic will pass and that “the outlook and pipeline for 2020-21 indicates more deal activity and a return to 2019 levels is likely,” Bruno said. “Third quarter 2020 deal activity is expected to close 25% higher than the second quarter but still lagging year-over-year from 2019. We expect 44 deals will close in the quarter.”

Also of note, Bruno said, “even with the sharp, 25% market downturn in the first quarter, valuations have held strong, primarily because most RIAs have diversified portfolios.”

Bruno said there are primarily three motivations driving a company’s desire to be bought. First is the motivated sale, whereby an adviser is looking for a lifestyle change, or to diversify holdings and with shareholder considerations in mind. Second is an opportunistic sale, where a company approaches the firm with an attractive offer, or where a company believes its business has peaked and it is the right time to exit. Finally, there is the strategic sale, where increasing costs and competition pose a threat. The company may see a path for new markets or clients through a sale, or, perhaps operational efficiencies.

Compliance September 18, 2020

DB Plan Investment Provider and Investment Adviser Sued Over Market Losses

The Blue Cross and Blue Shield Association National Employee Benefits Committee says if the investment strategy of certain funds had been followed, they wouldn't have lost as much this year.

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The Blue Cross and Blue Shield Association National Employee Benefits Committee, fiduciary of the master trust holding the assets of the employee defined benefit (DB) pension plans that participate in the National Retirement Program of the Blue Cross and Blue Shield Association, has filed an Employee Retirement Income Security Act (ERISA) lawsuit against Allianz Global Investors and Aon Investments USA.

The trust claims that promised downside protection for several AllianzGI Structured Alpha funds was not implemented, resulting in “staggering” losses to the trust during the market crash and volatility caused by the COVID-19 pandemic. “While the funds would generate returns through an options trading strategy, Allianz promised that hedges would be in place ‘at all times’ to cap the downside risk of that strategy. Allianz claimed these hedges would cabin investment losses to a ‘defined maximum loss,’ afford ‘reinsurance’ against a market crash and eliminate the risk of a margin call. Allianz also assured the committee that Structured Alpha’s investment strategy was ‘non-directional’ and would ‘perform whether equity markets are up or down, smooth or volatile,’” the complaint states.

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The committee says the claimed protections were critical to its decision to invest in and maintain the Structured Alpha investments. However, the committee says, it did not know that Allianz had abandoned the hedging strategy, “leaving the portfolio almost entirely unhedged against a spike in market volatility.” Even worse, the committee says, Allianz had placed a directional bet that volatility would remain relatively low, one it had promised “never” to make.

According to the complaint, Allianz has since admitted it constructed the portfolio to offer no downside protection against the market decline and volatility spike that occurred in February and March. “Allianz had purchased no hedges for an entire segment of the portfolio. Meanwhile, the so-called hedges that Allianz did purchase were not the hedges Allianz said it would buy,” the lawsuit states.

In what the committee calls a “further derogation of its duties” and a “scrambling to address the fallout from its imprudent management,” Allianz “sold the hedges that could have protected the trust’s investment and then added more risk-bearing positions in an apparent bet that the market would recover.” The new risk-bearing positions “were also built without an appropriate hedge in place, exposing the funds to further, catastrophic losses and ultimately the margin call that Allianz had said could never happen,” the complaint alleges.

As of January 31, the trust had approximately $2.9 billion invested in the Structured Alpha funds, according to the complaint. Six weeks later, the trust faced a margin call, leaving no choice but to liquidate the investment. “The trust ultimately suffered a realized loss exceeding $2 billion, far beyond what the trust would have lost had Allianz managed the funds prudently or had the trust been invested in the equity markets or in a comparable, prudently managed investment strategy,” the lawsuit says.

As for Aon, the committee’s fiduciary investment adviser, the complaint says it agreed to conduct “active, ongoing monitoring” of Allianz to “identify any forward-looking” risks “that could impact performance.” Aon also agreed to “inform itself” of any information necessary to discharge its duty to monitor, including information about the actual options positions Allianz had constructed. The committee says it was entitled to, and did, rely on Aon’s investment advice.

The complaint alleges that Aon violated its fiduciary duties, repeatedly recommending that the committee invest the trust’s assets in the Structured Alpha funds. It says that as recently as June 2019, Aon assured the committee that Structured Alpha remained one of its “highest conviction strategies,” even though by that time, Allianz had strayed from the hedging strategy that should have been in place. The complaint says Aon would have known and advised the committee about this if it had properly discharged its duties.

“A prudent investment adviser entrusted with the duties Aon undertook would have monitored the funds’ actual holdings to verify that Allianz was managing the strategy as it said it would,” the lawsuit states.

The committee says Aon also breached its fiduciary duties when it recommended that the committee maintain a much greater percentage of DB plan assets invested in the Structured Alpha funds than Aon’s other clients did. According to the lawsuit, when the committee raised concerns in 2018 and 2019 about the concentration of plan assets invested in the funds and how the strategy would perform in a market dislocation, “Aon falsely advised the committee that only a small portion of the plan assets invested in Structured Alpha were at risk and that the strategy contributed little incremental risk to the trust.”

The committee says if Aon had informed it of the actual risks, the trust would have avoided the losses sustained in February and March.

Aon told PLANADVISER it does not comment on pending legislation. Allianz Global Investors has not responded to a request for comment. Allianz Global Investors said: “While the losses sustained by the Structured Alpha portfolio during the market downturn in late February and March were disappointing, AllianzGI believes the allegations made by Blue Cross Blue Shield are legally and factually flawed. We will defend ourselves vigorously against these claims. Blue Cross Blue Shield was advised by a sophisticated investment consultant to evaluate the Structured Alpha strategy. These funds sought to deliver substantial returns of as much as 10% above, net of fees, the returns of the fund’s benchmark, an index like the S&P 500. As was fully disclosed to Blue Cross Blue Shield, the Structured Alpha strategy involved risks commensurate with those higher returns. Blue Cross Blue Shield and its consultant determined that the Structured Alpha Portfolio fit with their overall investment goals and risk tolerances.”

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