The Henderson-Janus tie-up creates an active player in a passive world

The merger of Henderson and Janus will provide them with the heft to better compete with passive fund managers.

Andrew Formica, Henderson Global Investors chief executive in Sydney in 2014. (Peter Morris/Sydney Heads)

Australians will have more than a passing interest in the merger of the UK-based Henderson Group and US asset manager Janus Capital Group announced overnight.

It’s not just that Henderson is majority owned by Australians, a legacy of its relatively brief and unhappy history as part of AMP back in the late 1990s and early 2000s during the tumultuous period when George Trumbull was its controversial and aggressive post-demutualisation chief executive.

The merger, to form one of the world’s top 50 asset management groups, also reflects the structural pressures within the asset management sector that are squeezing margins and lowering costs as funds increasingly flow towards low-cost passive index-tracking funds.

The nil-premium, all-scrip deal, which will give the new Janus Henderson Global Investors about $US322 billion of assets under management, is a response to the coincidence of the surge in costs driven by increased regulation and technology investment and the massive diversion of fund flows away from active managers towards passive funds.

The rationale for the combination of Henderson, which has a global focus with a skew in its client base towards Europe, and Janus, whose customer base is predominantly American, is that it will provide scale, cost synergies of about $US110 million a year, a global distribution network and a more complete product range.

Interestingly, even though Henderson represents less than half the combined assets under management and earnings, its shareholders — and it is about 60 per cent owned by ASX investors — will end up with 57 per cent of the merged group.

That presumably reflects the strength of its performance and fund flows under its Australian CEO (and former AMP Capital fund manager) Andrew Formica in recent years, relative to the outflows Janus has experienced.

For the Australian shareholders, many of whom gained their shares when Henderson was de-merged from AMP in 2003, the near-17 per cent spike in Henderson’s share price in London in response to the announcement — which gave the group a market capitalisation of about $5bn — adds to what has been a surprising success story.

In 2003, AMP was under acute financial pressure and was effectively forced to offload the UK life insurance assets Trumbull had acquired — and the Henderson funds management business — because of the stress the insurance businesses and their voracious capital requirements were placing on its own balance sheet.

Unable to sell the UK operations, it ended up de-merging them and, to facilitate a UK listing, raising capital from institutions at 72 cents a share.

Within a year, Henderson had organised a sale of the UK insurance businesses, which were closed and in run-off mode, for $2.6bn and returned $2.2bn to shareholders, leaving it as essentially a pure funds management company. Recently, Henderson shares have traded at around $4.

Beyond the ASX listing it retained — and which, despite relinquishing its London listing, the new entity will maintain — Henderson has a presence in this market, as does Janus. Each has about $US12bn under management in Australia.

Interestingly, the merged group, which will have dual chief executives in Formica and Janus’ Dick Weil, will be headquartered in London despite relinquishing its London listing. London, despite Brexit, is regarded by the companies as the best centre for a global asset management business.

For Henderson investors, who saw their shares plummet nearly 30 per cent in the immediate aftermath of the Brexit vote — and only regained their pre-Brexit level in response to the merger announcement — the deal will dilute a Brexit risk that Formica said would, over a 10 to 15-year time frame, be regarded as “just a drop in the ocean.”

While the merger, its terms and hopefully its success is directly relevant to Henderson’s local shareholder base, the rationale for the deal has wider significance.

Active fund managers are being slaughtered by passive managers in terms of fund flows, largely because of their cost/fees. In the US assets managed within index-tracking funds, which charge about a quarter of the fees of active managers, have been growing at four times the rate of the active managers in recent years.

It isn’t only the cost advantage that has powered the index managers like Black Rock, State Street and Vanguard but the fact that the passive managers have generally outperformed the average active manager. To compete, active managers have to lower their costs and add value beyond the indices.

Lowering costs is becoming harder because, globally, the costs of regulation for the sector are rising.

In Europe, there is a series of far-reaching, and costly, reforms to financial services regulations that will cut in from 2018. As Formica said last night, the costs are the same whether spread over $US10bn of assets or $US100bn, which means scale becomes valuable.

Out-performing passive funds is a more complex issue for active managers given that their performance tends to be assessed relative to the performance of the indices for their various asset classes, which creates a tendency for managers to hug their benchmarks rather than risk underperforming and losing funds under management.

The growth and scale of passive funds also complicates active investment given that the nature of index-tracking means that it exaggerates movement in the indices — the passive funds generate momentum in markets that is unrelated to concepts of value.

That’s an issue that financial regulators are starting to pay attention to as the index-trackers become ever-larger market participants, given that it may generate significant concentration risk, greatly exaggerate market volatility and muffle the risk-return signals that markets are supposed to provide.