Decline of 138-year-old wealth icon shows bigger isn’t always better

The idea that bigger is better pervades much of the business world: CEOs don’t typically boast about plans to shrink the company. However, the story of a 138-year-old icon of Australian financial services shows how rapid growth through acquisitions can be a very different matter from delivering performance for shareholders.

The big talking point in local funds management lately has been the break-up of Perpetual, an investment conglomerate founded in 1886 by a group of people including Australia’s future first prime minister, Edmund Barton. Last week, US private equity giant KKR proposed to split up the company, in a deal that would remove the Perpetual brand from the well-known stock-picking business.

Perpetual shares have fallen about 40 per cent, even as funds under management have surged due to acquisitions.Credit: James Alcock

Is it surprising Perpetual looks set to be broken up?

Not really. The company’s share price has dropped 40 per cent in five years, and there’s long been speculation about it selling off its corporate trust business. Late last year, it launched a “strategic review” – always a sign that a deal is likely – after receiving a takeover bid from its biggest shareholder, Washington H. Soul Pattinson.

What might surprise you, however, is that while Perpetual’s share price has been sliding, the actual business is far bigger than it was a few years ago, thanks to a buying spree. It has more than $200 billion in funds under management today, compared with $27 billion in 2019, after a string of acquisitions under chief executive Rob Adams.

What’s more, the rationale for these acquisitions was generally pretty sensible. Perpetual was trying to get greater “scale”, in response to the industry-wide challenge of outflows and pressure on margins.

Funds management can be highly lucrative when it’s going well, but lately this business model has been steadily eroded by pressure from two giants of the investment world: global index funds and superannuation funds.

Its expansion stands in contrast to its ASX-listed peers Magellan Financial Group and Platinum Asset Management, which have also experienced (worse) share price weakness, but are managing much less money than they were five years ago.

So, why hasn’t becoming a much bigger business paid off for Perpetual shareholders?

To answer this, it’s worth first looking at the tough backdrop facing stock pickers such as Perpetual, Magellan and Platinum.

These businesses are all “active” managers: they charge investors fees for attempting to beat the sharemarket’s average return. Funds management can be highly lucrative when it’s going well, but lately this business model has been steadily eroded by pressure from two giants of the investment world: global index funds and superannuation funds.

Index funds – also known as “passive” funds – charge a fraction of the fees of active managers to give you the average returns from a market index such as the ASX 200. Given how tough it is for fund managers to consistently beat the market, more and more people have decided to put their money in an index fund.

Super funds, meanwhile, are also throwing less business to external fund managers such as Perpetual. Under pressure to cut their fees, more and more super funds have become so large that it makes more sense for them to employ their own fund managers, rather than pay external managers.

The bottom line: many active managers have suffered outflows, and profit margins are being squeezed.

Perpetual’s response to this unhappy situation was to get more “scale”, by bulking up its funds under management. It bought environmental, social governance stock picker Trillium in 2020, then it snapped up a larger US fund manager called Barrow Hanley, and finally, it merged with its big local rival, Pendal (formerly known as BT Investment Management).

In picking over Perpetual’s poor share price performance in recent years, analysts and investors agree that it probably needed to gain scale, but they say it had mixed success with these deals. Buying Trillium was a success, but many believe Perpetual overpaid for Pendal, a deal finalised in early 2023.

Critics at the time also highlighted the difficulties of merging fund managers, which can result in key money managers leaving, or in added complexity.

Since the Pendal deal was finalised early last year, Perpetual’s shares have fallen about 15 per cent. Private equity giant KKR now wants to buy Perpetual’s corporate trust business and a wealth management arm, leaving Perpetual shareholders owning a “pure play” fund manager with about $200 billion in funds under management.

How would a stand-alone and specialist fund manager deal with the industry-wide challenges of stiff competition from index funds and the growing clout of super funds?

Perpetual argues that it will have the scale and range of different investment styles it needs to grow “organically” (without buying other firms). Perhaps, but there’s little doubt it is a harder environment for stock-picking businesses, even ones managing $200 billion.

Morningstar analyst Shaun Ler says even after the proposed break-up of Perpetual, the company will still face the same long-term challenges to its business model.

Passive funds or quant funds using algorithms can often effectively match the average market-wide returns for a much lower fee than what is charged by active managers, including Perpetual. While some stock pickers beat the market, it’s very hard for them to do this consistently over the long term.

“There are active managers investing into global equities that charge more than 1.3 per cent of [funds under management], but there are passive options that can do the same thing and charge around 0.2 per cent or less,” Ler says.

“There is still room for active managers, but I would say the consistently poorer performing ones are at risk of closure or being consolidated. The surviving ones need to rethink their business proposition, their fees and their cost base.”

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.