Taken together, the factors make the economics of hedge fund firms increasingly problematic. With FRM currently managing around $8 billion, the enlarged fund of funds group in Man will be running around $19 billion. And while that merged operation will be rebranded FRM, its partners, including controlling shareholder Blaine Tomlinson, are doing the deal without any upfront consideration.
“This financially compelling transaction provides us with the opportunity to significantly improve the profitability of our multi-manager business,” Peter Clarke, the Man Group chief executive said. “By combining the complementary investor bases of the two businesses and pairing FRM’s well regarded investment process with Man’s managed accounts infrastructure, we can increase revenues with no material change to Man’s current cost base. The transaction has been structured so that the consideration adjusts in line with asset retention, to ensure an attractive return for our shareholders.”
At a time when many funds of funds are struggling to make money the Man-FRM deal creates business level synergies that are strong. Annual operating costs will fall post-integration by about $30 million. It will also bring Man’s multi-manager business closer to a number of sovereign wealth funds and insurance company investors. Integration risk is being minimised with Luke Ellis, the former FRM managing director who took over Man multi-manager in 2010, being kept on to run the enlarged operation, while Tomlinson will chair the unit.
“The truth is there are a lot of unique characteristics around this transaction,” Clarke said, citing the complimentary client and geographical balance of the businesses as well as the expertise of Ellis in both operations. “It makes the risks associated with execution very low. This is a significant move for the multi-manager business. (It is) a low risk and financially compelling one, that is relatively unique. There aren’t a lot of these things around.”
A prime consideration for Man Group is the acquisition price. For a firm that once had fund of fund assets exceeding $50 billion, the attractions of bulking up without a down payment are obvious. Though the deal probably won’t propel Man shares toward a rerating with investors, it should be accretive to earnings per share immediately.
The ceiling on the consideration for the transaction is $82.8 million dependent on asset retention plus a share of performance fees over the next three years. This amounts to a modest 1% of FRM’s current AUM and likely some $20-50 million later covered by performance fees. Philip Middleton, analyst with Bank of America Merrill Lynch, says the acquisition isn’t expensive, costing about 2.5 times FRM’s annual management fee revenue.
Reaction to the link-up from rivals is predictably critical and perhaps exaggerated. Asked to comment on the deal, a rival fund of fund executive said: “Weak + weak = weak.” Another US hedge fund veteran observed that “two failed business models don’t make a successful one.”
Investors, however, bid up Man stock around 5% when the deal was announced on May 21, though the stock remains mired at decade lows. As well, each segment of the business has a positive performance record from inception (See Table 1).
Certainly, it is impossible to imagine the Man-FRM deal being done on similar terms only a few years earlier. Indeed, it is rumoured that FRM had previously rejected more than one overture from potential suitors that valued it at upwards of $500 million. True or not, it is undeniable that the perceived value of funds of funds businesses has fallen. Indeed, exactly a decade ago Man paid $837 million to acquire RMF – a fund of funds which at the time of the deal had only slightly higher AUM than FRM does now.
For Man shareholders, the most immediate gain is that the multi-manager business which has struggled to make a profit in recent years should now do so. Prior to the credit crunch, Man ran multi-manger businesses with over $50 billion in assets. However, internal deleveraging, fallout from RMF losing $360 million in the Madoff fraud and investors accessing hedge fund managers directly has hit the multi-manager business hard. Bringing in FRM, will thus give multi-manager a leg up and help it, in Clarke’s words, “get on the front foot again.”
SMT approve deal
Around 50% of FRM’s assets come from clients advised by Sumitomo Matsui Trust which effectively pre-approved the transaction. Man has an existing relationship with SMT which is an investor in the AHL managed futures fund. This is thought to have made it relatively easy for SMT to tacitly approve the transaction.
After that a further 30% of FRM’s assets come from a combination of six to eight single client accounts held by sovereign wealth funds and insurers. Man executives said in the investor call that most of these investment relationships date back to Ellis being at FRM. The response of these investors was termed “constructive” and it is thus thought they will remain onboard, but the transaction has hedges should a significant number of them depart.
“Our goal with this acquisition is to be able to provide solutions across a (wide) spectrum,” Ellis said. “To have best of breed co-mingled products; to have flexible solutions across managed accounts and pure infrastructure solutions.” Scale, he added, means greater ability to invest in infrastructure and benefit from better terms and conditions.
“It is a given that institutions are going to invest more in hedge funds given tiny bond yields and low beta equity returns,” he added.
“The question is how can institutions build a hedge fund investing programme? Going solo (is possible). But most pension funds don’t have the resources so they need help (whether) they buy a fund of fund, use a consultant or do other things.”