Blitzscaling or Blitzflailing

• Top 25 largest firms captured more than a third of capital allocations
• Three-quarters of asset managers considering a strategic consolidation with another asset manager
• GCM Grosvenor says formation of new funds or platforms will remain suppressed - investors currently show a preference for established managers??

In retrospect, last year began comparatively benign even considering the extraordinary forced marriage of UBS and Credit Suisse. The merged company instantly became a top 5 real estate investment manager with €156bn in assets. Then, the deals came in quick succession, CVC purchasing a majority stake in DIF Capital Partners, TPG acquiring Angelo Gordon, and many others. Size matters. In 91 of the 157 primary industries tracked by S&P Global Market Intelligence, the five largest U.S. companies by revenue combine for at least 80% of total revenue among publicly traded companies in their respective industries. In private markets, the top 25 largest competitors captured more than a third of the $506bn of new capital allocated to PE towards the end of 2023. There is a real bifurcation between the managers that can raise money and those that cannot; which will accelerate the process of natural selection as the industry grows in size.

There is likely to be plenty more activity to come in 2024, following the largest decline in global assets under management in a decade. According to the PwC Global Asset & Wealth Management Survey one in six asset and wealth management companies is expected to either be acquired or fall by the wayside in the next five years, with nearly three-quarters of asset managers considering a strategic consolidation with another asset manager. The result will be consolidation: it is predicted that by 2027, the top ten asset managers will control around half of mutual fund assets globally, up from 42.5% in 2020. Moreover, private markets are anticipated to contribute up to half of Asset and Wealth Management (AWM) revenues by 2027, up from 37.6% in 2020.

Last year was also a challenging one for the alternative assets industry. The scarcity of M&A and IPOs hindered managers from returning cash to their limited partners, who, in turn, are hesitant to commit new funds. The pain is expected to continue. Bain & Company's analysis of Preqin data indicates that funds seeking to raise $3tn from investors are likely to raise only $1tn. More concerning is the potential impact on the viability of some private capital managers. According to Partners Group, the industry is likely to contract to just 100 "next-generation" firms. While concentration is a common occurrence in maturing industries, the key question remains whether asset allocators will be comfortable channelling funds to a select few fund managers.

According to Alvarez & Marsal, citing investment bank Piper Sandler, as of October last year there were 321 global asset management transactions. Consolidation in the private markets space was necessary as managers strove to expand assets under management and fees they generate in a more challenging environment. Merger and acquisition activity was also driven by alternative funds’ need to expand into new geographies, business lines and/or asset classes. A&M continued, writing that a sample of deals in 2023 show alternative managers were looking to acquire new capabilities away from their traditional core competencies, observing that “large, Private Markets managers seek[ing] opportunities to diversify offerings, increase asset gathering and expand fee related earnings (FRE) margins.”

Brookfield Asset Management anticipates that challenging financial markets will continue to drive the consolidation in the private capital industry too, with smaller players seeking refuge within larger financial institutions giving rise to a handful of industry giants. Bruce Flatt, CEO of the Toronto-based group, which oversees $834bn in assets and is the second-largest alternative asset manager globally, stated, “Every industry eventually goes through consolidation. Every industry goes through this cycle, and the alternatives industry is in the midst of this today.” Brookfield has been a major force in this consolidation, acquiring a controlling stake in credit manager Oaktree Capital Management in 2019. It invested $174m in the most recent quarter to raise its ownership of Oaktree from 64% to 68%.

BlackRock is another major player, it's venture into alternative investments led to discussions with Warburg Pincus as the world's largest money manager aimed for a transformative deal that could reshape the $27tn private funds industry. BlackRock was keen on a collaboration with Warburg Pincus because its CEO, Larry Fink, had identified alternative investments as a strategic growth area. BlackRock announced its acquisition of Global Infrastructure Partners (GIP) for $12.5bn, marking a significant move into alternative assets. BlackRock, which manages $10tn across all markets, has been on the hunt for a transformative deal, with CEO Larry Fink stating last year that the company was engaged in more deal talks than it had been in 'many, many years.' Established in 2006, GIP manages a portfolio of more than $100bn, which includes assets such as Gatwick airport, the Port of Melbourne, and major offshore wind projects. “Infrastructure is one of the most exciting long-term investment opportunities, as a number of structural shifts re-shape the global economy," said Fink. Infrastructure has gained popularity as an investment class, due to the enormous expenditure needed to move away from high-carbon energy and the growing demand for digital infrastructure and logistics.

Private market consolidation is true in the real estate milieu too. Speaking the year before last in Real Estate Capital, Savills Investment Management's CEO expected to see further consolidation across the global real estate universe as larger managers acquire small market players to expand their expertise. “Both on the equity and debt side, the process of investing in real estate is becoming more intensive and requires significantly larger resources than was ever the case.” “Firms getting bigger also enables them to spread the cost of that expertise across a wider pool of assets under management, therefore keeping fees low for the benefit of clients.”

In a rare bright spot, Cambridge Associates anticipates a favourable environment for credit strategies in 2024 that provide capital solutions to larger corporates, especially those that would typically access the public market or can opportunistically pivot into distressed situations. While acknowledging that individual manager performance may vary, the expectation is that the next vintage of European opportunistic private credit managers will deliver returns above the average in the coming year.

Peter Braffman, Managing Director of Real Estate Investments at GCM Grosvenor, takes a rather different view claiming that the next three to five years will present an exceptional opportunity for emerging managers. Although, he notes that the current economic environment has significantly hindered the acquisition market, and this is unlikely to change until there is capitulation on asset repricing. Consequently, the formation of new funds or platforms will remain suppressed until such a shift occurs. He too identifies the debt space as an exceptional opportunity, which is expected to witness the emergence of new credit platforms capitalising on current interest rates and illiquidity. However, even in this domain, investors are currently showing a preference for established managers well-positioned to deploy debt capital promptly in this limited window of opportunity. Braffman highlights historical patterns, noting that after-market dislocations such as post-RTC in 1992, post-dot com in 2001, and post-GFC in 2007, there was a surge in new fund and business creation. This was mainly driven by the chance to acquire assets at cycle-low valuations. Additionally, the uncertainty surrounding the main economic disincentive to spin out – unrealised carried interest – has increased for many investment professionals. Braffman sees this as a time for individuals with entrepreneurial spirits to initiate new firms “While this vintage will have its own unique vagaries, likely including increased consolidation of the industry and more compressed windows for managers to be able to scale their businesses, that should not dampen this coming moment for emerging managers.”

America has 4,700 banks and savings institutions, or one for every 71,000 residents. In the EU, there is only one bank for every 85,000 people. Continued consolidation is likely. Similarly with the brokerage community. In the US for example there is approximately 125,000 brokerage firms, owners of smaller firms may seek to offload operational burdens in weak market conditions. However, Newmark CEO Barry Gosin threw cold water on any smouldering embers of merger talk on his company's recent earnings call when an analyst asked him if he thinks there is a "strong rationale for large-scale M&A" among the large publicly traded brokerage firms. "No, I don't," Gosin said, according to a Seeking Alpha transcript. “I think the enormity of friction and the conflicts and the coverage and the crowded nature makes it very difficult for large companies to merge. There has to be a perfect synergy and fit. And there's a point of no return or indifference makes it really, really hard to do.”

‘Scaling’ has become de rigueur doublespeak in the corporate arena. Reid Hoffman, one of Silicon Valley’s most illustrious personalities; founder of PayPal, LinkedIn, an early investor in Facebook and partner at venture capital firm greylock, co-authored in 2018 “Blitzscaling: The Lightning-Fast Path to Building Massively Valuable Companies.” It’s a concept that encourages entrepreneurs to prioritize speed over efficiency during a period of uncertainty and has intellectual parallels to World War II military tactics of “blitzkrieg”. The relevant parallel to the real estate industry shouldn’t have been the speed at which a business needed to grow – indeed, when WeWorked crashed, Hoffman posted an article on LinkedIn entitled “WeWork: Blitzscaling or Blitzflailing?” – but in the terminal size they need to become. As we have demonstrated, size matters. The larger the firm, the higher fees a business generates, the better the ability to expand into new geographies or asset classes, the easier access to capital becomes and much else. Smaller, niche firms do have an important place in the constellation amongst real estate managers, but success portends their demise. Bezos put it thus: “On the Internet, companies are scale businesses, characterized by high fixed costs and relatively low variable costs. You can be two sizes: You can be big, or you can be small. It's very hard to be medium.”