In mid-April, we hosted a webcast for over one hundred executives in the wealth management industry to specifically address how the sudden changes in market and economic conditions were influencing merger and acquisition activity.
Astonishingly, we received more than 50 questions before the webcast, with the majority focused on one topic: Valuations.
Coming off of a record year for M&A in 2019 – the seventh straight year that activity levels hit at an all-time high – a clear psychological and emotional concern had emerged. Would the COVID-19 crisis cause M&A activity to come to a halt and force deal values to plummet?
The velocity of change has a way of shaping the reality left in its wake.
It was clear that even leaders from some of the most successful businesses in financial services industry needed to hear an important reminder.
“Emotionally, you are in one place,” said Dan Seivert, the founder and CEO of ECHELON Partners. “Cognitively you need to be in another.”
Here’s the truth about valuations in the wealth management industry now: While equity markets experienced a historic decline in the first quarter, it was one chapter in a story that has much more depth and a number of more important defining characteristics.
The Two Truths
There are two critical considerations – let’s call them the Two Truths – that carry much more weight than the 20% drop in the S&P 500 during the first quarter.
1) Most wealth management firms are managing diversified portfolios for their clients, and equity exposure could account for just 60% the assets they manage, with fixed income and alternative investments making up the balance.
2) When a firm is acquired, a rolling four-quarter period leading up to a deal’s close is commonly used to analyze and assess a firm’s financials.
Combine these Two Truths and a more balanced view of reality emerges: On a rolling four-quarter basis through March 31, the S&P 500 declined 2.1%. The Bloomberg Barclays U.S. Aggregate Bond Index was up 2.2% across the same rolling period.
Applying these returns to a balanced portfolio of 60% equities and 40% bonds: The decline during a rolling four-quarter period at the end of March was a nominal 0.7%.
To be clear, wealth managers, whose revenues are largely based on fees charged to clients for the assets they manage, will take a financial hit during the first quarter, without question.
But the overall value of their businesses will be significantly less impaired on a relative basis.
The Bottom Line
A track record of established growth and recurring revenue streams, coupled with an expanding universe of professional buyers and funding sources, will continue to drive strong deal values in the wealth management industry. Equity markets have also surged since the close of the first quarter, with the S&P 500 up nearly 15% through May 5, and some of the revenue declines from the first quarter could be offset if markets remain relatively stable.
Will 2020 be yet another record year for M&A activity and deal values in the wealth management industry? While it is too soon to tell right now, activity remains strong and many deals continue to close and progress. We are gaining more information every day about the future of our economy and the impact it will have on the wealth management industry.
And that is precisely why I started this blog: To give you an inside – and an honest – point of view into the rapidly changing world of wealth management. These are unprecedented times and I’m privileged to have the opportunity to regularly share information and observations about the evolution of this industry. I invite you to submit questions and topics for future blog posts to me directly at firstname.lastname@example.org
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