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T Rowe Price diversifies with Oak Hill deal

T Rowe Price is known for several things: strong actively managed fund performance, low staff turnover and successful investments in companies such as Twitter and Warby Parker long before they went public. One thing it is not typically associated with is dealmaking. The Baltimore-based group has reached $1.61tn in assets under management (making it a top 20 player globally) largely through organic growth — shunning the route of so-called transformational mergers and acquisitions that some rivals have gone down.

But that all changed on Thursday when T Rowe unveiled the acquisition of New York-based Oak Hill Advisors for up to $4.2bn in cash and shares. It is the largest deal in T Rowe’s 84-year history, and ranks number 13 in terms of the biggest asset management industry deals of all time, according to Dealogic. Shares in the asset manager rose 5.7 per cent on the day the deal was announced, and this year they have nearly doubled the S&P 500’s performance. Read the full report from me and US investment editor Michael Mackenzie here.

So what does this transaction tell us about the state of the asset management industry?

Private markets are hot right now (as if we needed further confirmation)

For T Rowe, the deal marks a shift from being an active asset manager focused mainly in equities to a more diversified business, with a strong and growing position in one of the most desirable parts of the market: alternatives. Oak Hill has $53bn in assets under management across private, distressed, special situations, liquid, structured credit, and real asset strategies.

“There are three areas that investors are allocating their money towards. Passive, ESG and private markets,” said Rob Sharps, president and head of investments at T Rowe, who takes over as chief executive from Bill Stromberg when he steps down in January. “Passive is not a strategic aim for us,” added Sharps. “We are building our ESG presence, so that leaves private markets.”

Investors are rushing into private capital strategies in pursuit of growth, hoping that returns there will counteract the dimming outlook for traditional equity and bond markets. The overall industry, which includes sectors such as private credit, private equity and infrastructure, grew to $7.4tn at the end of 2020, is now about $8tn, and is expected to hit $13tn by the end of 2025, according to Morgan Stanley.

The oft-heard mantra is alive: differentiate or die

The march of low-cost passive providers such as BlackRock, Vanguard and State Street dealt a strong blow to the active asset management industry, heaping pressure on prices they can charge investors. The asset-weighted average cost of an actively managed US mutual fund has shrunk by a third over the past three decades, according to Morningstar, and no one in the industry thinks this trend is going to stop any time soon.

In this environment, groups such as T Rowe, Capital Group and Baillie Gifford have justified their existence — and their fees — by proving that you can beat the index if you take long-term, concentrated bets on individual stocks.

In many ways the growth of private assets (just look at the booming value of the five US listed groups) is another weapon in the fight against the passive tide: these strategies command a premium for locking up your money, they are difficult to replicate in a low-cost exchange traded fund, and they are growing as quickly as passive investing. Their growth reflects the “barbell” approach that many investors are adopting: allocating to cheap ETF strategies at one end of the spectrum, expensive alternatives strategies at the other — and squeezing out everything in between.

Toppy times: ‘systemic risks’ ahead

T Rowe’s purchase price for Oak Hill implies a mid-teens to high-teens multiple on 2022 earnings after-tax distributable, according to Morgan Stanley, a valuation that analysts said reflects heady competition for assets in this space.

But it is also worth sounding a note of caution amid the gold rush. My colleagues Robin Wigglesworth, Joe Rennison and Antoine Gara covered a striking report from Moody’s rating agency last week, which warned that opacity, eroding standards and the difficulty in trading private credit pose “systemic risks”.

While the rise of non-bank lenders such as Apollo, Blackstone and Ares has been a boon to many companies at a time when banks have retrenched, Moody’s says the “explosive” growth of private credit is storing up risks in a hard-to-monitor corner of the financial system. Meanwhile, Robin also argued in a recent column that the private capital party is getting dangerous and investors chasing after high returns could ultimately be left disappointed.

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Record profits are easing pressure on an industry hit by the global chip shortage

The booming used-car market has helped carmakers’ finance arms post record profits over the summer, easing the strain on the auto industry as production and sales are hampered by the global chip shortage.

Volkswagen’s financial services arm, which includes a bank and offers leasing, insurance and financing in more than 45 countries, almost trebled its pre-tax profit in the three months between July and September, to €1.5bn, the company said this week.

The German group’s car division, which delivered 2m vehicles worldwide during that period, made just €100m more, having been forced to shrink production by nearly a quarter due to supply chain bottlenecks.

Arno Antlitz, VW’s chief financial officer, told reporters that the financial services arm had benefited not just from higher demand for used cars, but also from “very good residual values and low risk costs”.

Carmakers’ financial arms tend to underwrite the financing for their dealers, and benefit both from higher-value loans and from used cars having a higher than expected resale, or residual, value at the end of their lease.

Prices in the used-car market have rocketed during the past year because of the squeeze on new car sales caused by the global chip shortage. In many cases, second-hand vehicles are changing hands for higher value than their factory-fresh counterparts.

VW competitor General Motors’ finance division also more than doubled its profits in the nine months to the end of September, the US carmaker revealed, with pre-tax earnings rising to $3.9bn, compared with $1.7bn a year ago.

“The big drivers were obviously the strong used-vehicle values . . . and lower depreciation expense for the nine months, as well as lower provision for loan losses as a result of the reserve levels that were increased in the first half of 2020 at the onset of the pandemic,” said chief financial officer Susan Sheffield.

Ford Credit, which provides financing for the American company’s customers and dealers, posted $3.7bn in earnings before taxes in the same period, which included a record-breaking second quarter. The figure already exceeds 2020’s total by $1bn.

Daimler’s financial services arm, Daimler Mobility, was hit by supply bottlenecks in the last quarter, but the Stuttgart-based carmaker said it, too, was aiming to “utilise new market potential in the used-car market as well as through more flexible leasing and rental products, especially for electric vehicles”. 

Not all carmakers have in-house finance arms, but some of them are moving into the area, conscious of the profits to be made.

Stellantis, the group formed by the merger of France’s PSA and Fiat Chrysler, is in the process of opening one in the US after buying financial services group First Investors in September.

“I think it’s really important for the business to have a finco,” Stellantis finance boss Richard Palmer said last week. “It’s clearly a big source of profitability in the medium term,” he said, citing rival GM’s decision to buy AmeriCredit as a foundation for its lending business, which now gives it a “very strong portfolio with a very profitable business”.

As their main businesses have been squeezed, some carmakers have even tapped their own finance arms to help fund their overall business. Renault received €1bn from RCI Banque, its in-house finance arm, after the European Central Bank changed rules this year about limits to dividend payments. The injection gives the French carmaker “sufficient margin to cover investment and restructuring” for the second half of the year, chief financial officer Clotilde Delbos said earlier this month.