Financial empire-building - no thanks

'Small herbs have grace, great weeds do grow apace:
And since, methinks, I would not grow so fast,
Because sweet flowers are slow, and weeds make

King Richard III

“Size matters” they say.  Unlike most advertising slogans this one can mean whatever you want it to.  If you wish, size can imply bigness and all the economies of scale that go with it.  If you prefer, it can refer to smallness and implied virtues of simplicity and clarity of content.  Which extreme depends on the message to be put over.  Size of itself is merely a reference to dimension.  Business today generally prefers its message to portray bigness as a prerequisite for growth, widened choice, and all that is good and glorious in the commercial firmament.

If sheer bigness is their main aspiration, businesses have broadly two choices.  They can become big through organic growth.  That route has much to commend it.  Alternatively, they can grow by buying or merging with another entity.  In 2018, global takeovers and mergers have been running at near record levels.  The value of these takeovers amounted to an unimaginable total of US$3½ trillion in the first nine months of this year.  Part of the cause of this activity lies in the difficulty of sustaining revenue growth over a decade of slack demand.  Takeover and merger activity has also been spurred by companies’ ability to borrow money at irresistibly low rates of interest.  Yet the dominant factor underlying bigness mania is, in all probability, naked ambition.  Business leaders’ desire to run ever bigger empires exerts a constant pull.  Furthermore, executives’ remuneration is often linked to measurements of scale – in hard numbers, the biggest companies tend to pay bosses the most.  In the UK, FTSE company CEOs received an average package worth £5.7 million in 2017, 18x the pay of those running smaller quoted companies.  Bigness means more responsibility, and therefore justifies more pay, so the argument runs.

But business has to be careful.  Sometimes the pendulum of customer preference can swing from one extreme to the other.  Size preferences have to be adjusted to suit changed priorities.  40 or so years ago nationally recognised beer brands monopolised space on a UK barman’s shelves.  However, consumer habits shifted.  National brands now contend for space with a huge range of locally produced craft beers.  Products from local, smaller scale breweries occupy as much shelf space as national brands.  Naturally, well established supra-national brands still enjoy global reach and acceptance. Nevertheless, another business model has found its place in the industry.

In our own sector, there are signs of a shift in customers’ preferences.  As in other commercial fields, giants in the making have become aware of a need for their message to convey a concern for the personal touch.  Certainly the financial industry is consolidating rapidly.  But in recent cases, mergers and takeovers look more like defensive manoeuvres aimed at protecting existing market positions than evidence of ambition building on strength.  In the first half of 2018, the value of merger deals in the UK financial sector totalled £12½ billion.  When it comes to size, few of these have exceeded that of Standard Life and Aberdeen Asset Management a little over a year ago.  Since the merger announcement, the group’s share price has fallen (after adjusting for a once-off cash distribution) by 32%.  The scale of the fall may be prompting some shareholders to reconsider the wisdom of the agglomeration in the first place.  Obviously it is far too
early to assess the worth of the project in the longer term.  Nonetheless, its promoters have a fair bit of credibility to recover.  It is no consolation that the value of some other big fund management groups has also fallen.

In the case of publicly quoted investment management companies, the rationale offered generally centres on a need to spread rising costs of compliance, administration, and IT spending over a bigger revenue base.  As justification for a merger deal, parties sometimes hold out the expectation that customers and clients may be persuaded to pay up for a more comprehensive investment service.  No doubt some will be convinced.  Just how many customers will accept their status as simply a revenue stream in someone else’s business expansion plan remains to be seen.  The danger is that as financial businesses grow, formerly independent firms become mere satrapies within a financial empire.  Receptionists and checkout staff or their equivalent in the wider commercial sector usually continue to be cheery and helpful.  Similarly, culture change within merged fund management groups is not necessarily evidenced by the client-facing people.  Local fund managers will be generally well known to loyal and appreciative clients.  Noticeable change is more likely to occur in the shift from local control and accountability to a new relationship between branch and hub.  Experience suggests that takeover planners often underestimate the risk of trying to merge what may be very different cultures.  Rather than culture assessment, revenue and cost considerations will likely have underlain the acquisition strategy in the first place.  The same considerations will govern its future direction.

The trend to bigness in our sector is both cause and product of another problem.  That is the growth of regulatory intervention in the sector.  When big firms get into trouble, bigger problems ensue for the wider public.  Regulation has to catch up.  Despite recent restrictions on trading for their own account, so-called investment “banks” still conduct a large range of activities, many related to short-term trading of various sorts.  Esoteric financial instruments known as “derivatives” today constitute by far the largest amount by value of trading on American and UK capital markets.  Various ancillary banking services underpin such activity.  When the bell rings time on current market trends, much of the financial system will be exposed to risks already visible.  These include possible breakdown in the chain of settlement procedure for derivatives contracts.  Lehmans will not be the last entity to expose a systemic risk.  Risk today remains rooted in a loss of the means to control every link in a long financial chain.  Of course smaller financial firms can run into problems too.  Even so, they generally pose little risk to the whole system if only because their operations are rarely complex and clients’ assets are in any case ring-fenced.  Smaller firms are capable of keeping effective control over their affairs.

Candyfloss phrases routinely sugar the creation of yet another financial colossus.  Yes, automation is changing the world, is essential to the efficiency of most financial entities, and is costly to install.  Sure, if you want to build a vast financial conglomerate, you need a lot of moving parts and a wide range of skills.  Some skills may need to be acquired.  As to the merits of bigness for its own sake, there is one simple question to answer.  Does it engender a culture that customers will want to be part of and within which employees will be content to spend their working lives?

This firm’s own role in the sector serves but one purpose.  That is to develop and sustain mutually rewarding professional relationships with its clients.  And yes, success in this effort too depends to a degree on costly inputs.  Success, however, does not rely on sheer scale, but on addressing customers’ real needs and inculcating in employees a sense that the work is worth doing for its own sake.

The media have hijacked the French word “boutique” to describe firms like this one.  The term conveys the image of a cosy little shop retailing high-quality ladies’ clothing in a side road off Regent Street.  Successful boutiques are very often owned and run by individuals or families.  If financial shoppers recognise some of these attributes in what happens here, well and good.  It feels like no bad thing to be a member of such a club.

Who knows? Perhaps one day changed dynamics entailed by the evolution of our sector may persuade us otherwise.  Yet as far as one can see, the grounds for a relatively small firm to keep ploughing its own furrow seem stronger than ever.  The prospect of continuity is vital to any enduring relationship.  Presumably that is what clients want to see.  So far as size goes, there are signs that the pendulum of customers’ preference may be beginning to swing back to the “boutique” end of the management scale.

If it swings further, that can only reflect a growing conviction that, at a time of tumultuous change in the financial sector, continuity of culture and competence has a value all its own.  Continuity in those respects is the quality above all that characterises the successful boutique.  We aim to sustain it.

16th November 2018

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