The Fix for Schroders? Follow Morgan Stanley’s Blueprint

(Bloomberg Opinion) — The stock market appears to be giving up on the most prestigious name in UK investment management – the venerable Schroders Plc. New Chief Executive Officer Richard Oldfield has limited options for restoring confidence. But the Schroders name still commands respect, and Oldfield has enough freedom of movement to achieve a share price to match.

Schroders’ market value has halved to £4.8 billion ($6.1 billion) in three years and much of that drop has come this year. Investors have valued the firm at an ever-decreasing multiple of its expected earnings, fretting that it has no viable growth plan. Earnings haven’t fallen as rapidly as the stock price and assets under management recently hit a record £777 billion.

The problems stem from its tepid response to the so-called “barbell” dynamic — the industry’s polarization between low-fee passive funds and high-fee alternative strategies offered by hedge funds and private equity firms. Traditional stock-picking occupies the painful middle ground.

Previous Schroders CEOs saw the problem and wisely diversified into private equity and other areas. Unfortunately, these initiatives were pursued with British understatement. What was needed was the brash, big-check-writing approach of US giant Blackrock Inc.

Oldfield must now focus on where he can win. Schroders has built a strong wealth-management business, which clearly commands trust among a large strata of the UK’s rich, who would surely have been impressed when Queen Elizabeth II opened its new headquarters in 2018. The franchise includes Cazenove Capital, which Schroders bought after US lender JPMorgan Chase & Co. acquired the broking arm of the Cazenove investment bank. Wealth management contributed less than 30% of operating profit in the first half of the year. It’s a no-brainer that Schroders should accelerate its strategy here by scooping up some of the many boutique firms servicing family offices across Europe.

Likewise, Schroders’s so-called “solutions” business, which advises pension funds and insurers on portfolio structuring and risk management, is a keeper. The revenue is prone to swings as large mandates come and go. But it’s an attractive niche.

That, of course, leaves the core business of asset management, an operation spanning mutual funds, institutional investing and the fledgling private capital unit. This business is for now reasonably profitable but is hard to grow. It needs scale in order to lower fees and stay competitive.

For Schroders’s operation to get to anything remotely comparable to, say, Capital Group Cos.’s $2.7 trillion under management requires either being subsumed into something bigger or buying up other sub-scale rival outfits. Tieups allow you to slash duplicate costs and brutally cherry pick the best portfolio managers from the combined pool.

Easier said than done. For starters, it’s not in Oldfield’s power to engineer a buyer. The bigger players in active asset management are mostly trying to diversify into alternatives rather than double down on their legacy business. And Schroders can scarcely afford to make acquisitions of its own with shares as weak as they are. Using debt would limit resources to invest in the more promising parts of the business.

Hence the default strategy in asset management is probably the one that’s most realistic: Make the business as efficient as possible; use the cash flow to invest elsewhere; wait and see. As Schroders’ revenue mix gradually reweights toward wealth management, so the share price should respond. Wealth-management stocks generally trade at higher multiples of profit than conventional asset managers. If a partnership or sale opportunity presents itself in the meantime, wonderful. Otherwise Schroders may gradually earn the backing of its shareholders to lead consolidation itself.

That leaves the private markets arm, Schroders Capital. It simply needs more client funds. How can it attract them when competing against Blackstone Inc., KKR & Co. and Apollo Global Management Inc.? Good luck pitching against these buyout leviathans for money from US endowments and pension plans.

Hence Schroders would be well advised to strike an alliance with one of the big incumbent private equity firms to give both sides more chance of winning business — above all targeting its existing clients as they allocate more to “alts.” Sharing bigger gains could be better than owning 100% of what Schroders can do by itself.

The stunning re-rating of Morgan Stanley stock — to more than twice its book equity value from less than 100%  — under former CEO James Gorman should provide inspiration. He expanded the US investment bank’s position in wealth and asset management, diversifying from volatile trading and corporate finance earnings.

What about a takeover of Schroders? The mix of businesses makes it look like a good fit for a universal bank. Imagine a combination with, say, JPMorgan. That would reunite the two Cazenove franchises and generate synergies in wealth and asset management. Or a private equity bid – the buyout industry has also been targeting the wealth-management sector.

The obvious obstacle is the founding Schroder family and its 44% stake. Understandably, it may not wish the legacy to be a sale – especially after the share price has fallen so far. And even now, the company would be a reasonable mouthful for any acquirer. That’s a gamble given the well-known downside of asset management acquisitions, namely that clients walk. A successful bid is not impossible. Minority shareholders should know that is still improbable.

So the fix here is slow — but a fix there is.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.

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