The Mutual Fund Directors Forum recently released guidance to fund directors for when a fund’s investment advisor is acquired by another investment advisor (for example, Invesco’s recent acquisition of OppenheimerFunds). In such cases, the agreement between the fund and the original advisor is, by law, automatically terminated, and both the fund’s board and shareholders must approve a new agreement with the new advisor in order to establish the relationship. Under these circumstances, the MFDF’s guidance suggests a number of issues for fund directors to consider, including the potential disruption to the fund’s operations or personnel, the capabilities of the new advisor, and the potential changes to the composition of the board.
However, while not technically incorrect, the guidance falls well short of addressing the most obvious obligations of a fund’s board in such transactions. Namely, what can the board do to maximize value for shareholders? A few ideas immediately come to mind, although a diligent director will certainly be capable of coming up with many more.
Sharing the Spoils. An advisor acquisition, in most cases, means that the parent company of the advisor being acquired is cashing out. The fund complex is apparently worthy of a suitor, and for one business reason or another, the parent company has decided that the time is right to sell. A diligent board should bear in mind — and remind the fund’s current advisor — that shareholders played a vital role in building the fund’s brand. A brand worth acquiring resulted from years, if not decades, of collaboration between the advisor and the board (as representative of the fund and its shareholders), and it was shareholders who put billions of their own dollars at risk to support the fund’s operations. If that were not enough, shareholders also paid to develop the brand through distribution fees earmarked to raise awareness of the fund in the marketplace.
With that backdrop, it seems clear that a diligent director should negotiate (or, at a minimum, consider negotiating) for a percentage of the acquisition amount to be shared with the fund and its shareholders. If the transaction is a realization of value in the brand — which was developed by both the advisor and shareholders — then it’s only appropriate that some of the proceeds are shared with shareholders.
Economies of Scale. The acquisition of a fund complex means that the acquiring advisor is growing in two ways: (A) it will manage more assets than it previously did before the transaction; and (B) it will manage more assets than the original advisor managed. More assets means greater economies of scale — and greater profits — in the investment management business. (This is a fundamental part of the business model, despite the efforts of some to obfuscate this fact.) A diligent director should seek to harvest those savings for the benefit of shareholders. The new advisor will almost certainly have analyzed the potential efficiencies of the transaction when it considered whether to make the acquisition in the first place. Directors should ask for that analysis, and then should ask for an appropriate share of any savings for investors.
Getting a Better Deal. Setting aside the specifics of the transaction, directors should consider an acquisition generally as an opportunity to obtain improvements for shareholders in the fund’s fee structure or the advisor’s services. For example, directors could ask:
- Are the fund’s advisory fees really at the lowest optimal level or could the new advisor do a little better without sacrificing quality?
- Would the new advisor consider implementing performance-based fees? How about new in-the-money breakpoints? How about additional out-of-the-money breakpoints?
- Are there distribution or recordkeeping expenses that could be shifted to the new advisor?
- Are there key technology and personnel investments that the new advisor could make for the benefit the fund?
These are only a few of potentially dozens of questions that diligent directors could press on behalf of a fund and its shareholders. The big miss in the MFDF’s recent guidance is not its explanation of the various operational, legal and regulatory implications of an acquisition, which is relatively thorough. Rather, it’s the failure to consider — at all — the board’s fiduciary duty to represent the interests of shareholders at the negotiating table. Directors must do so diligently when an acquisition is announced, and they shouldn’t come home empty handed.