Highlights this quarter:
Financial sector M&A activity is likely to remain centred on wealth management. In the immediate aftermath of COVID, companies understandably tended to their balance sheets and immediate liquidity, but we believe depressed valuations and lack of organic growth in some pockets will help drive M&A activity in 2021. Wealth managers specifically have seen interest from Private Equity and some larger deals have been executed in recent years. For the most part, we suggest wealth managers are hunters, picking up smaller players in the private space and bolting them on to existing operations. In terms of wealth managers that may be hunted, we believe Charles Stanley is the most likely candidate, especially from a Private Equity perspective. Lenders are the most likely sector to be on the selling end of transactions, since COVID has increased impairments and damaged demand for credit. Fund management activity is likely to be teams based in the small and midcap space, whereas big merger deals have been transacted in the large cap environment.
Rational but unconscious thinking forces market wisdom to assume financials have been hit hard by COVID. The likely perception that financials have been hit hard by COVID is in the most part untrue, since investors often assume financials are balance sheet businesses. However, in the small and midcap space, sub-sectors are varied and characterised by operational leverage (Fund Managers), capital light, high ROCE models (Exchanges) and integrated businesses tapping into very long term structural tailwinds (Wealth Managers). Even the assumed pressure on balance sheet businesses (Lenders) can be mitigated by the ability to quickly deleverage if collections remain high and impairments under control.
Mid-market M&A activity across the UK and Ireland is the lowest since 2009. We see this dip in activity as temporary, with an economic recovery and the rollout of a global vaccine supporting wider positives, such as availability of cash, attractive valuations in pockets of public markets, and previously delayed transactions being executed as uncertainty decreases. Historical M&A cycles suggest a strong recovery and pickup in activity is ahead, with financials specifically focussed on increasing digital capabilities in reaction to new ways of communicating in the post-COVID environment.
Economic data. Equity and ISA retail fund sales saw outflows of £0.5bn, with fixed income inflows largely in line with the previous quarter. Mortgage approvals continue to boom, perhaps not totally due to the stamp duty holiday but also to generally positive sentiment following global vaccine rollouts. Household leverage through consumer credit continues to fall as individuals get their houses in order ahead of the unwinding of the furlough scheme. Sub-sector performance. Lenders posted the largest quarterly gains in Q4, up 34.4%, having been the worst performer for the three quarters prior. Fund Managers registered another respectable performance of +26.3% and Wealth Managers were the worst performers, up just 3.1%, underperforming the FTSE All Share by 850bps.