"Whenever you find yourself on the side of the majority, it is time to pause and reflect," observed Mark Twain. The record levels of M&A activity in the past two years appear to herald the arrival of long-awaited consolidation. But behind the numbers, things are not that simple.

The over-rapid growth of the fund management industry has yet to produce a mature sector with the expertise, resilience and mindset necessary to tackle the resulting complexity. The learning curve has been steep, due to the craft nature of the industry. Hence, as new challenges have arisen, mergers and acquisitions have become irresistible.

"Factors such as perceived conflicts of interest between manufacturing and distribution, and separation of alpha and beta will drive M&A activity," says Tim Keaney, head of Europe for Bank of New York, which recently merged with Mellon Financial.

This is corroborated by a study sponsored by T. Rowe Price and Citigroup*. While anticipating further mergers, it concludes these will not polarise the industry between global players and nimble independent boutiques, squeezing out those in the middle. Instead, it projects two dominant trends whose green shoots are already evident.

The first involves decoupling and regrouping around three core activities - manufacturing, distribution and administration - in response to client needs. The second trend involves the adoption of a hard-nosed horses-for-courses approach to business growth within each activity:

* In administration, characterised by low margin high volume business, economies of scale will remain a key goal;

* In distribution, characterised by a shift from products to solutions, mass customisation will be the key imperative;

* In manufacturing, dominated by skills-based consistent returns, economies of scope (covering an array of asset classes) will be the name of the game.

Not surprisingly, pursuit of scale has been a critical consideration in deals involving administrators. Elsewhere, the story is different.

"It's skill, not scale that matters. M&A is about alpha. Many of the transactions are between fund managers looking for links to additional product sets that would expand breadth and capacity," says Ben Phillips, managing director and head of strategic analysis at Putnam Lovell NBF.

The annual data on M&A deals compiled by Mr Phillips over the last six years show that global funds under management held by the top 10 fund managers have remained static at about 31 per cent; and divestments account for 54 per cent of funds under management changing hands.

The numbers suggest greater specialisation bet-ween each of the three core activities, with movement within them. They also suggest more alliances between players across the activities.

The business swap between Citigroup and Legg Mason in 2005 was a good example of specialisation. The headlong growth of multi-manager funds and back-office outsourcing are good examples of alliances: they allow small and medium houses to flourish by focusing on their core investment strengths, thus amplifying the craft orientation at the manufacturing end. In many hedge fund businesses, for example, prime brokers and administrators are becoming an integral part of the front office by participating in product innovation.

Hence, instead of polarisation, the industry is witnessing the emergence of a web of relationships between players who focus on their unique capabilities within an ever more sophisticated "food chain". While M&A activity will continue, the end-game is hard to predict for two reasons.

First, mergers involving medium and large firms have created challenges in integration because of cultural differences, legacy arrangements and lack of management bandwidth. Crunching the businesses together has proved difficult.

The second reason is that deals that target skills necessarily rely on a decentralised operating model that gives significant autonomy to the newly acquired units. But if their performance deteriorates, disillusionment sets in due to the top-dollar price tags. Greater central control is imposed to the detriment of creativity and innovation.

This underlines a simple point: globalisation is changing the business contours but fund management remains a cottage industry. It will take a lot of burn and churn before we see significant consolidation.