For investors still cringing at their IRAs, 401(k)s or taxable mutual funds and exchange-traded funds, are you ready to take a chance on the companies that have brought you so many unhappy returns? "You have to be selective on the companies," says Greggory Warren, who follows the asset-management arena for the financial research firm Morningstar. "Some are in far better shape than others." Among sell-side analysts, there are no screaming buys among publicly traded asset-management firms. Most of the screaming comes from people whose funds and their asset-management-stock prices have dropped sharply over the past 12 months, often in harmony with the broader market, but occasionally much more.
Thomson Reuters compilations of sell-side analyst opinions for 10 asset management companies don't reveal any in which the number of buys surpasses the combined number of holds and sells. Give or take a few percentage points, some asset management stocks have matched the S&P 500, which was down 36% for the 12 months ended April 17. Many others made the S&P 500's decline look good. Legg Mason ( LM) was off 64%, Janus Capital Group ( JNS) dropped 65%, and AllianceBernstein Holding ( AB) fell 66%. Because asset-management stocks are driven by the health of the economy and the market, analysts say they bear watching for indications of a rebound. "This group is typically is a first mover on any signs of a recovery and will move well before underlying fundamentals," says a recent report by Stifel Nicolaus. "In any early market recovery, the stocks would look expensive until the fundamentals catch up, presenting a challenge to investors until a market recovery can be established."
Consider Eaton Vance ( EV). Analyst J. Jeffrey Hopson recently cut his rating to hold from buy thanks to a 16% gain from the beginning of the year to early April that outpaced the S&P 500, the average for companies he tracks and his target price for Eaton Vance. "Our opinion of Eaton Vance as a high quality, unique company has not changed," he said in a April 7 research report. "The current extreme valuation premium leaves little room for error, and we think that the group is a bit ahead of itself at this point," said Hopson, who doesn't own shares and whose firm doesn't have an investment banking relationship. For the 12 months ended April 17, Eaton Vance beat the S&P, losing 26%. Eaton Vance specializes in tax-managed funds and municipal funds, as well as being a major provider of closed-end funds. Thanks to its unusual fiscal year, Eaton Vance will release its February-April quarterly results in mid-May. Most asset managers will reveal their January-March quarters throughout the rest of April and in early May. A recent report from Goldman Sachs warned of a "tough" quarter. "Asset managers' valuations over-anticipate a sustained market rally" for the first quarter of 2009, the report said. The quarter should be "less worse" than the fourth quarter of 2008, the April 2 report said. "At current valuations, less worse is not good enough." Equity flows into the asset managers for the January-March quarter "improved from last quarter's panic level redemptions but remained negative as retail investors remain disengaged," the firm said.
Among companies the firm covers, first-quarter assets under management (AUM), a key indicator of health, will fall an average of 9% from 2008's fourth quarter. Companies whose funds favor value investing should be hit hardest, while those emphasizing growth-oriented investing should perform better, Goldman Sachs said. Aside from unique management issues, investors should examine general themes before deciding which asset-management strategy looks best in the context of their faith in how far and how fast the economy can rebound. In addition to revenue and profit, investors should examine AUM -- how fast the companies lost the assets and how quickly they are recovering them. Recent Morningstar reports show AUM declines of more than 20% to more than 30% were common last year vs. 2007. At Janus, the AUM fell by more than 40%. However, a rebound in the stock market should help growth-oriented asset managers like Janus, said a recent Merrill Lynch report. A sustained rally would provide the most benefit for Janus among the asset managers tracked by Merrill. Asset-management stocks can be pushed in different directions as the economy recovers based on such themes as their mixture of equity funds and money market funds or their exposure to international markets. For example, analysts praise the management of Federated Investors ( FII), but they say the company's stock could suffer if there's a sustained recovery in the equity market. Federated has a heavier-than-average emphasis on money market funds. The strategy provided "a shield against downturns in the equity and fixed-income markets," said a recent report by Morningstar analyst Drew Woodbury. However, this approach doesn't do as well during a healthy economy.
Federated could be hurt if the federal government increases its regulation of money market funds, said a recent Merrill Lynch report. Unlike some other asset managers, however, "Federated so far has distinguished itself by sidestepping serious credit issues," the report said. Other factors for investors to consider include the ratio of retail to institutional clients, diversification/acquisition strategies and emphasis on retirement accounts. As corporations cut back or eliminate contributions to 401(k) and other retirement plans, an asset manager like T. Rowe Price T. Rowe Price ( TROW) could take a hit in the near-term. Morningstar points out that two-thirds of its AUM are held in retirement accounts and annuity investments. Although T. Rowe Price could be hurt this year, this should be a "temporary issue," Morningstar's Warren says. "A lot of companies are in a lockdown mode
for contributing to retirement plans ," he says. "But 401(k) plans are a retention tool. Longer term it will be a lucrative area to step into." A recent Morningstar report said T. Rowe Price's assets under management fell by more than 30% in 2008 from 2007. However, much of the decline was due to market-related asset depreciation rather than investors removing their money. Warren and other analysts refer to this as the "stickiness" factor -- the willingness of clients to stay with an existing asset manager. A company with many clients investing in retirement funds can benefit from a "stickier set of assets" because investors don't want to incur tax penalties for early withdrawal or don't want the "paperwork hassle" of switching to another asset manager, Warren's report said.
"Stickiness" affects other aspects of investor loyalty. There's a greater stickiness for closed-end fund assets than open-end mutual funds. Asset-managers with a greater percentage of AUM from institutional investors can better cope with a market downturn than those with a heavier retail-investor tilt. Retail investors are more emotional and will be more prone to remove their funds held in taxable accounts, Warren says. Investors search for asset-management trends have encountered Wall Street's version of a perfect storm with Legg Mason -- a sharply falling stock price, a 30% drop in AUM, some awful fund performances, debt concerns and investments that hurt its money market operation. Morningstar's Warren says most companies covered by his firm had declines in AUM that were essentially split evenly between market depreciation and investors bailing out. With Legg Mason, however, the loss of AUM due to fleeing investors was three to four times the loss caused by market depreciation, he says. It didn't help that the firm's popular Legg Mason Value Trust ( LMVTX) was torched last year, losing 55.1%. For the first quarter of 2009, it was down 11.7%. The fund's total return has trailed the S&P 500 annually since 2006. Morningstar says the fund has lagged its peer category annually since 2005. Legg Mason also has struggled with a leveraged investment called a structured investment vehicle. SIVs are designed to profit from the spreads between short-term debt and longer-term debt products. The company took an $842 million loss during the October-December quarter to sell some of its SIVs. Last month, it sold the remaining $1.8 billion of its SIVs and similar investments, causing a net cash outflow of $1.2 billion. In early April, the company said it had repaid $250 million in a revolving credit facility and revised certain loan covenants. Legg Mason has provoked a wide response on Wall Street, ranging from those who say the stock is worth considering due to the company's diverse product offerings and those who say beware because they're not sure all problems have cleared up. "We expect Legg Mason to underperform due to prolonged investment under-performance by key managers
and due to net outflows from equity and fixed income," said a recent report from Merrill Lynch analyst Cynthia Mayer, who doesn't own shares. Poor fund results and below average internal growth "has damaged the Legg Brand," added Mayer, whose firm has had a recent investment banking relationship. "While the stock is statistically cheap and we are pleased that the company has put its SIV issues behind it, we think that the company will continue to struggle in the short-term," said a recent report by Hopson, of Stifel Nicolaus, who has a hold rating. He doesn't own shares. His firm has had a non-investment banking relationship.