Santoli: Shares of big fund companies now on sale

Published Sun, Feb 28 201610:33 PM ESTUpdated Mon, Feb 29 201611:09 AM EST

Fund managers who pick stocks for a living have soured on their own business. This doesn't mean professional investors dislike their jobs, though in these dicey markets, they might. Rather, they're shunning the shares of asset-management companies, which have shed anywhere from one-sixth to half their value in the past year, with most of the damage coming since last summer. The punishing sell-off in the sector owes to a worrisome mix of unstable financial markets, weak investor flows into funds and a broad shift toward lower-cost index-tracking products. The one-year declines range from 16 percent for the largest, sturdiest franchises such as BlackRock and T. Rowe Price to 33 percent for more globally exposed managers Invesco and Franklin Resources to 50 percent for smaller firms with stiffer business challenges, namely Legg Mason and Waddell & Reed Financial . As a result, though, these companies now appear inexpensive based on long-term valuation measures, and could offer an attractive opportunity for investors willing to bet that global markets won't face a 2008-style washout. This raises questions, of course, that the portfolio managers at most of these companies face every day: Are these stocks truly undervalued? Or are they cheap for good reason, because of bigger risks to their business model? BlackRock is the behemoth of the industry, with $4.6 trillion in assets under management and broad exposure across equity, fixed income, retail, institutional, index, actively managed, mutual funds and exchange-traded products. This heft and breadth bolsters its valuation, yet the stock trades for just over 16-times forecast earnings for this year, right in line with the broad market. The stock has a 3 percent dividend yield and its profit margins are steady near 30 percent — indicating the underlying attractiveness of large-scale money management that used to earn these companies a nice premium over the market multiple. T. Rowe Price, a top brand name and well-managed company, carries a similarly modest valuation based on projected profits. And most others sit at steep discounts to the overall market. By other standards, too, valuations seem a good deal more depressed. BlackRock's $52 billion market value represents just 1.1 percent of its latest assets under management. That's not much above the 0.9 percent BlackRock reached at the March 2009 bear-market low. The industry might never return to the days when money managers routinely fetched 3 percent of assets under management. Yet smaller firms such as Janus Capital , Eaton Vance and Waddell & Reed are now valued at 10 to 13 times 2016 earnings and at 1 to 2 percent of assets under management, levels that imply persistent future asset losses and little value to the franchises themselves. Affiliated Managers Group is an interesting case. A serial buyer of whole or partial stakes in asset managers, AMG was a beloved growth stock for most of its history. It's now sunk below 10 times earnings as its big bet on active managers and the ugly closure of a junk-bond fund at its Third Avenue Management affiliate late last year weigh heavily. It merits a close look as a play on better-than-average money managers. Of course, the market's concerns are rooted in strong, ongoing trends. A global bear market has swept equities, and credit markets have made it tough for bond managers, sapping fund assets. Investors pulled a net $82 billion from mutual funds in December and January, according to the Investment Company Institute. ETFs and index funds have been virtually the only bright spot, and most of the industry doesn't much profit from these. Indexing pioneer Vanguard Group last year drew an astonishing $216 billion in new money in 2015 — more than the next nine companies combined, according to consulting firm Cerulli Associates. Vanguard, of course, is owned mutually by its fund shareholders. It's as if Amazon.com were privately held, leaving investors to choose among also-ran competitors to play the rise of e-commerce. To extend the tech analogy, traditional asset managers are being viewed as the equivalent of PC-centric companies, stuck between the custom-focused mobile-social Web (hedge funds) and hyper-efficient cloud platforms (ETFs). As with Old Tech companies, asset manager stocks have now migrated into the hands of value investors. The top-performing JP Morgan Mid Cap Value fund has positions in Invesco, T. Rowe and Legg Mason. And Mario Gabelli, famed value investor and founder of Gamco Investors , recently had stakes in Janus, T. Rowe, Legg Mason, Calamos Asset Management and Waddell & Reed. There is no strong sign that retail investors will soon lose their strong preference for low-cost index funds, but big asset managers for now have a firm hold on 401(k) plans. And stock pickers — including hedge-fund grandee Bill Ackman — are loudly saying the passive trend has gone too far. If they're right, active funds should have the chance — indeed, the need — to prove their worth in a rocky market. Meantime, Eaton Vance just last Friday succeeded in a long effort to list the first in a class of actively managed ETFs, Eaton Vance Stock NextShares (EVSTC), aimed at melding the advantages of stock-selection and lower cost. Other asset managers are on track to follow. While the world isn't exactly begging for such a product, it shows the money-management industry won't stay passive in the fight for assets. Several big asset managers are due to appear this week at the Citi Asset Management, Broker-Dealer and Exchange conference in New York. Let's see if they can convince many of the portfolio managers in attendance that their own stocks are worth picking at today's depressed prices.

Traders work on the floor of the New York Stock Exchange.

Brendan McDermid | Reuters

Fund managers who pick stocks for a living have soured on their own business.

This doesn't mean professional investors dislike their jobs, though in these dicey markets, they might. Rather, they're shunning the shares of asset-management companies, which have shed anywhere from one-sixth to half their value in the past year, with most of the damage coming since last summer.

The punishing sell-off in the sector owes to a worrisome mix of unstable financial markets, weak investor flows into funds and a broad shift toward lower-cost index-tracking products.

The one-year declines range from 16 percent for the largest, sturdiest franchises such as BlackRock and T. Rowe Price to 33 percent for more globally exposed managers Invesco and Franklin Resources to 50 percent for smaller firms with stiffer business challenges, namely Legg Mason and Waddell & Reed Financial.

As a result, though, these companies now appear inexpensive based on long-term valuation measures, and could offer an attractive opportunity for investors willing to bet that global markets won't face a 2008-style washout.