A new research report points to a unique business model and increased demand for alternative investments – many of them uncorrelated to the performance of the stock market – should drive growth in The Blackstone Group L.P. (NYSE:BX).
In the research report, the Royal Bank of Canada (NYSE:RY) (TSE:RY) reiterated it’s outperform rating and $39 price target for The Blackstone Group L.P. (NYSE:BX). “Given the recent weakness in the shares, we believe Blackstone is a misunderstood growth and value story. Blackstone continues to be the most attractive exposure to the alternative asset management sector,” the report said.
Alternative investments have played an increasingly significant role in portfolios since 2008 when the first crash partially blamed on faulty derivatives structures took the stock market down nearly 50%. During that period of time, assets that were previously uncorrelated to one another all fell together – with the exception of some alternatives. Managed futures, for instance, a little known asset class had among its best performance in history as market volatility led to price persistence, where the price of stocks and commodities all trend in one consistent direction for a period of time. These and other strategies, such as alternative bond and private equity plays, make up a pantheon of alternatives. But there is no investment panacea. Although it performed positively in 2008, the lack of consistent market price trends has hurt many trend following managed futures funds. The lesson is that alternatives can be tricky for the novice investor, which is why a company like BlackRock, Inc. (NYSE:BLK) monitoring and packaging somewhat exotic investments adds value.
The Blackstone Group L.P. (NYSE:BX) has been on a rampage growing assets at nearly 31% per year, the report noted, which is likely to slow. “We expect Blackstone to continue to grow assets under management at a double digit rate,” the report said, just not at such a blistering pace. “Blackstone should continue to grow assets at low to mid-teens rates on average over the next 10 years.”
Big get bigger benefiting Blackstone
A significant trend in alternative investing has been for large funds and asset managers to garner the lion’s share of asset growth, while small and mid-sized firms are generally left to pick up the scraps. The RBC report said they expect this trend to continue and that size does matter. “We believe The Blackstone Group L.P. (NYSE:BX)’s size does provide a competitive advantage that could lead to sustainable growth. Larger alternative asset managers have been the beneficiaries of a trend to consolidate assets. We expect this to continue.”
RBC doesn’t see performance deterioration with size
A controversial topic in the alternative investing world is the notion that as a fund manager significantly grows in size their performance deteriorates. There are several academic and practitioner studies on both sides of the issue, but the fact that with asset growth comes constriction in terms of markets traded as well as a more argued detraction that larger funds are not as nimble entering and exiting trades. It is clear that large funds cannot enter smaller markets with the same force as larger markets without distorting the pricing balance in that market. In fact, many algorithmic trading funds are aware of the optimal trade size in the markets they trade. Larger funds simply don’t trade in smaller markets because the return potential relative to the small trade size required to keep the market balanced make the effort a high risk, low reward trade-off.
RBC seems to disagree with this notion in their report. “Concerns about a decline in performance due to growth in AUM seem overblown,” the report concluded, then mentioned a unique aspect of Blackstone that many successful funds adopt. “The fact that its investment professionals are required to ‘have skin in the game’ is an effective tool to manage risk over multiple years, in our view.”
RBC says Blackstone mostly immune to trend towards lower fees
In regards to fee compression, where investors demand lower performance and management fees, RBC seems to think The Blackstone Group L.P. (NYSE:BX) might be an exception. “While there is pressure on fees in the industry, we do not expect Blackstone to be impacted,” the report noted. “While competitors are adjusting pricing, the current level seems more in line with the rates Blackstone already charges its limited partners.”
The fact is larger institutional investors need to utilize large asset managers for several reasons, but most important and least discussed is career risk. The saying used to be, “You can’t go wrong selecting International Business Machines Corp. (NYSE:IBM),” my not be as in Vogue as it once was, but the concept that institutional managers who wish to avoid career risk have a handful of major players they might consider. This handful of players, Blackstone included, have pricing power while the smaller and mid-sized players will likely continue to fall prey to fee compression.
“Our conclusion is this: The Blackstone Group L.P. (NYSE:BX) has one of the most attractive business models in the industry,” the RBC report said, in rather decisive terms. “Investors with a long-term investment horizon should benefit as the Blackstone story unfolds.”